05 - Capital Budgeting Issues

  1. Incremental Cash Flows
    Occur only from the acceptance of a capital-budgeting project.

    • 'With/Without test'
    • With - incremental
    • Without not incremental
  2. Sunk Cost
    Past cash outflow or a cost that is not incremental to a particular project.
  3. Initial Outlay
    Any cash flow amount that occurs at or very near to the start of the first period of the project.
  4. Terminal Cash Flow
    Occurs only at or very near to the final period of the project.
  5. Capital Rationing
    Placing a limit by the firm on the amount of money for it's capital budget.

    Tightening of restrictions on the capital budget of the firm by placing limits on the amount of money for investment.

    Raising the required hurdle rate of return.
  6. Mutually Exclusive Projects
    Projects that essentially perform the same task, so that the acceptance of one necessarily means the rejection of the others.
  7. Size-disparity Problem
    Occurs when mutually exclusive projects of equal cash-flow timing patterns over the lives of the projects, but of unequal size, are evaluated.
  8. Time-disparity Problem
    Two projects of equal size have significantly different cash-flow timing patterns over their lives.
  9. Equivalent Annual Annuity (EAA)
    Annual annuity amount that yields the same PV as the project's NPV.
  10. Project's Stand-alone Risk
    Total risk of a projects (ignoring the fact that part of the risk can be diversified away).
  11. Project's Contribution-to-firm Risk
    Risk that remains after part of a project's total risk is diversified away.
  12. Systematic Risk
    Proportion of variations in investment returns that cannot be eliminated by investor diversification.

    These variations result from factors that affect all shares.
  13. Risk-adjusted Discount Rate
    Method for incorporating the project's level of risk into the capital-budgeting process.

    Discount rate is adjusted upward to compensate for higher-than-normal risk or downward for lower-than-normal risk.
  14. Certainty Equivilent
    Amount of cash a person would require with certainty to make him or her indifferent to the choice between this certain sum and a particular risky or uncertain sum.
  15. Pure Play Method
    Estimating a project's beta by identifying firms that are engaged in the same business as the project.
  16. Sensitivity Analysis
    Technique for assessing risk.
  17. Scenario Analysis
    Technique that allows the financial manager to simultaneously consider the effects of changes in the estimates of multiple input variables on the NPV of an investment project.
  18. Simulation Analysis
    Process of imitating the performance of an investment project through repeated evaluations (using a computer).
  19. Probability Tree
    Schematic representation of a problem in which all possible outcomes are graphically displayed.
  20. Real Options
    Opportunities that allow for the alteration of the project's cash-flow stream while the project is being operated.
Card Set
05 - Capital Budgeting Issues
211 - Capital Budgeting Issues