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43 Cards in this Set

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Process of identifying evaluating, and implementing a firm's investment opportunities.
Capital Budgeting
Selecting one project precludes other from being undertaken.
Mutually exclusive projects
Projects not in direct competition with one another.
Independent projects
Present value of a project's cash flows minus its cost.
Net present value
Mission, Objectives, GOals, and Strategies
MOGS
Finding potential capital investment opportunities and identifying whether a project involves a replacement decision and/or revenue expansion.
Identification stage
Requires estimeating relevant cash inflows and outflows.
Development stage
Applying appropriate capital budgeting techniques to help make a final accept or reject decision.
Selection stagae
Executing accepted projects.
Implementation stage
A stage in the capital budgeting process during which managers track review, or audit a project's results.
Follow-up
Project's required rate of return.
Cost of capital
The graphical relationship between a project's NPV and cost of capital.
NPV profile
Return that causes the net present value to be zero.
Internal rate of return (IRR) method
Ratio between the present value of the cash flows and the project's cost.
Profitability index (PI) - benefit/cost ratio
Determines the time in years it will take to recover, or pay back, the initial investment in fixed assets.
Payback period method
Analysis focuses on the project's own cash flows, uncontaminated by cash flows from the firm's other activities.
stand-alone principle
Represent the difference between the firm's after-tax cash flows with the project and the firm's after-tax cash flows without the project.
Incremental cash flows
Firm's after-tax cash flows without the project.
Base case
A project robs cash flow from the firm's existing lines of business.
Cannibalization
Increase in the cash flows of the firm's other products that occur because of a new project.
Enhancement
Cost of passing up the next best alternative.
Opportunity cost
Project-related expense not dependent upon whether or not the project is undertaken.
Sunk cost
Tax reduction due to depreciation of fixed assets; equals the amount of the depreciation expense multiplied by the firm's tax rate.
Depreciation tax shield
Adjusts the required rate of return at which the analyst discounts a project's cash flows. Projects with highter (or lower) risk levels requrie highter(or lower) discount rates.
Risk-adjusted discountrate (RADR)
Firm's mix of debt and equity.
Capital structure
Proportionate use of debt and equity that minimizes the firm's cost of capital.
Optimum debt/equity mix
Minimum acceptable rate of return to a firm on a project.
Cost of capital
Costs of issuing stock; includes accounting, legal and printing costs of offering shares to the public as well as the commission earned by the investment bankers who market the new securities to investors.
Flotation costs
Represents the minimum requried rate of return on a captial-budgeting project. It is found by multiplying the marginal cost of each capital structure component by its appropriate weight, and summing the terms.
Weighted average cost of captial (WACC)
A measure of how quickly a firm can grow without needing additional outside financing.
Internal growth rate
The proportion of each dollar of earnings that is kept by the firm.
Retention rate
the proportion of each dollar of earnings that is paid to shareholders as a divident; equals one minus the retention rate.
Dividend payout ratio
The estimate of how quickly a firm may grow by maintaining a constant mix of debt and equity.
Sustainable growth rate
Allows managers to see how different capital structure affect the earnings and risk levels of their firms.
EBIT/eps analysis
Measured by variability in EBIT over time.
Business risk
Measures the sensitivity of eps to changes in EBIT.
Degree of financial leverage (DFL)
Effect on earnings produced by the operating and financial leverage.
Combined leverage
Percentage change in earnings per share that results from a 1 percent change in sales volume.
Degree of combined leverage (DCL)
Explicit and implicit costs associated with financial distress.
Backruptcy costs
A theory that states firms attempt to balance the benefits of debt versus its disadvantages to determine an optimal capital structure.
Status tradeoff hypothesis
A theory that states managers prefer to use additions to retained earnings to finance the firm, then debt, and, as a final resort, new equity.
Pecking order hypothesis
Firms try to time the market by selling common stock when their stock price is high and repurchasing shares when their stock price is low.
Market timing hypothesis
Rquires financial managers to compare capital expenditures for plant and equipment against the cash flow benefits that will be received from these investments over several years.
Fixed-asset management