Term
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Definition
| the investment decision is made without regard to one more more alternative projects |
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Term
| mutually exclusive project |
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Definition
several alternative project choices are available of which only one will be selected.
-each independent project alternative must be fundable as an investment project |
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Term
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Definition
a process for making prudent capital investment decision based on timing and risk characteristics of available projects
prudence- NPV of projects cash flows are positive |
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Term
| good capital budgeting steps- |
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Definition
1. estimate cashf lows
2. asses riskiness of CFs
3. determine WACC
4. Find NPV and IRR
5. Accept NPV if grater than 0 or if IRR is greater than WACC |
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Term
| a good capital budgeting system |
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Definition
must tie into the firms long range strategic planning process- it chooses the direction of the firms business- including financing, production, marketing and research
- tie into a procedure for measurement of performence expost- |
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Term
| methods of capital budgeting |
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Definition
payback
discounted payback
NPV
IRR
MIRR
profitability index |
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Term
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Definition
number of years required to recover a projects cost
-never use paybacks to choose among mutually exclusive projects
-pick shortest payback period |
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Term
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Definition
provides indication of projects liquidity- measures how long investment will be tied up
-easy to calculate and understand |
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Term
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Definition
ignores the TVM
-ignores risk
-ignores cfs occuring after payback period
-terrible for mutually exclusive project selection |
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Term
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Definition
| uses discounted rather than raw CFs |
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Term
| strengths of discounted payback |
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Definition
provides indication of a projects liquidity: measures how long a project will be tied up
-easy to calculate and understand
-accounts for TVM and risk during payback period |
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Term
| weaknesses of discounted payback |
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Definition
| ignores cfs occurring after payback period |
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Term
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Definition
| profits that more than cover the opportunity cost of capital. Generally temporary- the case of an industy not yet in a long run equilibrium |
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Term
| The NPV of an investment is simply the discounted value of |
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Definition
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Term
sustainable economic rents: comparative advantage
competitors may not be able to enter market due to |
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Definition
barriers to entry
-a firm may not have a patent, properitary technology, or production cost advantage
-firm may have a contractual advantage with a supplier or distributer
1. cost advantage
2. differentiation advantage
3. focus |
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Term
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Definition
| discount rate that makes NPV 0 |
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Term
| decision rules for independent projects |
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Definition
if IRR>WACC -accept (means project return is greater than its costs)
if IRR< WACC- reject |
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Term
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Definition
| always go with NPV- IRR is considered more intuitive |
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Term
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Definition
NPV profile incorporates NPV and IRR
shows the sensitivity of the value of the project to the return on the project
its the plot of the npv of a project for different levesl of WACC |
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Term
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Definition
| accept when cost of capital is less than IRR |
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Term
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Definition
| accept when NPV>0 which only occurs when the cost of capital is less than IRR |
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Term
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Definition
move all cash flows out to the present at a discount rate of WACC
-move all revenues to the project termination
-find a discount rate, MIRR that makes these two values equal to present value
MIRR provides the true rate of return on a project
-fixes the multiple IRR problem
MIRR doesnt fix the multually exclusive problems of IRR |
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Term
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Definition
if IRR>WACC- accept project
if IRR |
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Term
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Definition
the return required by the provider of that capital
-opportunity cost
-rate of return investors are willing to provide financing |
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Term
| required rate of return depends on |
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Definition
business risk
financial risk |
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Term
| business risk is determined by |
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Definition
-demand and sales price variability
-imput cost variability
-innovation
-forigen, political, and echange risk exposure
-opperating leverage |
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Term
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Definition
trade off of FC vs. VC of production
-high FC- high operating leverage
-low FC- low operating leverage |
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Term
| debt in capital structure acts as what kind of cost |
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Definition
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Term
| the greater the D/V ratio- what happens to shareholders risk |
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Definition
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Term
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Definition
| affects the cost of capital and the equity beta- its affect is on non diversifiable risk |
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Term
| unleveraged equity is sensitive to what kind of risk |
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Definition
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Term
| leveraged equity is sensitive to what kind of risk |
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Definition
| both business and financial risk |
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Term
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Definition
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Term
