### payback period

The amount of time required for a firm to recover its initial investment in a project, as calculated from cash inflows.

### net present value (NPV)

A sophisticated capital budgeting technique; found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.

### internal rate of return (IRR)

A sophisticated capital budgeting technique; the discount rate that equates eh NPV of an investment opportunity with $0 (because the present value of cash inflows equals the initial investment); it is the compound annual rate of return that the firm will earn if it invests in the project and receives the given cah inflows.

### conflicting rankings

Conflicts in the ranking given a project by NPV and IRR, resulting from differences in the magnitude and timing of cash flows.

### multiple IRRs

More than one IRR resulting from a capital budgeting project with a nonconventional cash flow pattern; the maximum number of IRRs for a project is equal to the number of sign changes in its cash flows.

### real options

Opportunities that are embedded in capital projects that enable managers to alter their cash flows and risk in a way that affects project acceptability (NPV). Also called strategic options.

### internal rate of return approach

An approach to capital rationing that involves graphing project IRRs in descending order against the total dollar investment to determine the group of acceptable projects.

### investment opportunities schedule (IOS)

The graph that plots project IRRs in descending order against the total dollar investment.

### net present value approach

An approach to capital rationing that is based on the use of present values to determine the group of projects that will maximized owners' wealth.

### risk (in capital budgeting)

The chance that a project will prove unacceptable or, more formally, the degree of variability of cash flows.

### decision trees

A behavioral approach that uses diagrams to map the various investment decision alternative and payoffs, along with their probabilities of occurrence.

### simulation

A statistics-based behavioral approach that applies predetermined probability distributions and random numbers to estimate risky outcomes.

### exchange rate risk

The danger that an unexpected change in the exchange rate between the dollar and the currency in which a project's cash flows are denominated will reduce the market value of that project's cash flow.

### transfer prices

Prices that subsidiaries charge each other for the goods and services traded between them.