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85 Cards in this Set
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- Back
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payment for the use of someone else's money |
interest (i) |
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two points about interest |
stated as a per annum amount. Yearly interest |
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original amount borrowed or invested |
principal (p) |
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the number of years (periods) that the principal is borrowed or invested |
time |
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computed on the principal only |
simple interest |
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Simple interest formula |
principal x interest rate x time |
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computed on the principal and on any interest earned that has not been paid our or withdrawn |
compound interest |
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compound interest rate formula |
Interest factor * principal = balance |
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a dollar today is not worth the same as a dollar in ten years in the future and vice versa. |
significance of interest |
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is the value of an amount at a future date of a given amount invested assuming compound interest |
future value of a single amount |
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Whenever we take the principle and add the interest to it, we look at the... |
future value of 1 table (accumulated interest) |
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payments or receipts of equal amounts in each of the future periods |
annuity |
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For an annuity, what table do you go to? |
Future Value of an Ordinary Annuity Payments of One |
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the sum in the future of all of the payments (receipts) plus the accumulated compound interest on them |
future value of an annuity |
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Future value formula |
Deposit's Present value x (FV factor) |
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the amount of the value of the payments today |
present value |
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the sum today of all of the payments (receipts) minus the accumulated compound interest on them |
present value of an annuity |
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When we are talking about capital budgeting, we will be using... |
present value |
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Expect assets to last us more than one year... |
want to invest in assets that will pay for themselves |
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Ordinary annuity |
made at the end of the period |
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process of making decisions to purchase capital assest |
capital budgeting |
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Capital budgeting usually involves choosing... |
among various capital projects to find the one that will maximize a company's return on its financial investment |
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amount of real dollars that will be available or saved |
cash flows |
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Net Income adjusted for... |
Depreciation and other non-cash items |
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What is a cash flow also called? |
annual operating advantage operating advantage cost savings |
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Examples of outflows (4) |
initial investment repairs and maintenance increase operating costs overhaul of equipment |
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Examples of inflows |
sale of old equipment (trade-in) increased cash received from customers reduced cash outflows related to operating costs (savings) salvage value of equipment when project is complete. |
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the rate that a company must pay to obtain funds from creditors and stockholders |
cost of capital |
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What is the cost of capital also called? |
hurdle rate required rate of return discount rate cutoff rate |
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projects that are unrelated to one another, so investing in one does not preclude investment in the other |
independent projects |
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is a company that adopts one proposal it would be impossible to adopt another at the same time |
mutually exclusive |
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thorough evaluations of how well a project's actual performance matches the original projection |
post investment-audit |
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shows the profitability (net income) generated from the capital expenditure |
accounting (annual) rate of return |
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Formula for accounting rate of return |
expected net income/initial or average annual investment |
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Net income formula |
sales - expenses (includes depreciation) |
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Cash flows equation |
net income + depreciation |
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What is acceptable? |
annual rate of return > required rate of return |
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What is unacceptable? |
annual rate of return < required rate of return |
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Average investment = |
beginning of the year + end of the year/2 |
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What things go out? |
cash of the investment |
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What things go in? |
equal annual cash flow inflows salvage value |
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What things go either ? |
additional outlay or inflow |
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For all, look at... |
cost of the investment equal annual cash flows salvage value additional outlay or inflow |
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Cash payback... |
the amount of time it takes you to recoup your money (your investment) -talking just about the investment, not how much more beyond the investment |
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identifies the time period required to recover the cost of the capital investment from the annual cash flows produced by the investment |
cash playback |
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Formula for even cash flows |
investment/net annual cash inflow (NI + Depr. & +Amort) = number of years |
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For uneven cash flows... |
continue until total investment is recovered and then count the yesrs |
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Apportion a part of a year if necessary to...
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cover remaining investment (STOP AT ZERO) |
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Advantages of Cash Payback (2) |
easy to calculate shorter payback period than life of equipment acceptable (watch for other requirements) |
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2 Disadvantages of cash payback |
does not consider the time value of money ignores and cash inflows beyond the payback period |
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Investment/annual cash flow |
years to pay off |
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Accept if the payback is... |
shorter than the asset's life |
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Net Present Value considers... |
all the inflows and outflows and the time value of money |
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cash inflows are discounted to their present value and then compared with the capital outlay required by the investment |
net present value |
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Formula for present value of inflows |
cash inflows x PV factor (PVOA) + Any salvage value x PV factor (PV 1$) |
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formula for present value of the outflows |
Investment amount x 1@t + any additional outlay x PV factor |
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Net Present value= |
present value of inflows - PV of outflows |
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For NPV, accept the project if... |
NPV is positive |
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For NPV, reject the project if... |
NPV is negative |
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For NPV, indifferent if... |
NPV = 0 |
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Three advantages of NPV |
considers the time value of money considers all of the cash flows related to the investment tells whether the project should pay for itself |
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1 disadvantage of NPV |
does not rank the projects |
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We are not looking for the factors, we are looking for... |
the interest rate |
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Go to the life of the project and... |
go across that row only |
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determines the interest yield (rate of return) of the investment. |
Internal (Interest) rate of return |
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The internal rate of return is the rate that causes... |
the NPV of the project to be equal to zero |
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IRR = |
COC |
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Formula for even cash flows |
Investment/Annual Cash Inflows = Interest factor |
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Three steps for the interest factor |
Trace the factor to PVOA tables by going to the number of periods first and then trying to find the interest factor on that row only If found, read up to the interest rate at top of table If not found, look for factor larger and then smaller that that computed (left and right of amount on table). Interest is in between the two respective rates |
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Accept project is IRR... |
greater than cost of capital |
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Reject project if IRR... |
less than cost of capital. |
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Indifferent if IRR... |
equals the cost of capital |
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For uneven cash flows... |
not gonna happen in this class. |
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this method takes into account both the size of the original investment and the discounted cash flows |
profitability index (pi) |
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The PI ideally should be... |
one or greater |
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What does the PI tell you? |
the percent it will contribute |
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A PI greater than one tells us... |
that is pays for itself and contributes profit. |
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If PI is less than one... |
reject |
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Formula for PI |
PV of Cash Inflows/PV of investment (outflows) |
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What does a PI of less than one indicate? |
that the project will be a drain on current income |
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Two points for PI |
allows us to rank projects takes into account the time value of money |
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Four advantages of PI |
considers time value of money best tool for ranking projects considers all of the cash inflows and outflows related to the project Allows for comparing project with different initial investment (size) amounts |
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What is an alternate method for calculating PI |
NPV/investment |
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What does the alternate method do? |
gives you the number that adjusts the index of one |
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PI = |
1 + change (subtract if negative change) |
