Net Present Value and Other Investment Criteria Flashcards

A set of vocabulary flashcards covering the key investment criteria and capital budgeting concepts from Chapter 9.

Capital Budgeting

The process of allocating or budgeting capital to determine if proposed investments, such as new products or markets, are worth more than they cost.

Net Present Value (NPV)

The difference between an investment’s market value and its cost, representing a measure of how much value is created or added today by undertaking an investment.

Discounted Cash Flow (DCF) Valuation

The process of valuing an investment by discounting its future cash flows.

Payback Period

The amount of time required for an investment to generate cash flows sufficient to recover its initial cost.

Discounted Payback

The length of time required for an investment’s discounted cash flows to equal its initial cost.

Average Accounting Return (AAR)

An investment’s average net income divided by its average book value, calculated as $\frac{\text{Average Net Income}}{\text{Average Book Value}}$.

Internal Rate of Return (IRR)

The discount rate that makes the $NPV$ of an investment zero.

Net Present Value Profile

A graphical representation of the relationship between an investment’s $NPV$s and various discount rates.

Multiple Rates of Return Problem

The possibility that more than one discount rate will make the $NPV$ of an investment zero, which can occur when cash flows are nonconventional.

Mutually Exclusive Investment Decisions

A situation in which taking one investment prevents the taking of another; choice is typically made based on the largest $NPV$.

Independent Projects

Two or more projects that are not mutually exclusive, meaning the acceptance of one does not prevent the acceptance of another.

Modified Internal Rate of Return (MIRR)

A variation of the $IRR$ where cash flows are modified through discounting, reinvestment, or combination approaches to ensure a single result and eliminate multiple $IRR$ problems.

Profitability Index

Also known as the benefit-cost ratio, it is the present value of an investment’s future cash flows divided by its initial cost, expressed as $\frac{\text{PV of Future Cash Flows}}{\text{Initial Cost}}$.