Session 19: Capital budgeting Flashcards
Measures of Invetsment Return
NPV IRR Payback Period Book Rate of Return Profitability Index
Which two measures of investment return do not adjust for risk and time
Payback period
Book rate of return
Process of planning and managing a firm’s long term investment in projects and ventures
Capital budgeting
Capital budgeting involves estimating the
Amount, timing and risk of future cash flows
Difference between the value and cost of investment; PV of a projects expected cash flows discounted for risk and timing
Net Present Value
Invest in projects if NPV is
Positive
Rate of return expected to be earned on a project; discounting rate that makes the NPV of an investment equal to zero
Internal Rate of Return (IRR)
IRR Rule: If the investment has an IRR that is higher than some predetermined required rate of return, you should
Accept the investment
Length of time the return on an investment takes to cover the cost of the investment; involved only gross cash flows and not discounted cash flows
Payback Period
Payback Period Rule; If the investment’s payback Period is less than a predetermined number of years you should,
Accept the investment
Payback Period is equal to
Expected cost/ cash flows
An accounting ratio calculated by dividing the company’s accounting profits by the book value of the company’s assets
Book Rate of Return
Book Rate Of Return Rule
If the investments BRR > predetermined target book return, accept the investment
Profitability Index is
The NPV of an investment divided by its cost
Used to identify projects that will receive the best return associated with the amount of dollars invested by ranking the projects
Profitability Index
PI Rule
Accept the venture with the highest PI first
You do not accept project with a
Negative PI
When a firm makes an investment, it’s stock prices should rise by
NPV of the investment
BRR is going by
Income/Book Value
Capital budgeting compares
Present value of cash flows with initial costs
