Chapter 10

capital budgeting

the process of evaluating and selecting long-term investments that contribute to the firm’s goal of maximizing owner’s wealth

capital expenditure

an outlay of funds by the firm that the firm expects to produce benefits over a period of time greater than 1 year

operating expenditure

an outlay of funds by the firm resulting in benefits received within 1 year

independent projects

projects whose cash flows are unrelated to (or independent of) one another; accepting or rejecting one project does not change desirability of other projects

mutually exlusive projects

projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function

payback period

the time it takes an investment to generate cash inflows sufficient to recoup the initial outlay required to make the investment

net present value (NPV)

a capital budgeting technique that measures an investment’s value by calculating the present value of its cash inflows and outflows

internal rate of return (IRR)

the discount rate that equates the NPV of an investment opportunity with $0 (because the present value of cash inflows equals the initial investment); it is a rate of return that the firm will earn if it invests in the project and receives the given cash inflows

net present value profile

graph that depicts a project’s NPVs calculated at different discount rates