Deck 10: Project Analysis

Question 1

Financial Calculator Company proposes to invest $12 million in a new calculator making plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of capital is 20%, what is the break-even level of annual rates? (Approximately)(Assume no taxes.)

A) 150,000 units
B) 342,290 units
C) 381,777 units
D) None of the above

Answer 1

381,777 units

Question 2

Firms often calculate a project's break-even sales using book earnings. Generally, break- even sales based on NPV is:

A) Higher than the one calculated using book earnings
B) Lower than the one calculated using book earnings
C) Equal to the one calculated using book earnings
D) None of the above

Answer 2

Higher than the one calculated using book earnings

Question 3

A firm's capital investment proposals should reflect:
I. Capital budgeting process
II. Strategic planning process
III. Middle managers' ideas and views

A) I only
B) I and II only
C) I, II, and III
D) III only

Answer 3

I and II only

Question 4

Generally, postaudits for projects are conducted:
I. to identify problems that need fixing
II. to check the accuracy of forecasts
III. to come up with questions that should have been asked before the project was undertaken

A) I only
B) II only
C) I and II only
D) I, II, and III

Question 5

Discounted cash flow (DCF) analysis generally:
I. assumes that firms hold assets passively when it invests in a project
II. considers opportunities to expand a project if the project is successful
III. considers opportunities to abandon a project if the project is a failure

A) I only
B) II only
C) II and III only
D) I, II, and III

Question 6

You are given the following data for year-1. Revenue = $43; Total costs = $30; Depreciation = $3; Tax rate = 30%. Calculate the operating cash flow for the project for year-1)

A) $7
B) $10
C) $13
D) None of the above

Question 7

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 15%. What would the NPV of the project be if the revenues were higher by
10% and the costs were 65% of the revenues?

A) $8443
B) $964
C) $5566
D) None of the above

Question 8

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 15%. Cash flows from the project are:

A) CF0: -90,000; CF1: 12,600; CF2: 12,600; CF3: 29,600
B) CF0: -100,000; CF1: 42,600; CF2: 42,600; CF3: 59,600
C) CF0: -100,000; CF1: 42,600; CF2: 42,600; CF3: 42,600
D) none of the above

Question 9

Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for $20/unit. If the plant lasts for 3 years and the cost of capital is12%, what is the approximate break-even level of annual sales? (Assume no taxes.)(approximately)

A) $133,333 units
B) $272,117 units
C) $227,533 units
D) None of the above

Question 10

The following are drawbacks of sensitivity analysis except:

A) it provides ambiguous results.
B) underlying variables are likely to be interrelated.
C) it provides additional information about the project that is useful.
D) all of the above statements are drawbacks of sensitivity analysis.

Question 11

A project has the following cash flows: C0 = -100,000; C1 = 50,000; C2 = 150,000; C3 =100,000. If the discount rate changes from 12% to 15%, what is the change in the NPV of the
Project (approximately)?

A) 12,750 increase
B) 12,750 decrease
C) 122,650 increase
D) 135,400 decrease

Question 12

Generally, postaudits are conducted for large projects:

A) shortly after the completion of the project
B) after several years after the completion of the project
C) shortly after the project has begun to operate
D) well before the start of the project

Question 13

You are given the following data for year-1: Revenues = 100, Fixed costs = 30; Total variable costs = 50; Depreciation = $10; Tax rate = 30%. Calculate the after tax cash flow for the project for year-1.

A) $17
B) $7
C) $10
D) None of the above

Question 14

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 12%. Calculate the NPV of the project:

A) 14,418
B) 8443
C) -2735
D) None of the above

Question 15

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 15%. What would the NPV if the discount rate were higher by 10%?

A) $5648
B) $3840
C) -$2735
D) None of the above

Question 16

You have come up with the following estimates of project cash flows:
$$\begin{array} { l c c c } & \text { Pessimistic } & \text { Most Likely } & \text { Optimistic } \\\text { Investments } & - 100 & - 80 & - 60 \\\text { Total Revenues } & + 30 & + 40 & + 50 \\\text { Total Costs } & - 20 & - 15 & - 10\end{array}$$
The cash flows are perpetuities and the cost of capital is 8%. What does a sensitivity analysis of NPV (without taxes) show?

A) 25, +232.50, +440
B) -100, +500, +800
C) -90, -55, -20
D) None of the above

Question 17

A project has an initial investment of 100. You have come up with the following estimates of the projects with cash flows.
$$\begin{array} { l r c c } &\text { Pessimistic NPV } & \text { Most Likely } & \text { Optimistic } \\\text { Revenues } & 15 & 20 & 25 \\\text { Costs } & - 10 & - 8 & - 5\end{array}$$
If the cash flows are perpetuities and the cost of capital is 10%. What does a sensitivity analysis of NPV (no taxes) show?

A) -50, 20, +100
B) -100, -50, +80
C) -50, +50, +70
D) None of the above

Question 18

A project requires an initial investment in equipment of $90,000 and then requires an investment in working capital of $10,000 at the beginning (t = 0). The project is expected to produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the cost of capital is 15%. Calculate the NPV of the project:

A) 3840
B) 8443
C) -2735
D) None of the above

Question 19

Which of the following statements most appropriately describes "Scenario Analysis".

