arbitrage pricing

theory (APT)

An equilibrium asset pricing theory that is derived from a factor model by

using diversification and arbitrage. It shows that the expected return on any
risky asset is a linear combination of various factors.
(See page(s) 394)

beta coefficient

Amount of systematic risk present in a particular risky asset relative to an

average risky asset.
(See page(s) 382)

capital asset pricing

model (CAPM)

Equation of the SML showing relationship between expected return and beta.
(See page(s) 391)

cost of capital

The minimum required return on a new investment.

(See page(s) 393)

expected return

Return on a risky asset expected in the future.

(See page(s) 364)

market risk premium Slope of the SML, the difference between the expected return on a market
portfolio and the risk-free rate.
(See page(s) 391)
portfolio

Group of assets such as stocks and bonds held by an investor.

(See page(s) 367)

portfolio weight

Percentage of a portfolio's total value in a particular asset.

(See page(s) 367)

principle of
diversification

Principle stating that spreading an investment across a number of assets

eliminates some, but not all, of the risk.
(See page(s) 380)

security market line

(SML)

Positively sloped straight line displaying the relationship between expected

return and beta.
(See page(s) 390)

systematic risk

A risk that influences a large number of assets. Also market risk.

(See page(s) 377)

systematic risk
principle

Principle stating that the expected return on a risky asset depends only on
that asset's systematic risk.
(See page(s) 382)

unsystematic risk

A risk that affects at most a small number of assets. Also unique or assetspecific risks.
(See page(s) 377

efficient capital market

Market in which security prices reflect available information.

(See page(s) 352)

efficient markets
hypothesis (EMH)

The hypothesis is that actual capital markets, such as the TSE, are
efficient.
(See page(s) 353)

normal distribution

A symmetric, bell-shaped frequency distribution that can be defined by

its mean and standard deviation.
(See page(s) 349)

risk premium

The excess return required from an investment in a risky asset over a

risk-free investment.
(See page(s) 345)

standard deviation

The positive square root of the variance.

(See page(s) 346)

value at risk (VaR)

Statistical measure of maximum loss used by banks and other financial

institutions to manage risk exposures.
(See page(s) 350)

variance

The average squared deviation between the actual return and the
average return.
(See page(s) 346)

accounting break-even The sales level that results in zero project net income.
(See page(s) 314)
capital rationing The situation that exists if a firm has positive NPV projects but cannot find the
necessary financing.
(See page(s) 328)
cash break-even The sales level where operating cash flow is equal to zero.
(See page(s) 320)
contingency planning Taking into account the managerial options implicit in a project.
(See page(s) 325)
degree of operating leverage The percentage change in operating cash flow relative to the percentage
change in quantity sold.
(See page(s) 322)
financial break-even The sales level that results in a zero NPV.
(See page(s) 320)
fixed costs Costs that do not change when the quantity of output changes during a particular time
period.
(See page(s) 313)
forecasting risk The possibility that errors in projected cash flows lead to incorrect decisions.
(See page(s) 307)
hard rationing The situation that occurs when a business cannot raise financing for a project under any
circumstances.
(See page(s) 328)
managerial options Opportunities that managers can exploit if certain things happen in the future.
(See page(s) 325)
marginal or incremental cost The change in costs that occurs when there is a small change in output.
(See page(s) 314)
operating leverage The degree to which a firm or project relies on fixed costs.
(See page(s) 321)
scenario analysis The determination of what happens to NPV estimates when we ask what-if questions.
(See page(s) 309)
sensitivity analysis Investigation of what happens to NPV when only one variable is changed.
(See page(s) 310)
simulation analysis A combination of scenario and sensitivity analyses.
(See page(s) 312)
soft rationing The situation that occurs when units in a business are allocated a certain amount of

financing for capital budgeting.

