adjusted present value (APV), 83, 86–87

definition, 86

arbitrage pricing theory (APT), 45, 103

concept of, 45–46

book cost, 14

book value, 14, 24, 80

breakeven

definition, 113

labour intense vs. capital intense, 113f, 114

point, 114, 123

capital asset pricing model (CAPM), 36, 40–41, 42f, 68, 84

advantage of, 46

arbitrage pricing theory, 45

asset class, 42, 44, 53, 58, 69, 87

and beta estimation, 45, 66, 68, 70

capital assets, 42

and cost of capital, 40

and individual projects, 64–67

and risk-free rate, 43

theory of, 41–42

capital budget, 2, 13, 15, 21, 30, 31, 32, 36, 39, 48, 53, 57, 65, 69, 74, 78, 88, 92, 103, 133. See also capital; capital rationing; real option analysis

budgeting processes in, 52, 55, 56

capital allocation, 54–56

capital asset liquidity, 53–54

capital charge in, 31

expense vs. investment, 32, 33

vs. operating budget, 30, 35, 36, 37

risk adjustment in, 87–89

capital project, 2, 13, 15, 21 31, 32, 36, 39, 48, 53, 65, 69, 74, 78, 92, 103, 133. See also capital budget; corporate budget

breakeven, 113–114

economy of scale, 111–113, 121

and free cash flow, 81–84

funding of, 31

and net present value, 103

and option purchase, 106

option types, 115

real option analysis

advantages of, 104

disadvantages of, 104–105

financial logic in, 103

in decision making, 103

phasing and scheduling, 103

real option pricing, 103

underinvestment problem, 107–109

risk-neutral pricing, 110–111

stages in, 95–96

capital rationing

cost of capital in, 57

need for, 57, 59

profitability index, 60–61

project ranking for, 59–60

use of hurdle rate in, 58–59

capital risk, 16, 40

capital structure, 17, 18, 22, 27, 33, 37, 64, 108. See also weighted average cost of capital

and bond, 18, 19

cost of capital, 18

debt risk, 18

equity vs. debt financing, 18

goal of, 23

capital, 2, 3, 4, 5, 10, 12, 16, 17, 21, 34, 35, 37, 39, 46, 57, 58, 133. See also capital budget; capital rationing

definition, 2

equity owner vs. bond creditor, 7

ownership, 3, 4, 7, 8

and resource cost, 3

capitalism, 2, 4, 6, 8, 11, 16, 133, 134

and economic value-added, 6, 134

corporate budget

capital charge in, 31

capital vs. operating, 30, 36, 37, 82

investment vs. expense, 32, 33

project capital, 31

corporate portfolio, 5, 6, 97

corporate strategy, 1, 5, 22, 37, 57

corporation, 3, 4, 5, 6, 8, 18, 21, 26, 30, 33, 40, 64, 68

and board of directors, 3

and capital, 33

and economic value-added, 6

and hurdle rate, 68

and master budget, 30

and ownership, 3, 4

cost of capital, 3, 7, 11, 17, 18, 19, 21, 24, 27, 31, 40, 48, 52, 56, 65, 86

capital appreciation, 20

and capital asset pricing model, 40–41

definition, 21

and discount rate, 22

dividend, 7

interest expense, 7

and liquidity risk, 19

and principal risk, 20

and return risk, 20

weighted average cost of capital, 22–23

cost of debt, 38

capital risk, 40

components in, 38–39

and inflation, 39

risk-free rate, 38–39

debt financing, 17, 18, 53, 64, 69

discount rate, 22, 49, 52, 56, 58, 64, 74, 76, 89, 110

and beta risk , 66, 69, 70

for corporate divisions, 69–70

and individual project, 64

and net present value, 65

risk adjusted discount rate,
67–69, 76

discounted cash flow (DCF),
47, 48, 73

and cost of capital, 48

and depreciation, 78–81

and discount rate, 48, 74

and internal rate of return, 51–53

and net present value, 48–49, 74–75

net present value vs. future value, 75

net present value vs. internal rate of return, 75–76

principle, 48

project return, 74, 75

sales revenue, 74

economic profit. See economic
value-added (EVA)

economic value-added (EVA),
5, 6, 9, 12, 14, 16, 21,
31, 37, 40, 77. See also free cash flow; project economic value-added

