IFMP Capital Budgeting – Corporate Finance Certification (CBCFC), Pakistan key terms

The process of evaluating long-term investment projects, deciding which to accept, and allocating scarce funds among them so that firm value rises.

The sum of a project's expected cash flows discounted at the required rate of return, minus the initial outlay; a positive value means the project adds wealth.

The discount rate at which a project's NPV equals zero; it is compared with the hurdle rate to decide acceptance, but can mislead when cash flows change sign.

The time needed for cumulative cash inflows to recover the original investment, ignoring the time value of money; a simple liquidity screen rather than a value measure.

The number of periods required for the present value of cash inflows to equal the initial outlay, so the measure accounts for the cost of capital.

The present value of a project's future cash flows divided by its initial investment; a ratio above one indicates an acceptable project and helps rank projects under rationing.

The rate used to convert future cash flows into present value, reflecting the time value of money and the project's risk; often the firm's weighted average cost of capital.

The minimum required return a project must earn to be acceptable, set by management and usually at or above the firm's cost of capital.

The change in the firm's total cash flow caused by accepting a project, measured against the no-project scenario and excluding sunk costs and financing charges.

A cost already incurred that cannot be recovered regardless of the decision, so it must be ignored when evaluating a project's incremental cash flows.

The value of the best alternative forgone when a resource is used in a project, such as rental income lost when owned premises are used for a new venture.

The loss of sales on existing products caused by a new product, which must be treated as a cost when estimating the new project's incremental cash flows.

The reduction in cash flows from existing operations attributable to a new investment; it is deducted from the new project's benefits in the analysis.

The additional inventory, receivables, and cash needed to support a project, net of payables; it is an initial outflow recovered when the project ends.

The estimated value of a project's cash flows beyond the explicit forecast horizon, or the salvage and working capital recovery at the end of the project's life.

The expected resale or scrap proceeds from an asset at the end of its useful life, adjusted for tax effects on any gain or loss relative to book value.

The tax saving created by deducting depreciation from taxable income, equal to the depreciation charge multiplied by the tax rate; a non-cash expense with cash value.

The situation where a firm has more acceptable projects than funds available, forcing it to select a subset; soft rationing is self-imposed, hard rationing comes from external constraints.

Projects that compete for the same resources, so accepting one rules out the others; ranking conflicts between NPV and IRR matter most here.

The discount rate at which two mutually exclusive projects have equal NPV; above or below it, the ranking of the projects by NPV reverses.

A situation where a project's cash flows change sign more than once, producing more than one discount rate at which NPV equals zero, making IRR unreliable.

A variant of IRR that assumes inflows are reinvested at the cost of capital and outflows are financed at that rate, yielding a single unambiguous rate.

The constant annual cash flow over a project's life that has the same present value as the project, used to compare alternatives with unequal lives.

The average after-tax cost of the firm's debt and equity, weighted by their market-value proportions; it is the standard discount rate for average-risk projects.

The return shareholders require on their investment, often estimated with the capital asset pricing model or the dividend growth model.

The effective after-tax rate a firm pays on borrowed funds, calculated as the interest rate times one minus the corporate tax rate.

A model that estimates required return as the risk-free rate plus beta times the market risk premium, linking systematic risk to expected return.

A measure of a security's or project's sensitivity to market movements; a beta above one indicates more systematic risk than the market average.

Risk that affects the whole market and cannot be removed by diversification, such as interest rate or inflation shocks; it is the risk that earns a premium.

Firm-specific or project-specific risk that can be largely eliminated through diversification, so investors are not compensated for bearing it.

Spreading investment across many assets so that firm-specific risks offset each other, leaving only market-wide risk in a well-diversified portfolio.

Evaluating a project under several coherent sets of assumptions, such as best, base, and worst cases, to see how outcomes vary with combined changes.

Testing how NPV responds to changing one input at a time, such as sales volume or price, to identify which variables most affect the decision.

A probabilistic technique, commonly Monte Carlo, that draws many random combinations of input values from assumed distributions to build a distribution of project NPVs.

The right, but not obligation, to alter a project later, such as to expand, delay, or abandon it; this flexibility has value that static NPV may ignore.

The right to stop a project and recover its salvage value if results are poor, which reduces downside risk and raises the project's effective value.

The firm's formal plan listing approved investment projects and the funds allocated to each over a planning period, usually aligned with strategic priorities.

The choice of whether to replace an existing asset with a newer one, based on comparing the incremental costs and benefits of the replacement.

Nominal cash flows include expected inflation while real cash flows are stated in today's prices; the discount rate must match the cash flow basis used.