(See page(s) 328)
strategic options Options for future, related business products or strategies.
(See page(s) 327)
variable costs Costs that change when the quantity of output changes.
(See page(s) 313)
capital cost
allowance (CCA)

Depreciation method under Canadian tax law allowing for the accelerated
write-off of property under various classifications.
(See page(s) 269)

depreciation (CCA)
tax shield

See CCA Tax Shield

(See page(s) 279)

equivalent annual
cost (EAC)

The present value of a project's costs calculated on an annual basis.

(See page(s) 288)

erosion

The portion of cash flows of a new project that come at the expense of a firm's
existing operations.
(See page(s) 267)

incremental cash
flows

The difference between a firm's future cash flows with a project and without
the project.
(See page(s) 266)

opportunity cost

The most valuable alternative that is given up if a particular investment is

undertaken.
(See page(s) 267)

pro forma financial

statements

Financial statements projecting future years' operations.

(See page(s) 269)

stand-alone
principle

Evaluation of a project based on the project's incremental cash flows.

(See page(s) 266)

sunk cost

A cost that has already been incurred and cannot be removed and therefore
should not be considered in an investment decision.
(See page(s) 266)
The costs associated with holding too little cash. Also shortage costs.
(See page(s) 573)

adjustment costs
debit card

An automated teller machine card used at the point of purchase to avoid the
use of cash. As this is not a credit card, money must be available in the user's
bank account.
(See page(s) 581)

dividend capture

A strategy in which an investor purchases securities to own them on the day of

record and then quickly sells them; designed to attain dividends but avoid the
risk of a lengthy hold.
(See page(s) 587)

float

The difference between book cash and bank cash, representing the net effect
of cheques in the process of clearing.
(See page(s) 575)

lockboxes

Special post office boxes set up to intercept and speed up accounts receivable
payments.
(See page(s) 580)

precautionary

The need to hold cash as a safety margin to act as a financial reserve.

motive

(See page(s) 572)

same day value

Bank makes proceeds of cheques deposited available the same day before
cheques clear.
(See page(s) 582)

smart card

Much like an automated teller machine card; one use is within corporations to
control access to information by employees.
(See page(s) 579)

speculative motive

The need to hold cash to take advantage of additional investment

opportunities, such as bargain purchases.
(See page(s) 572)

target cash balance A firm's desired cash level as determined by the trade-off between carrying
costs and shortage costs.
(See page(s) 573)
transaction motive

The need to hold cash to satisfy normal disbursement and collection activities
associated with a firm's ongoing operations.
(See page(s) 572)

zero-balance
account

A chequing account in which a zero balance is maintained by transfers of funds

from a master account in an amount only large enough to cover cheques
presented.
(See page(s) 583)

accounts payable period The time between receipt of inventory and payment for it.
(See page(s) 541)
accounts receivable financing A secured short-term loan that involves either the assignment or
factoring of receivables.
(See page(s) 558)
accounts receivable period The time between sale of inventory and collection of the receivable.
(See page(s) 541)
carrying costs Costs that rise with increases in the level of investment in current assets.
(See page(s) 546)
cash budget A forecast of cash receipts and disbursements for the next planning period.
(See page(s) 552)
cash cycle The time between cash disbursement and cash collection.
(See page(s) 541)
cash flow time line Graphical representation of the operating cycle and the cash cycle.
(See page(s) 541)
covenants A promise by the firm, included in the debt contract, to perform certain acts. A restrictive
covenant imposes constraints on the firm to protect the interests of the debtholder.
(See page(s) 558)
inventory loan A secured short-term loan to purchase inventory.
(See page(s) 560)
inventory period The time it takes to acquire and sell inventory.
(See page(s) 541)
letter of credit A written statement by a bank that money will be paid, provided conditions specified in
the letter are met.

