Risk in Capital Budgeting - Vocabulary Flashcards

Flashcards covering the vocabulary and key concepts from Chapter 12 on Risk in Capital Budgeting.

Risk (in capital budgeting)

The uncertainty surrounding the cash flows that a project will generate or, more formally, the degree of variability of cash flows.

Scenario analysis

A behavioral approach that uses several possible alternative outcomes (scenarios), to obtain a sense of the variability of returns, measured here by NPV.

Exchange rate risk

The danger that an unexpected change in the exchange rate between the dollar and the currency in which a project’s cash flows are denominated will reduce the market value of that project’s cash flow.

Political risk

Firms that make investments abroad may find that the host-country government can limit the firm’s ability to return profits back home. Governments can seize the firm’s assets, or otherwise interfere with a project’s operation.

Risk-adjusted discount rates (RADR)

Rates of return that must be earned on a given project to compensate the firm’s owners adequately—that is, to maintain or improve the firm’s share price.

CAPM Formula

rj = RF + [bj ´ (rm – RF)] where rj = required return on asset j RF = risk-free rate of return bj = beta coefficient for asset j rm = return on the market portfolio of assets

Annualized net present value (ANPV) approach

An approach to evaluating unequal-lived projects that converts the net present value of unequal-lived, mutually exclusive projects into an equivalent annual amount (in NPV terms).