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52 Cards in this Set

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3 reasons why capital budgeting process is important.
1.it often involves costly long-term asset purchase. the decision is the key to future business success.
2.the princle of capital budgeting also apply apply to other managerment field like working capital managerment, strategic mergers and acquisitions etc.
3. good capital budgeting is consisstent with the primary goal of maximizing shareholders value.
4 steps of capital budgeting:
1.idea generation.
2.analyzing project proposals.(cash flow, profitability...)
3.create firm-wide capital budget.(is it ok of the timing of cash flow, available resouces, company's strategy plan?)
3.monitoring decisions and conducting post-audit.(does the actual result goes as predicted?)
6 categories of capital budgeting:
1.replacement projects to maintain business.
2.replacement projects to cut cost
3.expansion projects
4.new product or market development
5.mandatory projects.(government, environment concern, safty like RSPs.)
6. others

note: more and more detail of evaluation is require from 1 to 4.
6 categories of capital budgeting:
1.replacement projects to maintain business.
2.replacement projects to cut cost
3.expansion projects
4.new product or market development
5.mandatory projects.(government, environment concern, safty like RSPs.)
6. others

note: more and more detail of evaluation is require from 1 to 4.
externalities definition
the effect of new project on other firm cash flows.
cannibalizaion definition
a negative externality that the new projects eats some cash flow from the existing ones.
ex. diet coke may replace the sales of the origional coke.
cannibalizaion definition
a negative externality that the new projects eats some cash flow from the existing ones.
ex. diet coke may replace the sales of the origional coke.
cannibalizaion definition
a negative externality that the new projects eats some cash flow from the existing ones.
ex. diet coke may replace the sales of the origional coke.
principles of capital budgeting:
1. decisions are based on incremental cash flows, not accounting income
2. cash flow are based on opportunity costs.
3.the timming of cash flow is important(NPV)
4.cash flow are analyzed on after-tax basis.
5.Financial cost are refected in the project's required rate fo return.
independent projects definition
projects that unrealted to each other,and can be both accept at the same time
mutual exclusive projects definition:
projects that competed with each other, and only one can be accepted one time
project sequencing definition:
one project may be apply only by the condition of other projects.
ex. applicationf of future project may depent on the profitablity of today's project.
unlimited funds definition
if firm has unlimited fund available, all projects that have return rate higher then the cost of capital should allpy.
capital rationing definition
if firm has constraints on the amount of capital they can raise, capital rationing should be applied. if the profitable project opportunities exeed the amount of funds available, the firm must use its capital to the project in order to maximize shareholder value.
capital rationing definition
if firm has constraints on the amount of capital they can raise, capital rationing should be applied. if the profitable project opportunities exeed the amount of funds available, the firm must use its capital to the project in order to maximize shareholder value.
the drawback of payback or discounted payback principle:
it ignores the cash flow after the payback period, thus ignores the expected total payback. a shorter recovey will be accepted even if it generate far less cash flow overall.
payback or diccounted payback period:
the # of years the original investment to be reconvered.

