Project Evaluation and Decision Making FIN 310

These flashcards cover essential vocabulary and concepts related to project evaluation and decision-making in capital budgeting.

Net Present Value (NPV)

A method of ranking investment proposals equal to the present value of a project’s free cash flows, discounted at the cost of capital.

Internal Rate of Return (IRR)

The discount rate that makes the net present value (NPV) of an investment equal to zero.

Weighted Average Cost of Capital (WACC)

The average rate of return a company expects to pay its shareholders; crucial for capital budgeting decisions.

MIRR (Modified Internal Rate of Return)

A financial measure that adjusts the IRR to account for cost of funds and reinvestment rates.

Capital Budgeting

The process a firm uses to evaluate potential major projects or investments.

Cash Flow

The net amount of cash being transferred into and out of a business.

Opportunity Cost

The potential benefits an individual, investor, or business misses out on when choosing one alternative over another.

Independent Projects

Projects whose cash flows are unaffected by the acceptance of other projects.

Mutually Exclusive Projects

Projects where the acceptance of one project will negatively impact the cash flows of another.

Normal Cash Flow Stream

A cash flow that starts with an initial cost (negative cash flow) followed by a series of positive cash inflows.

Non-normal Cash Flow Stream

A cash flow that shows two or more sign changes.

Risk Adjusted Present Value

The present value adjusted for the risk associated with future cash flows.

Sunk Costs

Costs that have already been incurred and cannot be recovered; they should not affect future investment decisions.

Positive Externalities

Benefits experienced by third parties when a firm takes certain actions that impact them positively.

Negative Externalities

Costs experienced by third parties as a result of a firm's actions.

Capital Budgeting Steps

1. Estimate cash flows. 2. Assess riskiness of cash flows. 3. Determine the appropriate cost of capital. 4. Find NPV or IRR.

Rate of Return Rule

A principle stating to invest in any project offering a return higher than the opportunity cost of capital.

Net Present Value (NPV) Equation

NPV = \sum{t=0}^{n} \frac{CFt}{(1+r)^t}Where CF_t is the cash flow at time t, r is the discount rate (cost of capital), and n is the project's lifespan.

Internal Rate of Return (IRR) Equation Concept

The IRR is the discount rate r that makes the Net Present Value (NPV) equal to zero:\sum{t=0}^{n} \frac{CFt}{(1+IRR)^t} = 0

Weighted Average Cost of Capital (WACC) Equation

WACC = (E/V) * Re + (D/V) * Rd * (1-T)Where E is the market value of equity, D is the market value of debt, V = E + D, Re is the cost of equity, Rd is the cost of debt, and T is the corporate tax rate.

Modified Internal Rate of Return (MIRR) Equation

MIRR = \left(\frac{FVCI}{PVCO}\right)^{\frac{1}{n}} - 1Where PVCO is the present value of all cash outflows, FVCI is the future value of all cash inflows, and n is the number of periods.