Decision-Making in Capital Budgeting


business risk

possibility that a venture will not generate the expected profits

capital structure

manner in which a company funds the investments used to further its business goals, using debt, stocks, and retained earnings (net profits minus dividend payments)

degree of combined leverage (DCL)

ratio between a measure of a company's fixed and variable costs; a measure of a company's use of borrowed funds

degree of financial leverage (DFL)

measure of the effect of capital structure changes on the operating income of a company

degree of operating leverage (DOL)

measure of the change of a company's operating income with respect to change in sales

dividend payout ratio

ratio of the distribution of a corporation's earnings (in the form of cash, stock, or property) to the stockholders, divided by the net income of a company

earnings before interest and taxes (EBIT)

profit associated with operations

internal growth rate

maximum projected increase a company can sustain without getting outside financing such as loans and without selling bonds or stock

internal rate of return (IRR)

calculation of the discount that would make the net present value of the cash flow from an investment equal to that of the investment

market risk

systematic danger of loss because of the movement of greater economic influences

optimum debt/equity mix

best possible blend of long-term liabilities and equity in the capital structure to produce optimal earnings

risk and return trade-off

capital structure profile for the balance between the danger of loss and the income

standalone risk

danger of loss from a single capital structure, division, or unit decision

weighted average cost of capital (WACC)

formula for determining the relative average a company is expected to pay to all its security holders to finance its assets