Term
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Definition
| An important tool used in time value analysis; it is a graphical representation used to show the timing of cash flows. |
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Term
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Definition
| The amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate. |
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Term
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Definition
| The value today of a future cash flow or series of cash flows. |
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Term
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Definition
| The arithmetic process of determining the final value of a cash flow or series of cash flows when compound interest is applied. |
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Term
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Definition
| The best return that can be earned on assets the firm already owns if those assets are not used for the new project. |
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Term
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Definition
| The process of finding the present value of a cash flow or a series of cash flows; it is the reverse of compounding. |
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Term
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Definition
| A series of equal payments at fixed intervals for a specified number of periods. |
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Term
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Definition
| An annuity whose payments occur at the end of each period. |
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Term
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Definition
| An annuity whose payments occur at the beginning of each period. |
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Term
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Definition
| The future value of an annuity over N periods. |
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Term
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Definition
| The present value of an annuity of N periods. |
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Term
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Definition
| A perpetual bond issued by the British government to consolidate past debts; in general, any perpetual bond. |
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Term
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Definition
| A stream of equal payments at fixed intervals expected to continue forever. |
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Term
| uneven, or nonconstant, cash flows |
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Definition
| A series of cash flows where the amount varies from one period to the next. |
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Term
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Definition
| This term designates equal cash flows coming at regular intervals. |
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Term
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Definition
| This term designates a stream of cash that's not part of an annuity. |
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Term
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Definition
| The process of determining the final value of a cash flow or series of cash flows when interest is added once a year. |
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Term
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Definition
| The process of determining the final value of a cash flow or series of cash flows when interest is added twice a year. |
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Term
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Definition
| The contracted interest rate. |
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Term
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Definition
| The periodic rate times the number of periods per year. |
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Term
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Definition
| The annual rate of interest actually being earned, as opposed to the quoted rate. Also called the "equivalent annual rate." |
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Term
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Definition
| A loan that is repaid in equal payments over its life. |
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Term
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Definition
| A table showing precisely how a loan will be repaid. It gives the required payment on each payment date and a breakdown of the payment, showing how much is interest and how much is repayment of principal. |
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Term
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Definition
| An upward-sloping yield curve. |
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Term
| default risk premium (DRP) |
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Definition
| The difference between the interest rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability. |
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Term
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Definition
| The situation that exists when a country imports more than it exports. |
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Term
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Definition
| A yield curve where interest rates on medium-term maturities are higher than rates on both short- and long-term maturities. |
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Term
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Definition
| The amount by which prices increase over time. |
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Term
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Definition
| A premium equal to expected inflation that investors add to the real risk-free rate of return. |
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Term
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Definition
| The risk of capital losses to which investors are exposed because of changing interest rates. |
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Term
| inverted ('abnormal') yield curve |
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Definition
| A downward-sloping yield curve. |
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Term
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Definition
| A premium added to the equilibrium interest rate on a security if that security cannot be converted to cash on short notice and at close to its "fair market value." |
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Term
| maturity risk premium (MRP) |
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Definition
| A premium that reflects interest rate risk. |
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Term
| nominal (quoted) risk-free rate, rRF |
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Definition
| The rate of interest that is proxied by the T-bill rate or the T-bond rate. includes an inflation premium. |
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Term
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Definition
| The investment opportunities in productive (cash-generating) assets |
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Term
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Definition
| A theory that states that the shape of the yield curve depends on investors' hopes about future interest rates. |
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Term
| real risk-free rate of interest, r* |
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Definition
| The rate of interest that would exist on default-free U.S. Treasury securities if no inflation were expected. |
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Term
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Definition
| The risk that a decline in interest rates will lead to lower income when bonds mature and funds are reinvested. |
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Term
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Definition
| In a financial market context, the chance that an investment will provide a low or negative return. |
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Term
| term structure of interest rates |
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Definition
| The relationship between bond yields and maturities. |
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Term
| time preferences for consumption |
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Definition
| The preferences of consumers for current consumption as opposed to saving for future consumption. |
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Term
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Definition
| A graph showing the relationship between bond yields and maturities. |
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Term
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Definition
| A long-term debt instrument. |
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Term
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Definition
| A provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date. |
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Term
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Definition
| A bond that is exchangeable at the option of the holder for the issuing firm's common stock. |
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Term
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Definition
| Bonds issued by corporations. |
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Term
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Definition
| The stated annual interest rate on a bond. |
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Term
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Definition
| The specified number of dollars of interest paid each year. |