(See page(s) 558)

maturity factoring Short-term financing in which the factor purchases all of a firm's receivables and
forwards the proceeds to the seller as soon as they are collected.
(See page(s) 559)
operating cycle The time period between the acquisition of inventory and when cash is collected from
receivables.
(See page(s) 541)
operating loan Loan negotiated with banks for day-to-day operations.
(See page(s) 557)
shortage costs Costs that fall with increases in the level of investment in current assets.
(See page(s) 546)
trust receipt An instrument acknowledging that the borrower holds certain goods in trust for the
lender.
(See page(s) 560)
clientele effect Stocks attract particular groups based on dividend yield and the resulting tax effects.
(See page(s) 520)
date of payment Date on the dividend cheques.
(See page(s) 510)
date of record Date on which holders of record are designated to receive a dividend.
(See page(s) 509)
declaration date Date on which the board of directors passes a resolution to pay a dividend.
(See page(s) 509)
distribution Payment made by a firm to its owners from sources other than current or accumulated
earnings.
(See page(s) 508)
dividend Payment made out of a firm's earnings to its owners, either in the form of cash or stock.
(See page(s) 508)
ex-dividend date Date two business days before the date of record, establishing those individuals
entitled to a dividend.
(See page(s) 509)
homemade dividends Idea that individual investors can undo corporate dividend policy by reinvesting
dividends or selling shares of stock.
(See page(s) 512)
information content effect The market's reaction to a change in corporate dividend payout.
(See page(s) 519)
regular cash dividend Cash payment made by a firm to its owners in the normal course of business,
usually made four times a year.
(See page(s) 508)
repurchase Another method used to pay out a firm's earnings to its owners, which provides more
preferable tax treatment than dividends.
(See page(s) 525)

residual dividend approach Policy where a firm pays dividends only after meeting its investment needs
while maintaining a desired debt-to-equity ratio.
(See page(s) 521)
reverse split Procedure where a firm's number of shares outstanding is reduced.
(See page(s) 529)
stock dividend Payment made by a firm to its owners in the form of stock, diluting the value of each
share outstanding.
(See page(s) 527)
stock split An increase in a firm's shares outstanding without any change in owner's equity.
(See page(s) 527)
stripped common shares Common stock on which dividends and capital gains are repackaged and sold
separately.
(See page(s) 512)
target payout ratio A firm's long-term desired dividend-to-earnings ratio.
(See page(s) 525)
trading range Price range between highest and lowest prices at which a stock is traded.
(See page(s) 529)
bankruptcy

A legal proceeding for liquidating or reorganizing a business. Also, the

transfer of some or all of a firm's assets to its creditors.
(See page(s) 496)

business risk

The equity risk that comes from the nature of the firm's operating
activities.
(See page(s) 482)

direct bankruptcy costs

The costs that are directly associated with bankruptcy, such as legal and
administrative expenses.
(See page(s) 487)

financial distress costs

The direct and indirect costs associated with going bankrupt or

experiencing financial distress.
(See page(s) 487)

financial risk

The equity risk that comes from the financial policy (i.e., capital
structure) of the firm.
(See page(s) 482)

homemade leverage

The use of personal borrowing to change the overall amount of financial

leverage to which the individual is exposed.
(See page(s) 477)

indirect bankruptcy
costs

The difficulties of running a business that is experiencing financial

distress.
(See page(s) 487)

interest tax shield

The tax saving attained by a firm from interest expense.

(See page(s) 483)

liquidation

Termination of the firm as a going concern.

(See page(s) 496)

M&M Proposition I

The value of the firm is independent of its capital structure.

(See page(s) 478)

M&M Proposition II

A firm's cost of equity capital is a positive linear function of its capital

structure.
(See page(s) 479)

reorganization

Financial restructuring of a failing firm to attempt to continue operations

as a going concern.
(See page(s) 496)

static theory of capital

structure

Theory that a firm borrows up to the point where the tax benefit from an
extra dollar in debt is exactly equal to the cost that comes from the
increased probability of financial distress.
(See page(s) 489)

unlevered cost of
capital
best efforts
underwriting

The cost of capital of a firm that has no debt.

