Capital Budgeting

Crossover Rate

The crossover rate is the discount rate that makes the NPVs of Projects A and B equal. That is, it makes the NPV of the differences between the two projects' cash flows equal zero. To determine the crossover rate, subtract the cash flows of Project B from those of Project A and calculate the IRR of the differences.

Internal Rate of Return (IRR)

The discount rate that makes the PV(cash inflows)=PV(cash outflows) If IRR > the required rate of return, accept the project. If IRR < the required rate of return, reject the project.

Sustainable Growth Rate

Used in the DDM approach to calculate RoR-Equity. g = (retention rate)(return on equity) = (1 - payout rate)(ROE)

Capital Asset Pricing Model (CAPM )

Used to calculate ROR-Equity

Dividend Discount Model Approach

Used to calculate ROR-Equity Where D= Next Year's Dividend Re= Required Rate of Equity G= Growth Rate Po= Price of share

After-tax Cost of Debt

interest rate at which firms can issue new debt (kd) net of the tax savings from the tax deductibility of interest kd(1 - t) In WACC calc, this is used as the debt rate- do not use the coupon rate.

Cost of Equity Capital

Required rate of return on the firm's common stock. The firm could avoid part of the cost of common stock outstanding by using retained earnings to buy back shares of its own stock.

Bond Yield Plus Risk Premium

Adhoc approach to calculate ROR-Equity Bond Yield+ Risk Premium

Weighted Average Cost of Capital (WACC)

Cost of financing firm assets.

NPV Profiles

NPV on Y-Axis, Cost of Capital on X-Axis IRRs intersect the X-Axis

Payback Period (PBP)

Number of years it takes to recover the initial cost of an investment. payback period = full years until recovery + unrecovered cost at the beginning of last year cash flow during the last year

Profitability Index

Present value of future cash flows divided by the inital cost.