Deck 14: Risk in Project Analysis

Question 1

A risk-averse investor is one that given a choice between two investments with the same expected return would always prefer the less risky one.

Answer 1

True

Question 2

An elementary event consists of a number of composite events.

Answer 2

False

Question 3

A risk-neutral investor will choose the riskier of two investments with the same expected return, regardless of their risk.

Answer 3

False

Question 4

A composite event consists of all elementary events that satisfy a particular outcome.

Question 5

The expected value of an investment is found by multiplying each possible outcome by the probability that it will occur, then summing these values.

Question 6

Each event in a listing of all possible outcomes of a given situation is called an elementary event.

Question 7

In project analysis, the assumption usually made is that the decision maker is risk averse.

Question 8

A risk-neutral investor is indifferent between two investments with the same expected return, regardless of their risk.

Question 9

In probability analysis, the term "event" is used to designate an outcome.

Question 10

In project analysis, the assumption usually made is that the decision maker is a risk seeker.

Question 11

An event set consists of all elementary events that satisfy a particular outcome.

Question 12

A risk-return indifference curve shows combinations of increasingly risky investments with decreasing rates of return that are equally attractive to an investor.

Question 13

If we assume that the decision maker is risk-averse, then we can conclude that the economic nature of risk is that its presence increases the desirability of a given undertaking or investment project.

Question 14

An event's probability can be viewed as the odds that the event will occur or the percentage of times it will take place when a given set of circumstances is repeated many times.

Question 15

If we assume that the decision maker is risk-averse, then we can conclude that the economic nature of risk is that its presence lessens the desirability of a given undertaking or investment project.

Question 16

A subjective probability is a probability value that is assigned to an event by an investigator.

Question 17

A composite event consists of a number of elementary events.

Question 18

Each event in a listing of all possible outcomes of a given situation is called a composite event.

Question 19

A risk-return indifference curve shows combinations of risk and return that are equally attractive to an investor.

Question 20

A risk seeker is an investor that given a choice between two investments with the same expected return would always prefer the riskier one.

Question 21

Each event in a listing of all the possible outcomes of a given situation is called:

A) an event set.
B) a composite event.
C) an elementary event.
D) a probable event.
E) a subjective probability event.

Question 22

If we assume that the decision maker is risk-averse, then we can conclude that the economic nature of risk is that its presence will have the following effect on the desirability of a given undertaking or investment project.

A) Increase the desirability of a given undertaking or investment project.
B) Has no effect on the desirability of a given undertaking or investment project.
C) Lessen the desirability of a given undertaking or investment project.
D) Its presence is not related to the desirability of a given undertaking or investment project.
E) Increase the market efficiency of a given undertaking or investment project.

Question 23

The standard deviation, another measure of risk, is the square root of the variance.

Question 24

A investor that is given a choice between two investments with the same expected return and who always prefers the less risky one is said to be:

A) risk-averse.
B) a risk seeker.
C) risk-neutral.
D) risk indifferent.
E) risk efficient.

Question 25

The value of an investment that is found by multiplying each possible outcome by the probability that it will occur, then summing these values is called the:

A) expected value.
B) standard deviation.
C) variance.
D) normal distribution.
D) probability distribution.

Question 26

An efficient portfolio is a project or a combination of investments that will involve an acceptable level of risk for a given rate of return.

Question 27

A number of elementary events is called:

A) an event set.
B) a composite event.
C) an elementary event.
D) a probable event.
E) a subjective probability event.

Question 28

A continuous probability distribution would be represented by a bar graph and would not contain information on the probability values in between those value illustrated in the graph.

Question 29

A continuous probability distribution would be represented by a line rather than a bar graph and would contain information on the probability values associated with a wide range of possible payoffs.

Question 30

Use the following information to answer questions 10-12
A one year project has the following possible returns in relation to the percentage growth in personal income: The management of Roller King has determined the following subjective probabilities concerning the percentage growth in personal income:
What is the standard deviation of the inflows?

