Principles of finance chapter 10 – Flashcards
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What is capital budgeting?
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The process of evaluating and selecting long-term investments consistent with the firm's goal of owner wealth maximization
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What are earning assets?
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Assets that are fixed assets that provide the basis for the firms profit and value
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What is the most common motive for adding fixed assets to the firm?
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Expansion
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What are mutually exclusive projects?
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Projects that compete with one another, so that the acceptance of one eliminates the others from further consideration
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What is a firm with limited dollars available for capital expenditures subject to?
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Capital expenditures
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What is the payback period?
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The exact amount of time it takes the firm to recover its initial investment
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What is the cost of capital?
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The minimum return that must be earned on a project in order to leave the firms value unchanged.
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What is the Net Present Value?
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A sophisticated capital budgeting technique; found by subtracting a projects initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.
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What is the Internal Rate of Return?
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The discount rate that equates the present values of the cash inflows with the initial investment
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Comparing net present value and internal rate of return analysis always results in the same accept/reject decision. True or false?
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True!
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What is the decision process of the NPV and IRR?
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Accept if positive, reject if negative
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On a theoretical basis, what is the better approach to capital budgeting?
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NPV
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Why is the NPV a better choice?
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Because it measures the benefits relative to the amount invested
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Comparing IRR and NPV which one is superior in their methods of evaluation?
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NPV
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Which methods of evaluation do the financial managers prefer to use?
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IRR
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What is the Profitability Index? (PI)
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The present value of cash inflows divided by the into suk cash flow.