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Term
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Definition
| A long-term bond that is not secured by a mortgage on specific property. |
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Term
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Definition
| A bond that sells below its par value; occurs whenever the going rate of interest is above the coupon rate. |
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Term
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Definition
| A bond whose interest rate is fixed for its entire life. |
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Term
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Definition
| A bond whose interest rate fluctuates with shifts in the general level of interest rates. |
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Term
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Definition
| Bonds issued by foreign governments or by foreign corporations. |
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Term
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Definition
| A bond that pays interest only if it is earned. |
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Term
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Definition
| A formal agreement between the issuer and the bondholders. |
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Term
| indexed (purchasing power) bond |
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Definition
| A bond that has interest payments based on an inflation index so as to protect the holder from inflation. |
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Term
| interest rate (price) risk |
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Definition
| The risk of a decline in a bond's price due to an increase in interest rates. |
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Term
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Definition
| The period of time an investor plans to hold a particular investment. |
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Term
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Definition
| Bonds rated triple-B or higher; many banks and other institutional investors are permitted by law to hold only these bonds. |
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Term
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Definition
| A high-risk, high-yield bond. |
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Term
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Definition
| A specified date on which the par value of a bond must be repaid. |
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Term
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Definition
| A bond backed by fixed assets. First mortgage bonds are senior in priority to claims of second mortgage bonds. |
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Term
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Definition
| Bonds issued by state and local governments. |
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Term
| original issue discount (OID) bond |
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Definition
| Any bond originally offered at a price below its par value. |
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Term
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Definition
| The number of years to maturity at the time a bond is issued. |
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Term
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Definition
| The face value of a bond. |
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Term
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Definition
| A bond that sells above its par value; occurs whenever the going rate of interest is below the coupon rate. |
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Term
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Definition
| A bond with a provision that allows its investors to sell it back to the company prior to maturity at a prearranged price. |
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Term
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Definition
| The risk that a decline in interest rates will lead to lower income when bonds mature and funds are reinvested. |
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Term
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Definition
| A provision in a bond contract that requires the issuer to retire a portion of the bond issue each year. |
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Term
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Definition
| A bond having a claim on assets only after the senior debt has been paid off in the event of liquidation. |
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Term
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Definition
| Bonds issued by the federal government, sometimes referred to as government bonds. |
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Term
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Definition
| A long-term option to buy a stated number of shares of common stock at a specified price |
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Term
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Definition
| The rate of return earned on a bond when it is called before its maturity date. |
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Term
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Definition
| The rate of return earned on a bond if it is held to maturity |
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Term
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Definition
| A bond that pays no annual interest but is sold at a discount below par, thus compensating investors in the form of capital appreciation |
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Term
| average stock's beta (bA) |
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Definition
| By definition, bA = 1 because an average-risk stock is one that tends to move up and down in step with the general market. |
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Term
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Definition
| A metric that shows the extent to which a given stock's returns move up and down with the stock market. Beta thus measures market risk. |
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Term
| capital asset pricing model (CAPM) |
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Definition
| A model based on the proposition that any stock's required rate of return is equal to the risk-free rate of return plus a risk premium that reflects only the risk remaining after diversification. |
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Term
| coefficient of variation (CV) |
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Definition
| The standardized measure of the risk per unit of return; calculated as the standard deviation divided by the expected return. |
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Term
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Definition
| The tendency of two variables to move together. |
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Term
| correlation coefficient (ρ) |
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Definition
| A measure of the degree of relationship between two variables. (ρ) |
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Term
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Definition
| That part of a security's risk associated with random events; it can be eliminated by proper diversification. This risk is also known as company-specific, or unsystematic, risk. |
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Term
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Definition
| The rate of return expected to be realized from an investment; the weighted average of the probability distribution of possible results. |
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Term
| expected return on a portfolio |
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Definition
| The weighted average of the expected returns on the assets held in the portfolio. (r^(p) |
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Term
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Definition
| A portfolio consisting of all stocks. |
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Term
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Definition
| The risk that remains in a portfolio after diversification has eliminated all company-specific risk. This risk is also known as nondiversifiable or systematic or beta risk. |
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Term
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Definition
| The additional return over the risk-free rate needed to compensate investors for assuming an average amount of risk. (RPM) |
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Term
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Definition
| A listing of possible outcomes or events with a probability (chance of occurrence) assigned to each outcome. |
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Term
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Definition
| The return that was actually earned during some past period. The actual return r bar usually turns out to be different from the expected return r hat except for riskless assets. |
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Term
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Definition
| The risk that remains once a stock is in a diversified portfolio is its contribution to the portfolio's market risk. It is measured by the extent to which the stock moves up or down with the market. |
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Term
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Definition
| In a financial market context, the chance that an investment will provide a low or negative return. |
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Term
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Definition