A) 4609.77
B) 5590.17
C) 6422.62
D) 7158.91
E) none of the above

Question 31

All elementary events that satisfy a particular outcome are called:

A) an event set.
B) a composite event.
C) an elementary event.
D) a probable event.
E) a subjective probability event.

Question 32

A probability value that is assigned to an event by an investigator.

A) an expected value.
B) a composite value.
C) an elementary value.
D) a subjective probability.
E) a subjective value.

Question 33

The variance of an investment is found by multiplying each possible outcome by the probability that it will occur, then summing these values.

Question 34

A investor that is indifferent between two investments with the same expected return, regardless of their risk is said to be:

A) risk-averse.
B) a risk seeker.
C) risk-neutral.
D) risk indifferent.
E) risk efficient.

Question 35

A investor that is given a choice between two investments with the same expected return and who always prefers the riskier one is said to be:

A) risk-averse.
B) a risk seeker.
C) risk-neutral.
D) risk indifferent.
E) risk efficient.

Question 36

Use the following information to answer questions 10-12
A one year project has the following possible returns in relation to the percentage growth in personal income: The management of Roller King has determined the following subjective probabilities concerning the percentage growth in personal income:
What is the variance of the inflows?

A) 21,250,00
B) 31,250,000
C) 41,250,000
D) 51,250,000
E) none of the above

Question 37

The variance, a measure of the dispersion of possible project outcomes, is one indicator of risk.

Question 38

Use the following information to answer questions 10-12
A one year project has the following possible returns in relation to the percentage growth in personal income: The management of Roller King has determined the following subjective probabilities concerning the percentage growth in personal income:
What is the Expected value of the cash inflow from the project?

A) 7,500
B) 12,500
C) 17,500
D) 22,500
E) 27,500

Question 39

An efficient portfolio is a project or a combination of investments that will involve the least risk for a given rate of return.

Question 40

The expected value, a measure of the dispersion of possible project outcomes, is one indicator of risk.

Question 41

A project, or combination of investments, that will involve the least risk for a given rate of return is:

A) a portfolio.
B) a diversified portfolio.
C) an efficient set.
D) an efficient portfolio.
E) a project portfolio.

Question 42

Use the following information to answer questions 13 - 15
The following data is on two one period capital projects.
What is the variance of each project's cash flow?

A) A = 25,500, B = 9,700
B) A = 50,100. B = 19,400
C) A = 75,200, B = 29,100
D) A = 100,200, B = 38,800
E) A = 125,400, B = 48,500

Question 43

The value of an investment that is found by taking the square root of the variance is called the:

A) expected value.
B) standard deviation.
C) standard value.
D) normal distribution.
D) probability distribution.

Question 44

For a normal distribution, the amount of the distribution that lies within plus or minus two standard deviations of the mean is approximately:

A) 68 percent.
B) 95 percent.
C) 98 percent.
D) 99 percent.
E) 64 percent.

Question 45

Genovese, Capone and Lansky, Inc., a small importer of virgin olive oil in the Chicago area, has two possible investment opportunities. The first is to expand in an area already being developed by the company. The expansion bribes to local officials, cement, bullets, legal and accounting fees, bribes to state officials, dead fish, old newspaper, white ties, spaghetti sauce, bribes to federal officials, wine, bullet proof cars, etc.) is expected to cost $498,000,000. As expenses of this size require two signatures, Ralphie "The Terminator" Franconi has called in his administrative assistant Vinnie "The Calculator" Melillo. Mr Melillo, a recent graduate of the Harvard Business School, also called in his father, Gennaro "The Slide Rule" Melillo, for some additional advice. After considerable time and effort, and the help of their "Big 6" outside auditors, they were able to arrive at a cash flow estimate. The accountants were a little confused as to how all that money was going to come from an operation that imported only 12 cases of olive oil in all of 1996. They were told to make believe it was 1985 and they were auditing an S & L - close their eyes, collect their fees and keep their mouths shut. They determined that the net cash inflows are expected to be $211,900,000 per year over the life of the project, which is 6 years. The other opportunity is to develop a relatively little known area of South Texas, the city of San Antonio. They believe growth resulting from NAFTA will create many opportunities in San Antonio. Due largely to the lower cost of bribing local officials, the project will cost only $315,000,000 and have net cash inflows of $152,540,000 per year for 6 years. Even with the political unrest in Chicago, Genovese, Capone and Lansky, Inc. realizes that it will be more risky to develop the property in South Texas due to the greater political instability of the area. The firm's executive committee, chaired by Guido "Boom Boom" Mezanotti, has assigned a risk adjusted discount rate of 32% to the South Texas project and 28% to the Chicago project since it believes that the Chicago project is less risky). However, due to the level of political unrest in both of the areas, and the growing movement toward term limitations in Chicago and the adoption of term limitations in San Antonio, management is unwilling to assign salvage values to either of the projects. Which project should Genovese's management accept if it can accomplish only one project out of this month's cash flows?

