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21 Cards in this Set
- Front
- Back
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Two types of capital budgeting decisions |
1. Screening decisions: does the project meet or exceed a hurdle rate 2. Preference decisions: For those projects that meet or exceed a hurdle rate, which is best? |
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Why is a dollar today worth more than a dollar a year from now? |
A dollar today can be invested and earn compounded interest |
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Methods that consider time and value of money |
1. NPV (Net Present Value) 2. IRR (Internal Rate of Return) 3. Profitability Index |
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Methods that don't consider time and value of money |
1. Payback Period 2. Accounting Rate of Return |
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Net Present Value ( NPV) |
PV of Cash Inflows - PV of Cash Outflows Accept if... NVP >= 0 Compares the present value of a project's cash inflows with the present value of its cash outflows -Considers the time value of money |
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Profitability Index |
NVP of Cash Flows / Investments (in project) Best way to compare project of different sizes/NPV of alternative investments -Higher index, more desirable the product is -Considers the time value of money |
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Internal Rate of Return (IRR) |
Investment / Net Annual Cash Flows Discount rate that results in a NPV of 0 Accept if... IRR >= Minimum Required Rate of Return -Rate of return promised by an investment project over its useful life -Considers the time value of money |
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Payback Method |
Investment / Net Annual Cash Flows *Equation only when annual cash inflow is the same each year Number of years needed to recover the investment -Doesn't consider the time value of money |
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Accounting (Simple) Rate of Return |
Annual Net Operating Income / Investment Reduced by salvage value of old equipment |
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Cash Outflows
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-Initial Investment in equipment (or other assets) -Expansion of working capital (Current Ass. - Current Liab) -Additional costs for repairs and maintenance in certain years *Depreciation ISN'T current cash outflow |
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Cash Inflows |
-Increase annual revenues or reduced costs -Salvage value when the equipment is sold -Release of working capital |
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Simplifying Assumptions made in NPV analysis |
-Cash Flows: (except initial investment) occur at the end of periods -All cash flows are immediately reinvented at the discount rate |
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Annuity |
1/r[1-(1/(1+r)^n)] |
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Single Sum |
1/(1+r)^n |
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Least Cost Decision |
Choose the investment that has the lowest net present value
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NOI Equation for Simple Rate of Return |
Cash Inflows - Depreciation |
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Depreciation |
(Investment - Salvage) / Years of Life |
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Annual Incremental Net Operating Income for Simple Rate of Return |
NOI / Investment |
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Simple Tax Return
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Taxable Revenue - Tax Deductible Expenses --------------------------------------- Taxable Income * Tax Rate --------------------------------------- Tax Expense -Tax Payments --------------------------------------- Tax Liability |
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After-Tax Cost (Net Cash Outflow) |
(1-tax Rate) * Tax-Deductible Cash Expense |
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Tax Shield |
Tax Rate * Deductible Expense |
