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Flashcards covering key vocabulary and definitions from the lecture on Capital Investment Analysis and Stock Valuation.
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Relevant Cash Flows
Cash flows that are different between two worlds: one where the investment is made and one where it is rejected.
Accrual Accounting
Accounting method where revenues and expenses are recognized when they are earned or incurred, not when cash changes hands.
Timeline Recognition
Recognizing cash flows only when the money actually moves, not when the accountant says money is accruing.
Sunk Costs
Costs that have already been incurred and cannot be recovered, thus irrelevant to future investment decisions.
Erosion Costs
The reduction in cash flows from existing projects when a new project is introduced (e.g., customers shifting from an existing Home Depot to a new one).
Opportunity Costs
The potential benefits a company misses out on when choosing one alternative over another (e.g., potential lease revenue from a property if not used for a new project).
Working Capital
The investment in current assets (e.g., inventory) required for a project, typically a cash outflow at the beginning and inflow at the end.
Depreciation
A non-cash expense; projects net income statements which is revenue minus cost minus depreciation times one minus tax rate.
Free Cash Flow
Operating cash flow minus capital requirements, used in NPV computations and discounted at the cost of capital.
NPV (Net Present Value)
The present value of all future cash flows, discounted at the cost of capital; a key metric for investment decisions.
Nominal Rate of Return
The percentage change in the amount of money you have.
Real Rate of Return
The percentage change in the amount of stuff you can actually buy.
Fisher Effect
The relationship between nominal return, real return, and the inflation rate: 1 + Nominal Return = (1 + Real Return) * (1 + Inflation Rate).
Sensitivity Analysis
Asking 'what if' questions to assess how changes in key variables (e.g., market share, costs) impact project NPV.
Simulation
Using computer software (e.g., @RISK) to model uncertainty by assigning probability distributions to key variables and running thousands of iterations to estimate the range of potential NPVs and IRRs.
Stock Valuation
The present value of all future expected cash flows.
Zero Growth Model
A valuation model that assumes a company's dividends will remain constant for the foreseeable future, often used for preferred stock valuation. Stock valuation is simply the present value of all future cash flows.
Constant Growth Model
A valuation model that assumes dividends will grow at a steady rate (g) indefinitely. The formula simplifies to Dividend 1 / (R - g).
Differential Growth Model
A valuation model that accounts for varying growth rates in the early part of a company's life cycle before settling into a constant growth rate.
Retention Ratio
1 - Dividend Payout Ratio which multiplied by the return on retained earnings give you growth rate.
Cash Cow
A company that pays all of its earnings as dividends and has no growth opportunities; its stock price is simply EPS / R.
Price-Earnings (P/E) Ratio
Price per share divided by earnings per share, often used to compare company values.
Enterprise Value (EV)
Market value of equity + market value of debt - cash; used in valuation ratios like EV/EBITDA.
EBITDA
Earnings Before Interest, Taxes, Depreciation, and Amortization