Question 46

Complete the following table.

A) 1.2, 1.2143, 1.1176, 1.2474, 1.2
B) 1.2, 1.1176, 1.2474, 1.2143, 1.2
C) .8333, .8947, .8235, .8017, .8333
D) .8333, .8235, .8947, .8017, .8333
E) None of the above

Question 47

A one year project has the following possible returns in relation to the percentage growth in personal income:

The management of Roller King has determined the following subjective probabilities concerning the percentage growth in personal income:

a. What is the expected value of the cash inflow from the project?
b. Determine the variance of the inflows.
c. Determine the standard deviation of the inflows

Question 48

Given the following data on two one period capital projects, calculate 1) the expected value of each project's cash flows and 2) the standard deviation of probable cash flows from each project. Indicate which of the two projects would be chosen by a risk-averse decision maker if their prices were the same and they had similar lives.

Question 49

Develop a set of certainty equivalent adjustment factors to 4 decimal places) from the following information. The data has been derived by the firm's management.

Question 50

Use the following information to answer questions 13 - 15
The following data is on two one period capital projects.
What is the expected value of each project's cash flow?

A) A = 630, B = 640
B) A = 640, B = 630
C) A = 3200, B = 3100
D) A = 3100, B = 3200
E) None of the above

Question 51

A continuous probability distribution would:

A) if symmetrically shaped about its mean or expected value, be called a normal distribution.
B) be represented by a line rather than a bar graph.
C) if we added up all of the probability values associated with its outcomes, yield a value of one for their cumulative probability and have a 100 percent probability that one of the outcomes will occur.
D) contain information on the probability values associated with a wide range of possible payoffs.
E) all of the above.

Question 52

Develop a set of certainty equivalent adjustment factors to 4 decimal places) from the following information. The data has been derived from the decision maker's preferences.

Question 53

Given the following data on two one period capital projects, calculate 1) the expected value of each project's cash flows and 2) the standard deviation of probable cash flows from each project. Indicate which of the two projects would be chosen by a risk-averse decision maker if their prices were the same and they had similar lives.

Question 54

The probability distribution that would be represented by a line rather than a bar graph and would contain information on the probability values associated with a wide range of possible payoffs would be called:

A) a discrete probability distribution.
B) an inverse probability distribution.
C) a direct probability distribution.
D) a continuous probability distribution.
E) a cumulative probability distribution.

Question 55

Use the following information to answer questions 13 - 15
The following data is on two one period capital projects.
What is the standard deviation of probable cash flows from each project?

A) A = 159.69, B = 98.49
B) A = 223.83, B = 139.28
C) A = 274.22, B = 170.59
D) A = 316.54, B = 196.98
E) A = 354.11, B = 220.22

Question 56

The value of an investment that is found by subtracting the expected value of the project from each possible outcome, squaring each of these values, multiplying each squared deviation by the probability of each respective outcome, and then summing the resulting products is called the:

A) expected value.
B) standard deviation.
C) variance.
D) normal distribution.
D) probability distribution.

Question 57

For a normal distribution, the amount of the distribution that lies within plus or minus one standard deviation of the mean is approximately:

A) 68 percent.
B) 95 percent.
C) 98 percent.
D) 99 percent.
E) 64 percent.