Finals Flashcards
The process of deciding whether or not to commit resources to projects, whose costs and benefits are spread over several time periods
Capital budgeting
The process of identifying, evaluating, planning, and financing capital investment projects of an organization
Capital budgeting
It involves the preparation of annual budget for capital investment
Capital budgeting
It involves assessment of funding capacities
Capital budgeting
It involves the allocation of resources, the renewal and expansion projects, which most clearly conform with the company’s priorities
Capital budgeting
Judgment about which assets to acquire to achieve the company’s stated objectives
Investment decision
Judgment regarding the method of racing capital to fund an investment
Financing decision
True or false
Capital investment decisions does not usually require large commitments of resources
False, usually require
True or false
Most capital investment decisions, involve long-term commitments
True
True or false
Capital investment decisions are easier to reverse than short term decisions
False, more difficult to reverse
True or false
Capital investment decisions involves so much risk and uncertainty
True
These are projects which are evaluating individually, and reviewed against redetermine corporate standards of acceptability resulting in an “accept” or “reject” decisions
Independent capital investment projects or screening decisions
These are projects which require the company to choose from among specific alternatives
Mutually exclusive capital investment projects or reference decisions
It represents the initial cash outlay that is required to obtain future returns or the net cash outflow to support a capital investment project
Net initial investment or project cost
These are the inflows of cash expected from a project, reduced by the cash cost that can be directly attributed to the project
Net cash returns
Opportunity cost may equal the average rate of return that the company will earn from alternative investment opportunities, or the cost of capital, which is the average rate of return that the firm must pay to attract investment fund
Minimum or lowest acceptable rate of return
Cost of debt formula
Cost of debt
= interest rate x (1-corporate tax rate)
Cost of preference shares formula
Cost of preference shares
= dividends per share / market value per share of preference shares
Cost of ordinary shares formula (stock price based)
Stock price based
= expected cash dividends per share / current price per share of ordinary shares
+ dividend growth rate
Cost of ordinary shares formula (book value based)
— this is used when dividend growth rate is not known
Book value based
= next year’s projected earnings per share / current price per share of ordinary shares
Cost of retained earnings formula
—the same as the cost of ordinary equity
Since the long-term profitability of most companies depends on the nature and quality of their capital investments, these investment opportunities should be carefully analyzed and evaluated
Finding investment opportunities
To effectively evaluate any investment opportunity, the expected cash flows from the project must be estimated and the total cash outlay necessary to place the investment in operative form must be determined.
Collect relevant information about opportunities
Before the cash flow can be evaluated, the discounted (cost of capital) must be established if the discounted cash flow approach is to be applied
Select discount rate
The techniques of capital budgeting are applied to the estimated cash flows developed in the second phase
Financial analysis of cash flows
Many factors, quantitative as well as qualitative, should be given consideration before the final decision is made as to the selection of a particular investment
Decision
Once the decision has been made to invest funds, more detailed plans for making the project operational are developed
Project implementation
It involves the assessment of how effective investment actually is. The evaluation may be in the form of continuous monitoring of the project.
Project evaluation and appraisal
The end of a project’s life will usually result in some cash flows. These cash flows are referred to as
Disinvestment flows
These are outlays (expenditures) that are expected to yield benefits to the firm over a period greater than one year
Capital investment decisions
A successful capital investment program starts with — for promising investment projects
Proposals
The basic concepts, underlying capital investment decision making is —
Cost-benefit analysis
The cost–benefit concept strives to accomplish the general goal of —
Maximizing the value of the firm
It is also known as payoff and pay out period
Payback period
It measures the length of time required to recover the amount of initial investment
Payback period
It is an approach which incorporates the salvage value in payback competitions
Bail-out period
It is reached when the cumulative cash earnings plus the salvage value at the end of a particular year equals the original investments
Bail-out period
It is also known as book value rate of return
Accounting rate of return, or simple rate of return
It measures profitability from the conventional accounting standpoint by relating the required investment to the future annual net income
Accounting rate of return
Under this method, you choose the project with the highest rate of return
Accounting rate of return
It is the rate of recovery of investment during the payback period
Payback reciprocal
It is also known as discounted rate of return and time–adjusted rate of return
Internal rate of return
It is the rate which equates the present value of the future cash inflows with the cost of the investment which produces them
Internal rate of return
It is also the equivalent maximum rate of interest that could be paid each year for the capital employed over the life of an investment without loss on the project
Internal rate of return
It is also known as present value index, benefit–cost rate, desirability index
Profitability index
It is the ratio of the total present value of future cash inflows to the initial investment
Profitability index
The index expresses the present value of cash benefits asked to an amount per peso of investment in a project, and is used as a measure of ranking projects in a descending order of desirability
Profitability index
It is a method that recognizes the time value of money in a payback context
Discounted payback period
It is used to compute the payback in terms of discounted, cash flow’s received in the future. That is, the periodic cash flow’s are discounted using an appropriate cost of capital rate.
Discounted payback period
The payback period is computed using the discounted cash flow values rather than the actual cash flows
Discounted payback period
