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Exam 4

Ch. 24: Capital Budgeting and Investment Analysis

TermDefinition
capital budgeting process of analyzing alternative investments and deciding which assets to acquire or sell
net cash flows cash inflows minus cash outflows
payback period (PBP) time-based measurement used to evaluate the acceptability of an investment; equals the time expected to pass before an investment’s net cash flows equal its initial cost
accounting rate of return (ARR) rate used to evaluate the acceptability of an investment; equals the after-tax periodic income from a project divided by the average investment in the asset; also called rate of return on average investment
average investment initial investment + salvage value/2
net present value (NPV) dollar estimate of an asset’s value that is used to evaluate the acceptability of an investment; computed by discounting future cash flows from the investment at the hurdle rate and then subtracting the initial cost of the investment
hurdle rate minimum acceptable rate of return (set by management) for an investment
cost of capital rate the company must pay to its long-term creditors and shareholders
annuity series of equal payments at equal intervals
profitability index relation between the expected benefits of a project and its investment, computed as the present value of expected future cash flows from the investment divided by the cost of the investment
profitability index a higher value (above 1) indicates a more desirable investment, and a value below 1 indicates an unacceptable project.
internal rate of return (IRR) rate used to evaluate the acceptability of an investment; equals the rate that yields a net present value of zero for an investment
break-even time time-based measurement used to evaluate the acceptability of an investment; equals the time expected to pass before the present value of the net cash flows from an investment equals its initial cost
Created by: ryanriggs18
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