note: under dicounted period, the cash flow will be discounted by capital cost ratio, k, then in tth year, the discount rate is (1+K)^t
what aspect does payback of dis.payback period indicate?
it is a good indicator of projects' riskness and liquidity.
relationship b/w NPV and economic value added:
positive relationship; namely, NPV is the PV of EVA
NPV method for capital budgeting equaiton:
similar with NPV in investment,except tht r is replaced by k, the cost of capital
payback period equation
PBP = full years untill recovery + (unrecovered amount / cash flow for that year)
Average accounting rate of return equation:
AAR = average net income of project / average book value of project
disadvantages of average accounting rate of return:
1. it us average net income instead of cash flow as numerator, which vilate the princple of CB 1.
2. it does not account for time of money, which make it poor for profitability evaluation.
profitability index equation:
PI = PV of future cash flow / CF0 = 1 + (NPV / CF0)
rationale of Profitability index:
if NPV > 0, PI > 1,accept the project.
if NPV < 0, PI < 1,reject the project.
main reason why NPV and IRR will conflict b/w mutually exclusive projects
1. size diff. A project with higher NPV may have lower IRR due to larger size.
2. time of cash flow. A hihger NPV project may have lower IRR due to smaller cash flow in the beginning
ther best assumption of reinvestment rate is:
at the cost of capital, k, which is consistent with NPV method.
2 ways of raising equity captial:
1.retaining earnig(internal equity)
2.issuing new common stock(external equity)
in calculating firm's debt cost, what kind of interest rate should be used?
the current market rate on new debt should be used, not the rate of firm's exising debts.
The capital asset pricing model approach :
1.estimate the risk-free rate
2.estimate the beta coefficient
3.estimate the average stock's expected return
4.sub all data in the CAPM equation.
capital asset pricing model approach equation:
Ks = Krf + (Km - Krf)Beta
The dividend discount approach equation:
If the expect dividend growth is constant at g then
P0 = D1/(Kcc - g)

then Kcc = D1/p0 - g

where P0 is the current price of stock, D1 is the dividend of next year.
and g = (retention rate)(ROE)=(1-PAYOUT RATE) (ROE)
Bond yield plus risk premium approach for cost of common price estimation :
Kcc = bond yield + risk premium
definition: operating leverage
the proportion of operating cost that is fixed.
in business term, it means a small change in sales can lead to a large change in ROE.
Definition: operating leverage
the % change in EBIT relative to the % change in sales.

% d ebit / % d sales.
equation: degree of operating leverage
DOL = % d EBIT / % d sales = (sales - TVC) / ( sales - TVC - Fixed cost)
Definition: Degree of financial leverage
the % change in EPS relative to % change in EBIT.
equation: degree of financial leverage
DFL = % d EPS / % d EBIT = EBIT/EBIT - interst
Business risk contains:
1.risk in sales
2. Operating risk(Operating leverage)
equation: degree of total leverage
DTL = DOL X DFL = %d EBIT / %d sales X %d EPS / %d EBIT = %d EPS / %d sales = (sales - TVC) / (sales - TVC - Fixed cost - interest expense)
creditors and owners, who have bigger risk shared by the company?
owners since when company go bankrupted, all the debts have to be cleared b4 clear assets.
equation: effective tax rate on dividend
ETR = corporate tax rate + (1-Corperate tax rate)(individual tax rate)
what may a dividend initiation imply?
1. positive : the company is sharing wealth with shareholders.
2.negative: the company is lack of profitable projects.
what might the unexpected dividend increase imply ?
it implies that the prospects of the future is strong for the firm.
what might a unexpected decrease in dividend imply?
1. the firm is in trouble
2. some extreme profitable projects is ongoing that the firm want to invest more onto them(which is not likely).
equation: dividend yield
DY = Dividend per share / share price.
what would the unexpected dividend decrease in asian countries implies?
nothing, so share price won't change (unlike in americas)
if the book value per share is lower than the market price, what will a repurchase in stock change its book vale per share?
will be lower
if the book value per share is higher than the market price, what will a repurchase in stock change its book vale per share?
higher
effects of EPS/price(earning yield) and after-tax interest on EPS in purchasing share from borrowing
if interest is lower than earning yield, price will be higher. if not, the opposite happened.
definition: Corporate governance
the set of internal controls, processes, and procedures by which firms are managed.
Good corporate governance practices seek to ensure that:
1.The board of directors protects shareholder interests.
2.the firm acts lawfully and ethically in dealings with shareholders.
3.The rights of shareholders are portected and shareholders have a voice in governance.
4.The board acts independently from management.
5.Proper procedures and controls cover management's day-to-day operations.
6.The firm's financial, operating, and governance activities are reported to shareholders in a fair, accurate, and timely maner.