Capital Budgeting and Risk Review

50 fill-in-the-blank practice flashcards covering time value of money, risk preferences, capital expenditure, capital budgeting techniques, and international risk considerations.

The financial method that allows individuals and firms to compare the value of cash flows occurring at different points in time.

Time Value of Money

The cost or fee associated with money that is borrowed or lent over a specified period.

Interest

A horizontal graphical diagram used to depict the timing and sequence of expected cash flows over consecutive periods.

Time Line

The accumulated value to which a current cash flow or series of cash flows will grow over a specified time frame when compounded at a given interest rate.

Future Value (FV)

The current monetary value of a future cash flow, determined by discounting it back to the present at a specific cost of capital or discount rate.

Present Value (PV)

The arithmetic process of calculating the final value of a cash flow or series of cash flows by applying interest earned on both principal and accumulated past interest.

Compounding

A financial structure consisting of a stream of equal cash payments occurring at regular, fixed intervals over a specified number of periods.

Annuity

An annuity structure where cash flow payments occur at the end of each periodic interval.

Ordinary (Deferred) Annuity

An annuity structure where cash flow payments occur at the beginning of each periodic interval.

Annuity Due

A measure of the uncertainty surrounding the actual financial return that an investment will earn.

Risk

The total gain or loss experienced on an investment over a given period of time, expressed relative to the initial investment.

Return

The investor preference or attitude where an increased expected return is required as compensation for taking on higher levels of risk.

Risk Averse

The investor attitude where choices between investments are made strictly on expected return without concern for the level of risk.

Risk Neutral

The investor attitude where higher-risk investments are preferred even if they offer lower expected returns.

Risk Seeking

A behavioral risk assessment approach that evaluates several possible alternative outcomes, such as pessimistic, most likely, and optimistic cases, to analyze return variability.

Scenario Analysis

A basic measure of risk calculated by subtracting the outcome associated with the pessimistic (worst-case) scenario from the optimistic (best-case) scenario.

Range

It provides the quantitative insights into an asset’s risk

Probability Distribution

A statistical distribution showing all possible outcomes and their corresponding probabilities for a given event across a continuous spectrum.

Continuous Probability Distribution

The corporate finance process of evaluating, selecting, and prioritizing long-term investments consistent with maximizing owners' wealth.

Capital Budgeting

An outlay of firm funds that is expected to produce financial benefits over a duration greater than $1\,\text{year}$.

Capital Expenditure

An outlay of firm funds resulting in benefits received entirely within a $1\,\text{year}$ period.

Operating Expenditure

Tangible long-term property items such as buildings, land, or heavy equipment acquired through capital expenditures.

Fixed Assets

A non-physical capital expenditure example that yields long-term benefits, such as a long term advertising campaign.

Non Fixed Asset

The structured five-step managerial workflow consisting of proposal generation, review and analysis, decision making, implementation, and follow-up.

Capital Budgeting Process

The formal evaluation step in capital budgeting where financial managers analyze the economic merits of investment proposals.

Review and Analysis

Proposals for new investment projects are made at all levels within a business organization and are reviewed by finance personnel. Proposals that require large outlays are more carefully scrutinized than less costly ones.

Proposal Generation

The execution phase of capital budgeting where capital is spent and project construction or deployment takes place, often in phases.

Implementation

The final stage of capital budgeting where actual post-implementation performance and costs are compared against original projections.

Follow-up

Projects whose individual cash flows are unrelated to one another, so accepting one does not eliminate others from consideration.

Independent Projects

Projects that directly compete with one another, such that accepting one automatically eliminates all alternative projects serving the same function.

Mutually Exclusive Projects

The ideal financial situation where a firm has access to sufficient financial capital to accept all independent projects offering an acceptable return.

Unlimited Funds

The financial constraint in which a firm has a fixed dollar budget available for long-term investments, forcing competing proposals to be prioritized.

Capital Rationing

The evaluation approach in capital budgeting that determines whether candidate proposals meet a firm's minimum acceptance benchmark.

Accept–Reject Approach

The evaluation method that orders capital expenditure proposals relative to one another based on a predetermined metric such as rate of return.

Ranking Approach

The exact length of time required for a firm to fully recover its initial outlay from a project's cumulative cash inflows.

Payback Period

A major weakness of the payback period method, caused by failing to consider project profitability beyond cost recovery or the time value of money.

Payback Period Limitations

A capital budgeting technique calculated by subtracting a project's initial investment from the present value of its future cash inflows discounted at the firm's cost of capital.

Net Present Value (NPV)

The decision criteria stating that an investment should be accepted if its Net Present Value is greater than $0$, and rejected if it is less than $0$.

NPV Decision Criteria

The discount rate that equates the present value of expected cash inflows with the initial investment, yielding a Net Present Value equal to $0$.

Internal Rate of Return (IRR)

The decision criteria stating that a project should be accepted if its Internal Rate of Return exceeds the firm's required cost of capital.

IRR Decision Criteria

Qualitative evaluation tools used by financial managers to gain an intuitive feel for project risk variability rather than measuring it mathematically.

Behavioral Approaches to Risk

The primary source of risk in long-term investments, stemming from uncertainty in future operating cash flows while the initial outlay is known with relative certainty.

Cash Flow Variability Risk

The practice of using financial derivative contracts like currency futures and options to hedge foreign currency risks in the short term.

Short-Term Exchange Rate Risk Management

The international risk management strategy of financing foreign projects using local currency to protect against long-term conversion exposure.

Long-Term Exchange Rate Risk Management

The risk that host country government actions—such as asset seizure, tax revisions, or profit repatriation bans—will negatively impact a firm's operations.

Political Risk