(See page(s) 484)
Underwriter sells as much of the issue as possible, but can return any
unsold shares to the issuer without financial responsibility.
(See page(s) 448)

bought deal

One underwriter buys securities from an issuing firm and sells them
directly to a small number of investors.
(See page(s) 448)

dilution

Loss in existing shareholders' value, in either ownership, market value,

book value, or EPS.
(See page(s) 462)

ex rights

Period when stock is selling without a recently declared right, normally

beginning four business days before the holder-of-record date.
(See page(s) 460)

firm commitment
underwriting

Underwriter buys the entire issue, assuming full financial responsibility for
any unsold shares.
(See page(s) 448)

holder-of-record date

The date on which existing shareholders on company records are

designated as the recipients of stock rights. Also the date of record.
(See page(s) 460)

initial public offering

(IPO)

A company's first equity issue made available to the public. Also an

unseasoned new issue.
(See page(s) 447)

oversubscription
privilege

Allows shareholders to purchase unsubscribed shares in a rights offering

at the subscription price.
(See page(s) 461)

private placements

Loans, usually long term in nature, provided directly by a limited number

of investors.
(See page(s) 465)

prospectus

Legal document describing details of the issuing corporation and the

proposed offering to potential investors.
(See page(s) 446)

public issue

Creation and sale of securities on public markets.

(See page(s) 445)

red herring

Preliminary prospectus distributed to prospective investors in a new issue

of securities.
(See page(s) 446)

regular underwriting

The purchase of securities from the issuing company by an investment

banker for resale to the public.
(See page(s) 448)

seasoned new issue

A new issue of securities by a firm that has already issued securities in

the past.
(See page(s) 447)

spread

The gap between the interest rate a bank pays on deposits and the rate it
charges on loans.
(See page(s) 448)

standby fee

Amount paid to underwriter participating in standby underwriting

agreement.
(See page(s) 461)

standby underwriting

Agreement where the underwriter agrees to purchase the unsubscribed

portion of the issue.
(See page(s) 461)

syndicate

A group of underwriters formed to reduce the risk and help to sell an

issue.
(See page(s) 448)

syndicated loans

Loans made by a group of banks or other institutions.

(See page(s) 464)

term loans

Direct business loans of, typically, one to five years.

(See page(s) 464)

venture capital

Financing for new, often high-risk ventures.

(See page(s) 444)
Base case net present value of a project's operating cash flows plus
present value of any financing benefits.
(See page(s) 433)

adjusted present value

(APV)
cost of debt

The return that lenders require on the firm's debt.

(See page(s) 412)

cost of equity

The return that equity investors require on their investment in the firm.
(See page(s) 408)

economic value added

(EVA)

Performance measure based on WACC.

(See page(s) 417)

pure play approach

Use of a WACC that is unique to a particular project.

(See page(s) 419)

retention ratio

Retained earnings divided by net income. Also called the plowback ratio.
(See page(s) 410)

return on equity (ROE)

Net income after interest and taxes divided by average common

shareholders' equity.
(See page(s) 410)

weighted average cost of The weighted average of the costs of debt and equity.
capital (WACC)
(See page(s) 414)
average tax rate
Total taxes paid divided by total taxable income.
(See page(s) 37)
balance sheet

Financial statement showing a firm's accounting value on a particular

date.
(See page(s) 24)

capital cost allowance

(CCA)

Depreciation method under Canadian tax law allowing for the accelerated
write-off of property under various classifications.
(See page(s) 40)

capital gains

The increase in value of an investment over its purchase price.

(See page(s) 38)

cash flow from assets

The total of cash flow to bondholders and cash flow to stockholders,

consisting of the following: operating cash flow, capital spending, and
additions to net working capital.
(See page(s) 31)

cash flow to creditors

A firm's interest payments to creditors less net new borrowings.

(See page(s) 33)

cash flow to
shareholders

Dividends paid out by a firm less net new equity raised.

(See page(s) 33)

dividend tax credit

Tax formula that reduces the effective tax rate on dividends.

(See page(s) 37)

free cash flow

Another name for cash flow from assets.

