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capital budgeting

The process of planning expediters on assets whose cash flows are expected to extend beyond one year.


replacement decisions

Decisions about whether to purchase capital assets to take the place of existing assets so as to maintain existing operations.


expansion decisions

Decisions about whether to purchase capital projects and add them to existing assets so as to increase existing operations.


independent projects

Projects whose cash flows are not affected by the acceptance or nonacceptance of other projects.


mutually exclusive projects

A set of projects where the acceptance of one project means that other projects cannot be accepted.


cash flows

The actual cash, as opposed to accounting profits, that a firm receives or pays during some specified period.


incremental cash flow

The change in a firm's net cash flow attributable to an investment project.


sunk cost

A cash outlay that already has been incurred and that cannot be recovered regardless of whether the project is accepted or rejected.


opportunity cost

The return on the best alternative use of an asset; the highest return that the firm will forgo if funds are invested in a particular project.



The way in which accepting a project affects the cash flows in other parts (areas) of the firm.


initial investment outlay

The incremental cash flows associated with a project that occur only at the start of a project's life, CF0-.


supplemental operating cash flows

The changes in day-to-day cash flows that result from the purchase of a capital project and continue until the firm disposes of the asset.


terminal cash flow

The net cash flow that occurs at the end of the life of a project, including the cash flows associated with 1) the final disposal of the project and 2) the return of the firm's operations to their state prior to the project's acceptance.


net present value (NPV)

A method of evaluating the capital investment proposals by finding the present value of the net cash flows, discounted at the rate of return required by the firm.


internal rate of return (IRR)

The discount rate that forces the present value of a project's expected cash flows to equal its cost. It is similar to the yield to maturity on a bond.


required rate of return (hurdle rate)

The discount rate (cost of funds) that the IRR must exceed for a project to be considered acceptable.


traditional payback period (PB)

The length of time it takes to recover the original cost of an investment from the project's expected cash flows.


discounted payback period (DPB)

The length of time it takes for a project's discounted cash flows to repay the initial cost of the investment.


reinvestment rate assumption

The assumption that cash flows from a project can be reinvested 1) at the cost of capital, if using the NPV method, or 2) at the internal rate of return, if using the IRR method.


multiple IRRs

The situation where a project has two or more IRRs.


modified IRR (MIRR)

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 required rat of return (cost of capital).


stand-alone risk

The risk that an asset would have if it were a firm's only asset. It is measured by the variability of the asset's expected returns.


corporate (within-firm) risk

The effect a project has on the total risk of the firm. It captures the risk relationships among the assets that the firm owns.


beta (market) risk

That part of a project's risk that cannot be eliminated by diversification. It is measured by the project's beta coefficient.


scenario analysis

A risk analysis technique in which "bad" and "good" sets of financial circumstances are compared with a most likely, or a base case, situation.


worst case scenario

An analysis in which all of the input variables are set at their worst reasonably forecasted values.


best case scenario

An analysis in which all of the input variables are set at their best reasonably forecasted values.


base case

An analysis in which all of the input variables are set at their most likely values.


projected required rate of return (rproj)

The risk-adjusted required rate of return for an individual project.


pure play method

An approach used for estimating the beta of a project in which a firm identifies companies whose only business is the product in question, determines the beta for each company, and then averages the betas to find an approximation of its own project's beta.