| investors dislike risk and require higher rates of return as an inducement to buy riskier securities. |
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Term
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Definition
| The difference between the expected rate of return on a given risky asset and that on a less risky asset. |
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Term
| security market line (SML) equation |
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Definition
| An equation that shows the relationship between risk as measured by beta and the required rates of return on individual securities. |
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Term
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Definition
| The risk an asset would have if it was a firm's only asset and if investors owned only one stock. It is measured by the variability of the asset's expected returns. |
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Term
| standard deviation, σ (sigma) |
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Definition
| A statistical measure of the variability of a set of observations. |
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Term
| actual (realized) rate of return |
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Definition
| The rate of return on a common stock actually received by stockholders in some past period. rbar subS may be greater or less than rhat subS and/or rs. |
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Term
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Definition
| The capital gain during a given year divided by the beginning price. |
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Term
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Definition
| Common stock that is given a special designation such as Class A or Class B to meet special needs of the company. |
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Term
| constant growth (Gordon) model |
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Definition
| Used to find the value of a constant growth stock. |
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Term
| corporate valuation model |
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Definition
| A valuation model used as an alternative to the discounted dividend model to determine a firm's value, especially one with no history of dividends, or the value of a division of a larger firm. |
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Term
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Definition
| The expected dividend divided by the current price of a share of stock. |
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Term
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Definition
| The situation in which the actual market price equals the intrinsic value, so investors are indifferent between buying or selling a stock. |
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Term
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Definition
| The sum of the expected dividend yield and the expected capital gains yield. |
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Term
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Definition
| Stock owned by the firm's founders that has sole voting rights but restricted dividends for a specified number of years. |
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Term
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Definition
| The expected rate of growth in dividends per share. |
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Term
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Definition
| The value where all the dividends remain constant |
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Term
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Definition
| A representative investor whose actions reflect the beliefs of those people who are currently trading a stock. It is the marginal investor who determines a stock's price. |
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Term
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Definition
| The price at which a stock sells in the market. (P0) |
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Term
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Definition
| A provision in the corporate charter or bylaws that gives common stockholders the right to purchase on a pro rata basis new issues of common stock (or convertible securities). |
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Term
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Definition
| A document giving one person the authority to act for another, typically the power to vote shares of common stock. |
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Term
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Definition
| An attempt by a person or group to gain control of a firm by getting its stockholders to grant that person or group the authority to vote its shares to replace the current management. |
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Term
| required rate of return, rs |
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Definition
| The minimum rate of return on a common stock that a stockholder considers acceptable. (rs) |
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Term
| supernormal (nonconstant) growth |
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Definition
| The part of the firm's life cycle in which it grows much faster than the economy as a whole. |
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Term
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Definition
| An action whereby a person or group succeeds in ousting a firm's management and taking control of the company. |
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Term
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Definition
| The date when the growth rate becomes constant. At this date, it is no longer necessary to forecast the individual dividends. |
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Term
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Definition
| A common stock whose future dividends are not expected to grow at all; that is, g = 0. |
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Term
| after-tax cost of debt, rd(1 - T) |
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Definition
| The relevant cost of new debt, taking into account the tax deductibility of interest; used to calculate the WACC. (rd(1 – T)) |
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Term
| before-tax cost of debt, rd |
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Definition
| The interest rate the firm must pay on new debt. (rd) |
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Term
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Definition
| One of the types of capital used by firms to raise funds. |
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Term
| cost of new common stock (re) |
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Definition
| The cost of external equity based on the cost of retained earnings but increased for flotation costs. (re) |
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Term
| cost of preferred stock (rp) |
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Definition
| The rate of return investors require on the firm's preferred stock. rp is calculated as the preferred dividend, Dp, divided by the current price, Pp. |
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Term
| cost of retained earnings (rs) |
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Definition
| The rate of return required by stockholders on a firm's common stock. (rs) |
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Term
| flotation cost adjustment |
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Definition
| The amount that must be added to rs to account for flotation costs to find re. |
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Term
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Definition
| The percentage cost of issuing new common stock. |
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Term
| retained earnings breakpoint |
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Definition
| The amount of capital raised beyond which new common stock must be issued. |
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Term
| weighted average cost of capital (WACC) |
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Definition
| A weighted average of the component costs of debt, preferred stock, and common equity. |
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Term
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Definition
| The process of planning expenditures on assets with cash flows that are expected to extend beyond one year. |
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Term
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Definition
| The cost of capital at which the NPV profiles of two projects cross and, thus, at which the projects' NPVs are equal. |
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Term
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Definition
| The length of time required for an investment's cash flows, discounted at the investment's cost of capital, to cover its cost. |
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Term
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Definition
| Projects with cash flows that are not affected by the acceptance or nonacceptance of other projects. |
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Term
| internal rate of return (IRR) |
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Definition
| The discount rate that forces a project's NPV to equal zero. |
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Term
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Definition
| The discount rate at which the present value of a project's cost is equal to the present value of its terminal value, where the terminal value is found as the sum of the future values of the cash inflows, compounded at the firm's cost of capital. |
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Term
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Definition
| The situation where a project has two or more IRRs. |
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Term
| mutually exclusive projects |
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Definition
| A set of projects where only one can be accepted. |
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Term
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Definition
| A method of ranking investment proposals , which is equal to the present value of future net cash flows, discounted at the cost of capital. |
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Term
| net present value profile |
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Definition
| A graph showing the relationship between a project's NPV and the firm's cost of capital. |
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Term
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Definition
| The length of time required for an investment's net revenues to cover its cost. |
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Term
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Definition
| A long-run plan that outlines in broad terms the firm's basic strategy for the next 5 to 10 years. |
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Term
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Definition
| The option to abandon a project if operating cash flows turn out to be lower than expected. This option can raise expected profitability and lower project risk. |
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Term
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Definition
| A method of estimating a project's beta by running a regression of the company's return on assets against the average return on assets for a large sample of firms. |
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Term
| annual depreciation rates |
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Definition
| The annual expense accountants charge against income for "wear and tear" of an asset. For tax purposes, the IRS provides that appropriate MACRS rates be used that are dependent on an asset's class life. |
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Term
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Definition
| The NPV when sales and other input variables are set equal to their most likely (or base-case) values. |
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Term
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Definition
| An analysis in which all of the input variables are set at their most likely values. |
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Term
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Definition
| An analysis in which all of the input variables are set at their best reasonably forecasted values. |
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Term
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Definition
| The situation when a new project reduces cash flows that the firm would otherwise have had. |
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Term
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Definition
| The situation in which a firm can raise only a specified, limited amount of capital regardless of how many good projects it has. |
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Term
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Definition
| The specified life of assets under the MACRS system. |
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Term
| corporate (within-firm) risk |
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Definition
| Risk considering the firm's diversification but not stockholder diversification. It is measured by a project's effect on uncertainty about the firm's expected future returns. |
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Term
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Definition
| A diagram that lays out different branches that are the result of different decisions made or the result of different economic situations. |
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Term
| equivalent annual annuity (EAA) method |
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Definition
| A method that calculates the annual payments that a project will provide if it is an annuity. When comparing projects with unequal lives, the one with the higher equivalent annual annuity (EAA) should be chosen. |
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Term
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Definition
| An effect on the firm or the environment that is not reflected in the project's cash flows. |
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Term
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Definition
| An investment that permits operations to be altered depending on how conditions change during a project's life. |
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Term
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Definition
| When an investment creates the opportunity to make other potentially profitable investments that would not otherwise be possible, the investment is said to contain a growth option. |
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Term
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Definition
| Assumes that assets are used for half the first year and half the last year. |
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Term
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Definition
| A cash flow that will occur if and only if the firm takes on a project. |
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Term
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Definition
| An option as to when to begin a project. Often if a firm can delay a decision, it can increase a project's expected NPV. |
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Term
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Definition
| Considers both firm and stockholder diversification. It is measured by the project's beta coefficient. |
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Term
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Definition
| A risk analysis technique in which probable future events are simulated on a computer, generating estimated rates of return and risk indexes. |
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Term
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Definition
| The best return that can be earned on assets the firm already owns if those assets are not used for the new project. |
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Term
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Definition
| The annual investment in long-term assets that maximizes the firm's value. |
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Term
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Definition
| The difference between the expected NPVs with and without the relevant option. It is the value that is not accounted for in a traditional NPV analysis. A positive ______ _______ expands the firm's opportunities. |
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Term
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Definition
| A comparison of actual versus expected results for a given capital project. |
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Term
| project cost of capital, rp |
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Definition
| The risk-adjusted cost of capital for an individual project. (rp) |
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Term
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Definition
| An approach used for estimating the beta of a project in which a firm (1) identifies several companies whose only business is to produce the product in question, (2) calculates the beta for each firm, and (3) averages the betas to find an approximation to its own project's beta. |
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Term
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Definition
| The right but not the obligation to take some action in the future. |
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Term
| replacement chain (common life) approach |
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Definition
| A method for comparing projects of unequal lives that assumes that each project can be repeated as many times as necessary to reach a common life span; the NPVs over this life span are then compared, and the project with the higher common life NPV is chosen. |
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Term
| risk-adjusted cost of capital |
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Definition
| The cost of capital appropriate for a given project, given the riskiness of that project. The greater the risk, the higher the cost of capital. |
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Term
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Definition
| A risk analysis technique in which "bad" and "good" sets of financial circumstances are compared with a most likely, or base-case, situation. |
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Term
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Definition
| Percentage change in NPV resulting from a given percentage change in an input variable, other things held constant. |
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Term
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Definition
| The risk an asset would have if it was a firm's only asset and if investors owned only one stock. It is measured by the variability of the asset's expected returns. |
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Term
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Definition
| A cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected. |
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Term
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Definition
| An analysis in which all of the input variables are set at their worst reasonably forecasted values. |
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