(See page(s) 33)

generally accepted
accounting principles

The common set of standards and procedures by which audited financial

statements are prepared.
(See page(s) 27)

half-year rule

CCRA's requirement to figure CCA on only one half of an asset's installed

cost for its first year of use.
(See page(s) 40)

income statement

Financial statement summarizing a firm's performance over a period of

time.
(See page(s) 29)

loss carry-forward, carry-Using a year's capital losses to offset capital gains in past or future years.
back
(See page(s) 39)
marginal tax rate

Amount of tax payable on the next dollar earned.

(See page(s) 37)

net acquisitions

Total installed cost of capital acquisitions minus adjusted cost of any

disposals within an asset pool.
(See page(s) 41)

non-cash items

Expenses charged against revenues that do not directly affect cash flow,
such as depreciation.
(See page(s) 30)

operating cash flow

Cash generated from a firm's normal business activities.

(See page(s) 31)

realized capital gains

The increase in value of an investment converted to cash.

(See page(s) 38)

recaptured depreciation

The taxable difference between adjusted cost of disposal and UCC when
UCC is greater.
(See page(s) 41)

terminal loss

The difference between UCC and adjusted cost of disposal when UCC is
greater.

agency problem

(See page(s) 41)

The possibility of conflicts of interest between the stockholders and
management of a firm.
(See page(s) 10)

capital budgeting

The process of planning and managing a firm's investment in long-term

assets.
(See page(s) 3)

capital markets

Financial markets where long-term debt and equity securities are bought
and sold.
(See page(s) 16)

capital structure

The mix of debt and equity maintained by a firm.

(See page(s) 3)

corporate governance

Rules for corporate organization and conduct; rules and practices relating
to how corporations are governed by management, directors, and
shareholders.
(See page(s) 12)

corporation

A business created as a distinct legal entity owned by one or more

individuals or entities.
(See page(s) 6)

derivative securities

Securities whose returns depend on the price of an underlying asset and

that allow market participants to offset the exposure of their cash market
positions
(See page(s) 19)

financial engineering

Creation of new securities or financial processes.

(See page(s) 19)

money markets

Financial markets where short-term debt securities are bought and sold.
(See page(s) 16)

partnership

A business formed by two or more co-owners.

(See page(s) 6)

regulatory dialectic

The pressures financial institutions and regulatory bodies exert on each

other.
(See page(s) 20)

sole proprietorship

A business owned by a single individual.

(See page(s) 5)

stakeholder

Anyone who potentially has a claim on a firm.

(See page(s) 13)

working capital
management
ommon-base-year
statement

Planning and managing the firm's current assets and liabilities.

(See page(s) 5)
A standardized financial statement presenting all items relative to a
certain base year amount.
(See page(s) 57)

common-size statement A standardized financial statement presenting all items in percentage

terms. Balance sheets are shown as a percentage of assets and income
statements as a percentage of sales.
(See page(s) 56)
Du Pont identity

Popular expression breaking ROE into three parts: profit margin, total
asset turnover, and financial leverage.

(See page(s) 69)

sources of cash

A firm's activities that generate cash.

(See page(s) 53)

statement of cash flows

A firm's financial statement that summarizes its sources and uses of cash
over a specified period.
(See page(s) 54)

uses of cash

A firm's activities in which cash is spent. Also applications of cash.

(See page(s) 53)
Interest earned on both the initial principal and the interest reinvested
from prior periods.
(See page(s) 115)

ompound interest

compounding

The process of accumulating interest in an investment over time to earn

more interest.
(See page(s) 115)

discount

Calculate the present value of some future amount.

(See page(s) 122)

discount rate

The rate used to calculate the present value of future cash flows.
(See page(s) 123)

future value (FV)

The amount an investment is worth after one or more periods. Also

compound value.
(See page(s) 115)

interest on interest

Interest earned on the reinvestment of previous interest payments.

(See page(s) 115)

present value (PV)

The current value of future cash flows discounted at the appropriate

discount rate.
(See page(s) 121)

simple interest

Interest earned only on the original principal amount invested.

