Corporate Finance Ch.9,10,11

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Payback period

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

Stand-alone principle

the assumption that evaluation of a project may be based on the projects incremental cash flows

Erosion

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

Marginal, or incremental, cost

the change in costs that occurs when there is a small change in output

Marginal, or incremental, revenue

the change in revenue that occurs when there is a small change in output

Operating leverage

the degree to which a firm or project relies on fixed costs

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

Net Present Value (NPV)

the difference between an investment's market value and its costs

Internal rate of return (IRR)

the discounted rate that makes the NPV of an investment zero

Discounted payback period

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

Opportunity cost

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

Degree of operating leverage (DOL)

the percentage change in operating cash flow relative to the percentage change in quantity sold

Pro forma financial statements

financial statements projecting future years' operations

Simulation analysis

a combination of scenario and sensitivity analysis

Sunk cost

a cost that has already been incurred and cannot be removed and therefore should not be considered in an investment decision

Accelerated cost recovery system (ACRS)

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

Net present value profile

a graphical representation of the relationship between an investment's NPVs and various discount rates

Mutually exclusive investment decisions

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

Sensitivity analysis

an investigation of what happens to NPV when only one variable is changed

Average accounting return (ARR)

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

Variable costs

costs that change when the quantity of output changes

Fixed costs

costs that do not change when the quantity of output changes during a particular time period

Forecasting risk

the possibility that errors in projected cash flows will lead to incorrect decisions. also known as estimation risk

Multiple rates of return

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

Equivalent annual cost (EAC)

the present value of a project's cost calculated on an annual basis

Profitability index (PI)

the present value of an investment's future cash flows divided by its initial cost. also called the benefit-cost ratio

Discounted cash flow (DCF) valuation

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

Financial break-even

the sales level that results in a zero NPV

Cash break-even

the sales level that results in a zero operating cash flow

Accounting break-even

the sales level that results in zero project net income

Capital rationing

the situation that exists if a firm has positive NPV projects but cannot find the necessary financing

Depreciation tax shield

the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate


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