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Exam 4
Ch. 24: Capital Budgeting and Investment Analysis
Term | Definition |
---|---|
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 |