(See page(s) 115)
Process by which smaller investment proposals of each of a firm's
operational units are added up and treated as one big project.
(See page(s) 84)

aggregation

capital intensity ratio

A firm's total assets divided by its sales, or the amount of assets needed
to generate $1 in sales.
(See page(s) 90)

debt capacity

The ability to borrow to increase firm value.

(See page(s) 96)

dividend payout ratio

Amount of cash paid out to shareholders divided by net income.

(See page(s) 89)

internal growth rate

The growth rate a firm can maintain with only internal financing.
(See page(s) 95)

percentage of sales
approach

Financial planning method in which accounts are projected depending on

a firm's predicted sales level.
(See page(s) 88)

planning horizon

The long-range time period the financial planning process focuses on,
usually the next two to five years.
(See page(s) 84)

retention ratio or
plowback ratio

Retained earnings divided by net income. Also called the plowback ratio.
(See page(s) 89)

sustainable growth rate

The growth rate a firm can maintain given its debt capacity, ROE, and
retention ratio.
(See page(s) 96)

bearer form Bond issued without record of the owner's name; payment is made to whoever holds the
bond.
(See page(s) 182)
bond refunding The process of replacing all or part of an issue of outstanding bonds.
(See page(s) page 203)
call premium Amount by which the call price exceeds the par value of the bond.
(See page(s) 183)
call protected Bond during period in which it cannot be redeemed by the issuer.
(See page(s) 183)
call provision Agreement giving the corporation the option to repurchase the bond at a specified price
before maturity.
(See page(s) 183)
Canada plus call Call provision which compensates bond investors for interest differential making call
unattractive for issuer.
(See page(s) 183)
Canada yield curve A plot of the yields on Government of Canada bonds relative to maturity.
(See page(s) 194)
coupon rate The annual coupon divided by the face value of a bond.
(See page(s) 173)
coupons The stated interest payments made on a bond.
(See page(s) 172)
debenture Unsecured debt, usually with a maturity of 10 years or more.
(See page(s) 182)
default risk premium The portion of a nominal interest rate or bond yield that represents
compensation for the possibility of default.
(See page(s) 195)
deferred call Call provision prohibiting the company from redeeming the bond before a certain date.
(See page(s) 183)
face value or par value The principal amount of a bond that is repaid at the end of the term. Also par
value.
(See page(s) 172)
Fisher effect Relationship between nominal returns, real returns, and inflation.
(See page(s) 192)
indenture Written agreement between the corporation and the lender detailing the terms of the debt
issue.
(See page(s) 181)
inflation premium The portion of a nominal interest rate that represents compensation for expected
future inflation.

(See page(s) 193)

interest rate risk premium The compensation investors demand for bearing interest rate risk.
(See page(s) 193)
liquidity premium The portion of a nominal interest rate or bond yield that represents compensation
for lack of liquidity.
(See page(s) 195)
maturity date Specified date at which the principal amount of a bond is paid.
(See page(s) 173)
note Unsecured debt, usually with a maturity under 10 years.
(See page(s) 182)
protective covenant Part of the indenture limiting certain transactions that can be taken during the
term of the loan, usually to protect the lender's interest.
(See page(s) 183)
registered form Registrar of company records ownership of each bond; payment is made directly to
the owner of record.
(See page(s) 182)
retractable bond Bond that may be sold back (put) to the issuer at a prespecified price before maturity.
(See page(s) 188)
sinking fund Account managed by the bond trustee for early bond redemption.
(See page(s) 183)
stripped bond/zero-coupon bond A bond that makes no coupon payments, thus initially priced at a
deep discount.
(See page(s) 187)
term structure of interest rates The relationship between nominal interest rates on default-free, pure
discount securities and time to maturity; that is, the pure time value of money.
(See page(s) 193)
yield to maturity (YTM) The market interest rate that equates a bond's present value of interest
payments and principal repayment with its price.
(See page(s) 173)
capital gains yield The dividend growth rate or the rate at which the value of an investment grows.
(See page(s) 217)
common stock Equity without priority for dividends or in bankruptcy.
(See page(s) 219)
cumulative voting Procedure where a shareholder may cast all votes for one member of the board of
directors.
(See page(s) 233)
dividend growth model Model that determines the current price of a stock at its dividend next period,
divided by the discount rate less the dividend growth rate.
(See page(s) 214)
dividend yield A stock's cash dividend divided by its current price.
(See page(s) 217)

