Chapter 9

Sunk cost

A cost that has already been incurred and cannot be recouped and therefore should not be considered in an investment decision.

Depreciated tax shield

The tax savings that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate.

Accelerated Cost Recovery System (ACRS)

Depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.

Pro forma financial statements

Financial statements projecting future years' operations.

Sensitivity analysis

Investigation of what happens to NPV when only one variable is changed.

Managerial options

Opportunities that managers can exploit if certain things happen in the future. Also known as "real" options.

strategic options

Options for future, related business products or strategies.

Contingency thinking

Taking into account the managerial options implicit in a project.

Stand-alone principle

The assumption that evaluation of a project may be based on the project's incremental cash flows.

Erosion

The cash flows of a new project that come at the expense of a firm's existing projects.

Scenario analysis

The determination of what happens to NPV estimates when we ask what-if questions.

Incremental cash flows

The difference between a firm's future cash flows with a project and those without the project.

Opportunity cost

The most valuable alternative that is given up if a particular investment is undertaken.

Forecasting risk

The possibility that errors in projected cash flows will lead to incorrect decisions

Capital rationing

The situation that exists if a firm has positive NPV projects but cannot obtain the necessary financing.

Hard rationing

The situation that occurs when a business cannot raise financing for a project under any circumstances.

Soft rationing

The situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting.