11.8: Glossary

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GLOSSARY

Annuity A series of equal cash inflows.

Capital budgeting The process of considering alternative capital projects and selecting those alternatives that provide the most profitable return on available funds, within the framework of company goals and objectives.

Capital project Any available alternative to purchase, build, lease, or renovate equipment, buildings, property, or other long-term assets.

Cost of capital The cost of all sources of capital (debt and equity) employed by a company.

Initial cost of an asset Any cash outflows necessary to acquire an asset and place it in a position and condition for its intended use.

Net cash inflow The periodic cash inflows from a project less the periodic cash outflows related to the project.

Net present value A project selection technique that discounts all expected after-tax cash inflows and outflows from the proposed investment to their present values using the company’s minimum rate of return as a discount rate. If the amount obtained by this process exceeds or equals the investment amount, the proposal is considered acceptable for further consideration.

Opportunity cost The benefits or returns lost by rejecting the best alternative investment.

Out-of-pocket cost A cost requiring a future outlay of resources, usually cash.

Payback period The period of time it takes for the cumulative sum of the annual net cash inflows from a project to equal the initial net cash outlay.

Profitability index The ratio of the present value of the expected net cash inflows (after taxes) divided by the initial cash outlay (or present value of cash outlays if future outlays are required).

Sunk costs Costs that have already been incurred. Nothing can be done about sunk costs at the present time; they cannot be avoided or changed in amount.

Time-adjusted rate of return A project selection technique that finds a rate of return that will equate the present value of future expected net cash inflows (after taxes) from an investment with the cost of the investment; also called internal rate of return.

Unadjusted (or accounting) rate of return The rate of return computed by dividing average annual income after taxes from a project by the average amount of the investment.