dividends Payment made out of a firm's earnings to its owners, either in the form of cash or stock.
(See page(s) 219)
preferred stock Stock with dividend priority over common stock, normally with a fixed dividend rate,
often without voting rights.
(See page(s) 221)
proxy Grant of authority by shareholder allowing for another individual to vote his or her shares.
(See page(s) 234)
straight voting Procedure where a shareholder may cast all votes for each member of the board of
directors.
(See page(s) 233)
average accounting return (AAR) An investment's average net income divided by its average book
value.
(See page(s) 244)
benefit/cost ratio The profitability index of an investment project.
(See page(s) 254)
discounted cash flow (DCF) valuation The process of valuing an investment by discounting its future
cash flows.
(See page(s) 238)
discounted payback period The length of time required for an investment's discounted cash flows to
equal its initial cost.
(See page(s) 243)
internal rate of return (IRR) The discount rate that makes the NPV of an investment zero.
(See page(s) 246)
multiple rates of return One potential problem in using the IRR method if more than one discount rate
makes the NPV of an investment zero.
(See page(s) 249)
mutually exclusive investment decisions One potential problem in using the IRR method if the
acceptance of one project excludes that of another.
(See page(s) 251)
net present value (NPV) A graphical representation of the relationship between an investment's NPVs
and various discount rates.
(See page(s) 237)
net present value profile A graphical representation of the relationship between an investment's NPVs
and various discount rates.
(See page(s) 247)
Nominal Rate of Interest Investment rate or rate of return that has not been adjusted for inflation.
(See page(s) 191)
payback period The amount of time required for an investment to generate cash flows to recover its
initial cost.
(See page(s) 241)
profitability index (PI) The present value of an investment's future cash flows divided by its initial cost.

ccounting break-even The sales level that results in zero project net income.
(See page(s) 314)
capital rationing

The situation that exists if a firm has positive NPV projects but cannot find
the necessary financing.
(See page(s) 328)

cash break-even

The sales level where operating cash flow is equal to zero.

(See page(s) 320)

contingency planning

Taking into account the managerial options implicit in a project.

(See page(s) 325)

degree of operating
leverage

The percentage change in operating cash flow relative to the percentage

change in quantity sold.
(See page(s) 322)

financial break-even

The sales level that results in a zero NPV.

(See page(s) 320)

fixed costs

Costs that do not change when the quantity of output changes during a
particular time period.
(See page(s) 313)

forecasting risk

The possibility that errors in projected cash flows lead to incorrect decisions.
(See page(s) 307)

hard rationing

The situation that occurs when a business cannot raise financing for a
project under any circumstances.
(See page(s) 328)

managerial options

Opportunities that managers can exploit if certain things happen in the

future.
(See page(s) 325)

marginal or
incremental cost

The change in costs that occurs when there is a small change in output.
(See page(s) 314)

operating leverage

The degree to which a firm or project relies on fixed costs.

(See page(s) 321)

scenario analysis

The determination of what happens to NPV estimates when we ask what-if

questions.
(See page(s) 309)

sensitivity analysis

Investigation of what happens to NPV when only one variable is changed.

(See page(s) 310)

simulation analysis

A combination of scenario and sensitivity analyses.

(See page(s) 312)

soft rationing

The situation that occurs when units in a business are allocated a certain
amount of financing for capital budgeting.
(See page(s) 328)

strategic options

Options for future, related business products or strategies.

(See page(s) 327)

variable costs

Costs that change when the quantity of output changes.

(See page(s) 313)