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Definition
standard measurement of a firms capital
-includes debt and equity
suppliers of capital will demand a RR that is proportional to risk |
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Term
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Definition
| source of risk, amount of risk an asset has required return an asset must earn for its risk |
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Term
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Definition
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Term
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Definition
| assets covariance with market portffolio of all assets |
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Term
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Definition
| is the amount of assets covariance with the market portfolio |
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Term
| when estimating the firms cost of debt |
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Definition
the historical cost of debt is irrelevant
cost of debt is observable-
--yield on currently outstanding debt
--yields on newly issued similarly rated bonds |
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Term
| in perfect capital markets financial leverage has what kind of affect on the WACC |
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Definition
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Term
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Definition
| independent of capital structures |
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Term
| if the firm uses WACC to evaluate new projects it wwill do what with accepting and rejecting |
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Definition
Accept negative NPV projects of above average risk
Reject positive projects with below average risk |
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Term
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Definition
1. single line business firm
2. estimate equity beta
3. deliver beta for each pure player
4. estimate projects BsubA (find average)
5. calculate rsuba=risk free rate +beta (risk premium)
6. calculate WACC= rsubA (1-T) |
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Term
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Definition
relevant capital structure- use the whole firm- not how any specific project is financed
exceptions are subsidiary and the parent is a major shareholder. |
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Term
| is NPV higher with straight line or MACRS |
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Definition
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Term
| methods for decision between 2 projects with different times |
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Definition
-replacment chain/common life
- equivalent annual annuity (EAA) analysis |
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Term
| do you pick the the higher or lower EAA |
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Definition
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Term
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Definition
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Term
| when comparing over common do you pick the higher or lower PV with regard to EAC |
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Definition
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Term
| use real or nominal dollars with EAC |
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Definition
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Term
| EAC is really just ____ with rev left out- follow by the annuitiziaion of NPV |
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Definition
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Term
| what decisions do managers need to account for with capital investment decisions |
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Definition
1. expansion of investments in new plant and equipment for new activities and operations
2. replacement investment to keep existing plant and equipment operational |
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Term
| EAC (EAA) analysis involves 2 steps |
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Definition
1. calculate the PV(NPV) for a cycle
2. annuitize that PV (NPV) over a cycle to get the EAC(EAA) |
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Term
| EAC analysis may be viewed as EAA with revenues set to ___ |
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Definition
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Term
| rate of growth in the asset or the rate of increase in cash flows is _____ with time |
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Definition
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Term
| Capital rationing results when |
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Definition
| a firm places limits on the amount of cash available for new investments by a department, division, or subsidiary |
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Term
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Definition
| limit the ability of corporations to raise funds in capital markets at fair prices |
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Term
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Definition
| associated with issuing securities may limit the amount of funds that a coproation can and is willing to raise in the market |
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Term
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Definition
| results from managmenet and organizational issues |
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Term
| career minded divisional managers- |
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Definition
| fighting for capital from coproate may overstate their investment opportunities- agency cost |
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Term
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Definition
.1 options for abandon
2. options to derfer/wait/learn/postpone
3. options to expand/follow on
4. options to extend
5. options to vary output/switch production methods |
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Term
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Definition
| the associated accelerated deprecition is calculated as a percentage of the depreciable basis |
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Term
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Definition
| under MACRS assumed project is bought in the middle of the year |
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Term
| straight line depreciation |
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Definition
| occurs under the tax code |
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Term
| incremental cash flows equation |
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Definition
| corporate cfs with project- corporate cfs without the project |
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Term
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Definition
positive if new projects are complements to exisitng projects
and negative is subsititues |
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Term
| things that change analysis |
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Definition
1. replacement of old equipment
2. erosion/canibalism
3. opporunity cost |
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Term
| do you include dividends or interest expense in cfs |
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Definition
| no they are already included |
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Term
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Definition
| putting one more more types of limits on the amoutn you can spend on capital budgeting projects |
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