Capital Budgeting & Financial Decisions

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Flashcards covering key capital budgeting and financial decision concepts, including NPV, IRR, payback period, and investment choice rules.

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13 Terms

1
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Net Present Value (NPV)

The sum of the present values of cash flows minus the initial investment; used for ranking projects and value creation. Accept if NPV > 0.

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Internal Rate of Return (IRR)

The discount rate at which NPV equals 0. For independent projects, accept if IRR > required return. For mutually exclusive projects, accept the project with the higher IRR only if IRR > cost of capital and there's no conflict with NPV.

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Crossover Rate

The rate at which NPV of Project A equals NPV of Project B. Calculated by subtracting Project B cash flows from Project A, then finding the IRR of the differences.

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Payback Period (Undiscounted)

The time it takes to recover the initial investment, calculated without considering the time value of money.

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Discounted Payback Period

Similar to the payback period, but each cash flow is discounted before calculating the recovery time.

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Future Value (FV)

The value of an asset or investment at a specified date in the future, based on an assumed rate of growth.

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Present Value (PV)

The current value of a future sum of money or stream of cash flows, given a specified rate of return.

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Independent Projects (Investment Choice Rules)

Accept all projects with NPV > 0.

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Mutually Exclusive Projects (Investment Choice Rules)

Pick the project with the highest NPV.

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Break-Even Rate of Return

The rate of return at which an investment neither gains nor loses money.

11
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Lottery & Annuity Problems Formula

Use present value of annuity: PV=PMT⋅[1−(1+r)−tr]

12
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Capital Expenditures on Cash Flow Statement

Look in Cash Flow from Investing for Purchase of property, plant, and equipment

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IRR and NPV Conflicts

Choose the project with the higher NPV for mutually exclusive projects.