Chapter 9 Finance

Capital structure question

How a firm chooses to finance its operations

Postitive

Should the Net Present Value be positive or negative to make it worth it?

Payback period

The amount of time required for an investment to generate cash flows sufficient to recover its initial cost

Net Present Value

The difference between an investment's market value and its costs. A measure of how much value is created or added today by undertaking in an investment.

Internal Rate of Return

The discount rate that makes the NPV of an investment equal to zero

Discounted payback period

The length of time required for an investment's discounted cash flows to equal its initial cost

Required Return

The minimum expected return you would need in order to purchase an asset, that is, to make the investment

Payback

the length of time it takes to recover our initial investment

Discounted cash flow valuation

the prices of valuing an investment by discounting its future cash flows

Capital Budgeting

trying to determine whether a proposed investment or project will be worth more, once it is in place, than it costs.

Goal of financial management

create value for stockholders

Working capital question

how a firm manages its short-term operating activities

Net Present Value Profit

A graphical representation of the relationship between an investment's NPV's and various discount rates

Mutually Exclusive Investment Decisions

A situation in which taking one investment prevents the taking of another

The IRR is greater than the required return

According to the IRR rule, an investment is acceptable if:

its aar exceeds a target aar

According to the average accounting return rule, a project is acceptable if:

Average Accounting Return (AAR)

An investment's average net income divided by its average book value

Yes

Do IRR and NPV rules always lead to the same decisions?

negatives of payback period rule

No discounting involved time value of money is completely ignored fails to consider risk differences no rule with coming up with the right cutoff period

Disadvantages of AAR

Not a true rate of return Time value of money is ignored uses an arbitrary benchmark cutoff rate Based on accounting values, not cash flow and market values

Multiple Rates of Return

The possibility that more than one discount rate will make the NPV of an investment zero

Profitability Index

The present value of an investment's future cash flows divided by its initial cost

True

True or False: If a project ever pays back on a discounted basis, then it must have a positive NPV?