Term
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Definition
| difference between investment's market value and its cost |
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Term
Discounted Cash Flow Valuation (DCF):
#1 |
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Definition
| calculating present value of future cash flow for its present value |
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Term
Discounted Cash Flow Valuation (DCF):
#2 |
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Definition
| The process of valuing investments by discounting its future cash flows |
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Term
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Definition
| amount of time required for an investment to generate cash flows sufficient to recover initial cost |
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Term
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Definition
| consider risk differences |
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Term
advantages of Payback Period Rule:
#1 |
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Definition
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Term
advantages of Payback Period Rule:
#2 |
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Definition
| adjusts for uncertainty of later cash flows |
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Term
advantages of Payback Period Rule:
#3 |
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Definition
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Term
Disadvantages of Payback Period Rule:
#1 |
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Definition
| Ignores the time value of money |
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Term
Disadvantages of Payback Period Rule:
#2 |
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Definition
| requires an arbitrary cutoff point |
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Term
Disadvantages of Payback Period Rule:
#3 |
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Definition
| Ignores cash flows beyond the cutoff date |
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Term
Disadvantages of Payback Period Rule:
#4 |
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Definition
| biased against long-term projects, such as research and development, and new projects |
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Term
| Average Accounting Return |
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Definition
| An investments average net income dividend by its average book value |
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Term
Advantages of the average accounting return
#1 |
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Definition
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Term
Advantages of the average accounting return:
#2 |
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Definition
| needed info will usually be available |
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Term
Disadvantages of the avg. accounting return:
#1 |
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Definition
| not a true rate of return, time value of money ignored |
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Term
Disadvantages of the avg. accounting return:
#2 |
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Definition
| uses an arbitrary benchmark cutoff rate |
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Term
Disadvantages of the avg. accounting return:
#3 |
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Definition
| Based on accounting income and book value, not cash flows and market values |
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Term
| Average accounting return rule |
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Definition
| a project is acceptable if its average accounting return exceeds target average accounting return |
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Term
| Internal Rate of Return (IRR) |
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Definition
| the discount rate that makes the net present value of an investment zero |
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Term
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Definition
| an investment is acceptable if the IRR exceeds required return, otherwise reject |
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Term
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Definition
| Closely related to NPV, leading to identical decisions |
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Term
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Definition
| Easy to understand and communicate |
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Term
Disadvantages of the IRR:
#1 |
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Definition
| result in multiple answers with non-conventional cash flows |
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Term
Disadvantages of the IRR:
#2 |
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Definition
| lead in incorrect decisions in comparisons of mutually exclusive investments |
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Term
| Modified Internal Rate of Return: (MIRR) |
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Definition
Modify the cash flows and then calculate IRR using modified cash flows
- Compounds all of the cash flows, except for initial cash flow to end of project |
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Term
| MIRR Method #1: Discounting approach |
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Definition
| we discount all negative cash flows back to the present at the required return and add them to the initial cost |
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Term
| MIRR Method #2: Reinvestment Approach |
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Definition
| we compound all cash flows (+&-) except the first out to the end of the project's life then calculate IRR |
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Term
| MIRR Method #3: The Combination Approach |
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Definition
| blends the first two methods: neg cash flows discounted to present and pos cash flows are compounded to end of project |
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Term
Profitability Index (PI)
(Benefit-Cost Ratio) |
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Definition
| present value of investment's future cash flows divided by its initial cost |
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Term
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Definition
| Closely related to NPV, identical decisions |
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Term
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Definition
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Term
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Definition
| useful when available investment funds are limited |
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Term
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Definition
| lead to incorrect decisions in comparisons of mutually exclusive investments |
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