and after-tax cash flow, 10

as a financial measure, 9

and book value, 14

equity owners vs. bond creditors, 7

vs. market value-added, 12

need of annual report for construction of, 6–8

residual income, 11–12

shot-term cash flow in, 11

economy of scale, 121

as a economic potential measure, 112

and average total cost, 112

breakeven, 113–114, 123

capital intensity, 114–115

definition, 111

and fixed cost, 111, 112

issues with, 112

and total cost, 111

economy, capitalist, 2, 55, 133

capitalism, 2, 133, 134

and ownership, 3, 4

equity, 10, 17, 18, 22, 23, 26, 27, 31, 40, 43, 64, 70, 83, 86, 109

free cash flow (FCF), 8, 11, 14, 22, 34, 58, 91, 134

adjusted present value, 83

as a business success measure, 8, 81

concept of, 82

vs. operating cash flow, 82

future value (FV), 75

Generally Accepted Accounting Principles (GAAP), 13, 30, 79

historical cost, 13, 14

hurdle rate, 36, 43, 56, 58, 64, 69, 87, 107, 134

as a rationing tool, 58–59

cost of debt in, 38

cost of equity in, 40–43

definition, 36

and financial strategy, 37

hybrid investments, 46–47

and operating budget, 37

and productivity, 37

hybrid investments, 46–47

convertibles, 46

preferred stocks, 46

internal rate of return (IRR), 37, 58

advantage of using, 76

issue with, 75–76

and net present value, 52, 75–76, 77

investment bubble, 1

market capitalization, 1, 2, 12

market cost, 14

market value, 14, 24, 38

and opportunity cost, 14, 15, 20

market value-added (MVA), 12

vs. economic value-added, 12

master budget, 30, 82

capital budget, 30, 36

operating budget, 30, 32, 35, 37

Musk, Elon, 2, 34, 130, 133, 134

net present value (NPV), 37, 48–49, 58, 61, 65, 69, 75, 76–77, 86, 103, 126

compound interest in, 51

and discount rates, 49, 51

and interest rate, 48, 49

vs. internal rate of return, 75–76, 77

pitfalls in application of, 109

and risk-adjusted discount rate, 76

role of inflation in, 49, 51

opportunity cost, 14, 15, 20, 21, 23, 53

payback, 15, 78

concept of margin in, 91

definition, 90

issues with, 91, 92

period, 90f, 93

use of, 90

profitability index (PI), 60–61

project economic value-added (EVA), 85–86

vs. corporate economic value-added, 85

flaws in, 85, 86

project net present value, 86

project stakeholders, 8, 10, 18, 24

real option analysis, 102

advantages of, 104

disadvantages of, 104–105

financial logic in, 103

for capital budgeting, 108

in decision making, 103

in risk-neutral pricing, 110–111

option types

growth options, 127–128

option to abandon, 126–127

option to alter operating scale, 121–124

option to defer, 117–118, 120–121

option to switch, 124–126

rainbow options, 130

time-to-build, 115–117

phasing and scheduling, 103

real option pricing, 103

and underinvestment problem, 107–109

reasons for, 108

relevant cash flow, 71

asset depreciation and retirement, 73

life cycle costs, 72

maintenance and upkeep expenses, 71–72

nature of, 71

role of capital assets, 72

residual income, 11, 12

return on investment (ROI), 12, 16, 20, 32, 36, 43, 75

vs. economic value-added, 13

definition, 13, 32

risk adjustment

in capital budget, 87–88

components in, 88

risk-adjusted discount rate (AADR), 76, 89–90

parts of, 89–90

process in

beta estimation by capital asset pricing model, 68–69

project categories for investment, 67–68

project net present value and ranking, 69

risk class vs. unique project risks, 67

risk-free rate, 38, 40, 41, 42, 65, 89, 110

and inflation, 39

risk-neutral pricing

benefit of, 110

and real option analysis, 110

Tesla, 1, 2, 7, 17, 18, 24, , 40, 46, 51, 53, 84, 86, 87, 91, 97, 105, 108, 115, 118, 124, 129, 133, 134

value chain, 6, 125

weighted average cost of capital (WACC), 22, 27, 31, 37, 40, 56, 58, 64, 68, 69, 70, 84, 90

and cost of debt, 40

and debt, 23

debt-to-equity ratio, 23

estimation of, 24, 25