Term
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Definition
| One of the types of capital used by firms to raise funds. |
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Term
| Weighted Average Cost of Capital (WACC) |
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Definition
| A weighted average of the component costs of debt, preferred stock, and common equity. |
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Term
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Definition
| The interest rate the firm must pay on new debt. |
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Term
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Definition
| The relevant cost of new debt, taking into account the tax deductibility of interest; used to calculate the WACC. |
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Term
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Definition
| The rate of return investors require on the firm's preferred stock. Cost of preferred stock is calculated as the preferred dividend divided by the current price. |
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Term
| Cost of Retained Earnings |
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Definition
| The rate of return required by stockholders on a firm's common stock. |
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Term
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Definition
| The cost of external equity based on the cost of retained earnings but increased for flotation costs. |
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Term
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Definition
| The percentage cost of issuing new common stock. |
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Term
| Flotation Cost Adjustment |
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Definition
| The amount that must be added to cost of retained earnings to account for flotation costs to find cost of new common stock. |
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Term
| Retained Earnings Breakpoint |
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Definition
| The amount of capital raised beyond which new common stock must be issued. |
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Term
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Definition
| The process of planning expenditures on assets with cash flows that are expected to extend beyond one year. |
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Term
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Definition
| A long-run plan that outlines in broad terms the firm's basic strategy for the next 5 to 10 years. |
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Term
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Definition
| A method of ranking investment proposals using the NPV, which is equal to the present value of future net cash flows, discounted at the cost of capital. |
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Term
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Definition
| Projects with cash flows that are not affected by the acceptance or nonacceptance of other projects. |
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Term
| Mutually Exclusive Projects |
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Definition
| A set of projects where only one can be accepted. |
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Term
| Internal Rate of Return (IRR) |
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Definition
| The discount rate that forces a project's NPV to equal zero. |
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Term
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Definition
| The situation where a project has two or more IRRs. |
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Term
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Definition
| The discount rate at which the present value of a project's cost is equal to the present value of its terminal value, where the terminal value is found as the sum of the future values of the cash inflows, compounded at the firm's cost of capital. |
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Term
| Net Present Value Profile |
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Definition
| A graph showing the relationship between a project's NPV and the firm's cost of capital. |
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Term
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Definition
| The cost of capital at which the NPV profiles of two projects cross and thus, at which he projects' NPVs are equal. |
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Term
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Definition
| The length of time required for an investment's net revenues to cover its cost. |
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Term
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Definition
| The length of time required for an investment's cash flows, discounted at the investment's cost of capital, to cover its cost. |
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Term
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Definition
| A cash flow that will occur if an only if the firm takes on a project. |
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Term
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Definition
| A cash outlay that has already been incurred and that cannot be recovered regardless of whether the project is accepted or rejected. |
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Term
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Definition
| The best return that can be earned on assets the firm already owns id those assets are not used for the new project. |
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Term
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Definition
| An effect on the firm or the environment that is not reflected in the project's cash flows. |
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Term
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Definition
| The situation when a new project reduces cash flows that the firm would otherwise have had. |
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Term
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Definition
| The risk an asset would have if it were a firm's only asset and if investors owned only one stock. It is measured by the variability of the asset's expected returns. |
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Term
| Corporate (Within-Firm) Risk |
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Definition
| Risk considering the firm's diversification but not stockholder diversification. It is measured by a project's effect on uncertainty about the firm' expected future returns. |
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Term
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Definition
| Considers both firm and stockholder diversification. It is measured by the project's beta coefficient. |
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Term
| Risk-Adjusted Cost of Capital |
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Definition
| The cost of capital appropriate for a given project, given the riskiness of the project. The greater the risk, the higher the cost of capital. |
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Term
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Definition
| Percentage change in NPV resulting from a given percentage change in an input variable, other things held constant. |
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Term
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Definition
| The NPV when sales and other input variables are set equal to their most likely (or base-case) values. |
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Term
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Definition
| A risk analysis technique in which "bad" and "good" sets of financial circumstances are compared with a most likely, or base-case, situation. |
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Term
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Definition
| An analysis in which all of the input variables are set at their most likely values. |
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Term
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Definition
| An analysis in which all of the input variables are set at their worst reasonable forecasted values. |
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Term
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Definition
| An analysis in which all of the input variables are set at their best reasonably forcasted values. |
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Term
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Definition
| A risk analysis technique in which probable future events are simulated on a computer, generating, estimated rates of return and risk indexes. |
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Term
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Definition
| The right but not the obligation to take some action in the future. |
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Term
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Definition
| The option to abandon a project if operating cash flows turn out to be lower than expected. This option can raise expected profitability and lower project risk. |
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Term
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Definition
| A diagram that lays out different branches that are the result of different decisions made or the result of different economic situations. |
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Term
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Definition
| The difference between the expected NPVs with and without the relevant option. It is the value that is not accounted for in a traditional NPV analysis. A positive option value expands the firm's opportunities. |
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Term
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Definition
| The annual investment in long-term assets that maximizes the firm's value. |
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Term
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Definition
| The situation in which a firm can raise only a specified, limited amount of capital regardless of how many good projects it has. |
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Term
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Definition
| A comparison of actual versus expected results for a given capital project. |
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Term
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Definition
| The specified life of assets under the MACRS system. |
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Term
| Annual Depreciation Rates |
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Definition
| The annual expense accountants charge against income for "wear and tear" of an asset. For tax purposes, the IRS provides that appropriate MACRS rates be used that are dependent on an asset's class life. |
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Term
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Definition
| Assumes assets are used for half the first year and half the last year. |
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Term
| Optimal Capital Structure |
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Definition
| The capital structure that maximizes a firm's stock price. |
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Term
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Definition
| The mix of debt, preferred stock, and common equity the firm wants to have. |
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Term
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Definition
| The riskiness inherent on the firm's operations if it uses no debt. |
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Term
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Definition
| The extent to which fixed costs are used in a firm's operations. |
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Term
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Definition
| The ouptut quantity at which EBIT = 0. |
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Term
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Definition
| An increase in stockholder's risk, over and above the firm's basic business risk, resulting from the use of financial leverage. |
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Term
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Definition
| The extent to which fixed-income securities (debt and preferred stock) are used in a firm's capital structure. |
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Term
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Definition
| The firm's beta coefficient if it has no debt. |
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Term
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Definition
| The capital structure theory that states that firms trade off the tax benefits of debt financing against problems caused by potential bankruptcy. |
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Term
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Definition
| The situation where investors and managers have identical information about firms' prospects. |
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Term
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Definition
| The situation where managers have different (better) information about firms' prospects than investors. |
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Term
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Definition
| An action taken by a firm's management that provides clues to investors about how management views the firm's prospects. |
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Term
| Reserve Borrowing Capacity |
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Definition
| The ability to borrow money at a reasonable cost when good investment opportunities arise. Firms often use less debt than specified by the MM optimal capital structure in "normal" times to ensure that they can obtain debt capital later if necessary. |
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