Flashcards in Chapter 10 Deck (30):

1

## capital

### long term assets used in production

2

## budget

### a plan that outlines projected expenditures during a future period

3

## capital budgeting

### the whole process of analyzing projects and deciding which ones to accept and thus include in the capital budget

4

## differences in security valuation and capital budgeting

### stocks and bonds exist in the secuurities markets and investors chose from available set, most investors have no influence over the cash flows produced by their investments

5

## Net Present Value

### the present value of a projects cash inflows minus the present value of its costs, tells us how much the project contributes to shareholder wealth.

6

## Larger NPV means

### the more value the project adds and the higher the stock price

7

## independent projects

### those whose cash flows are not affected by other projects

8

## mutually exclusive projects

### two different ways of accomplishing the same result, so if one is accepted the other must be rejected

9

## Internal Rate of Return

### the discount rate that forces the PV of the inflows to equal the initial cost. the is equivalent to forcing NPV to zero. an estimate of the project's rate of return, similar to ytm on a bond

10

## Multiple Internal Rates of Return

### if a project has nonnormal cash flwos (more than one sign change) then it has multiple IRRs.

11

## Assumption of the NPV calculation

### cash inflows can be reinvested at the projects WACC

12

## IRR assumption

### cash flows can be reinvested at the IRR

13

## Why is assuming reinvestment at the WACC better

### firms with good investments usually have access to debt and equity markets and can raise all of the capital it needs at the going rate, the WACC

14

## problem with the IRR

### overstates the expected return for accepted projects because cash flows cannot generally be reinvested at the IRR itself

15

## Modified IRR (MIRR)

### similar to the IRR but assumes that cash flows are reinvested at the WACC

16

## advantages of MIRR over IRR

### IRR assumes cash flows are reinvested at IRR, MIRR assumes reinvestment at COC, so MIRR is a better gauge of profitability. MIRR eliminates Multiple IRR problem

17

## Is MIRR as good as NPV?

### for indpendent projects NPV, IRR, MIRR will reach same coclusion. for mutually exclusive, NPV is best

18

## Net Present Value Profile

### find the project's NPV at a number of different discount rates and then plan those values to create a graph

19

## crossover rate

### where to npv profile lines cross, conflict if WACC is to the left, no conflict if to the right

20

## What happens to NPV when COC increases

### if cash flows happen in later years, sharp decline in npv. earlier cash flows not severely effected

21

## Profitability Index

### shows the relative profitability of any project, or the present value per dollar of initial cost

22

## payback period

### the number of years required to recover the funds invested in a project from its operating cash flows

23

## three flaws with regular payback

### 1. dollars received in different years all given the same weight, no time value considered 2. cash flows beyond payback year given no consideration 3. unlike npv and irr, there is no link back to investor welath gaines from the project

24

## discounted payback

### cash flows are discounted at the WACC and then used to find the payback

25

## When should we worry about analysis of unequal lives

### when looking at mutually exclusive projects with unequal lives

26

## economic life

### the life that maximizes npv and thus shareholder wealth

27

## physical or engineering life

### number of years of project

28

## optimal capital budget

### the set of projects that maximizes the value of the firn

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## complications of optimal capital budget

### 1. coc might increase as size of budget increase making it hard to know proper discount rate to use 2. firms may set an upper limit to size of capital budgets

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