A) it looks at the project by changing one variable at a time
B) it provides the break-even level of sales for the project
C) it looks at different but consistent combination of variables
D) each of the above statements describes "Scenario Analysis" correctly

Question 20

A project has an initial investment of $150. You have come up with the following estimates of revenues and costs. Calculate the NPV assuming that cash flow and perpetuities. (No taxes.) (Cost of capital = 10%)
$$\begin{array} { l c c c } & \text { Pessimistic } & \text { Most Likely } & \text { Optimistic } \\\text { Total revenues } & + 30 & + 50 & 65 \\\text { Total costs } & - 25 & - 20 & - 15\end{array}$$

A) 50, -100, +400
B) -50, +300, +500
C) -100, +150, +350
D) None of the above

Question 21

Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year which is also the cost of capital (Ignore taxes). Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year. If the project if postponed by one year, calculate the value of the option to wait for one year: (approximately)

A) +15,000,000
B) +40,000,000
C) +10,000,000
D) none of the above

Question 22

Hammer Company proposes to invest $6 million in a new type of hammer-making equipment. The fixed costs are $1.0 million per year. The equipment is expected to last for five years. The manufacturing cost per hammer is $1 and the selling price per hammer is $6. Calculate the break-even volume per year. (Ignore taxes.)

A) 500,000 units
B) 600,000 units
C) 100,000 units
D) None of the above

Question 23

Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore
Taxes). Calculate the NPV to invest today.

A) +10,000,000
B) +6,000,000
C) +4,000,000
D) none of the above

Question 24

Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore
Taxes). Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year and then expected NPV of the project if postponed by one year is:

A) +10,000,000
B) +25,000,000
C) +5,000,000
D) none of the above

Question 25

Project analysis, in addition to NPV analysis, includes the following procedures:
I. Sensitivity analysis
II. Break-even analysis
III. Monte Carlo simulation
IV. Scenario Analysis

A) I only
B) I and II only
C) I, II, and III only
D) I, II, III, and IV

Question 26

The following are real options except:

A) Stock options
B) Timing options
C) Option to expand
D) Option to abandon

Question 27

Option to expand a project is a:

A) Call option
B) Put option
C) Stock option
D) Swap

Question 28

The NPV break-even point occurs when:

A) the present value of inflows line cuts the present value of outflows line
B) the total revenue line cuts the fixed cost line
C) the total revenue line cuts the total cost line
D) none of the above

Question 29

Monte Carlo simulation involves the following steps:
I. Step 1: Modeling the project
II. Step 2: Specifying probabilities
III. Step 3: Simulate the cash flows
IV. Step 4: Calculate present value

A) I and II only
B) I, II, and III only
C) II, III, and IV only
D) I, II, III, and IV

Question 30

Hammer Company proposes to invest $6 million in a new type of hammer-making equipment. The fixed costs are $0.5 million per year. The equipment is expected to last for five years. The manufacturing cost per hammer is $1and the selling price per hammer is $6. Calculate the break-even volume per year. (Ignore taxes.)

A) 500,000 units
B) 600,000 units
C) 100,000 units
D) None of the above

Question 31

Which of the following simulation outputs is likely to be most useful and easy to interpret? The output shows the distribution(s) of the project:

A) Earnings
B) Internal rate of return
C) Cash flows
D) Profits

Question 32

Simulation models are useful:
I. To understand the project better
II. To forecast expected cash flows
III. To assess the project risk

A) I only
B) II only
C) III only
D) I, II and III

Question 33

Monte Carlo simulation is likely to be most useful:

A) For very complex problems
B) For problems of moderate complexity
C) For very simple problems
D) Regardless of the problem's complexity

Question 34

After the completion of project analysis, the final decision on the project would be from:

A) Sensitivity analysis
B) Break-even analysis
C) Decision trees
D) NPV

Question 35

Generally, the simulation models for projects are developed using a:

A) Pair of dice
B) Roulette wheel
C) Computer
D) Pack of cards

Question 36

Financial Calculator Company proposes to invest $12 million in a new calculator making plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of capital is 20%, what is the accounting break-even level? (Approximately)(Assume no taxes.)

A) 300,000 units
B) 150,000 units
C) 381,777 units
D) None of the above

Question 37

Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for $20/unit. If the plant lasts for 3 years and the cost of capital is 12%, what is the approximate break-even level (accounting) of annual sales? (Assume no taxes.)(approximately)

A) $133,334 units
B) $272,117 units
C) $244,444 units
D) None of the above

Question 38

Taj Mahal Tour Company proposes to invest $3 million in a new tour package project. Fixed costs are $1 million per year. The tour package costs $500 and can be sold at $1500 per package to tourists. This tour package is expected to be attractive for the next five years. If the cost of capital is 20%, what is the NPV break-even number of tourists per year? (Ignore taxes, give an approximate answer)

A) 1000
B) 2000
C) 15000
D) None of the above

Question 39

Everything else remaining the same, an increase in fixed costs:
I. increases the break-even point based on NPV
II. increases the accounting break-even point
III. decreases the break-even point based on NPV IV) decreases the accounting break-even point

A) I and III only
B) III and IV only
C) II and III only
D) I and II only

Question 40

The accounting break-even point occurs when:

A) the total revenue line cuts the fixed cost line
B) the present value of inflows line cuts the present value of outflows line
C) the total revenue line cuts the total cost line
D) none of the above

Question 41

Abandonment option is a call option, while the option to expand is a put option.

Question 42

Postaudits are conducted before the start of the projects.

Question 43

In constructing a simulation model of an investment project, one can ignore possible interdependencies between variables.

Question 44

You are planning to produce a new action figure called "Hillary". However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50 million per year for 3 years (starting next year). If it fails, you will only have net cash flows of $10 million per year for 2 years (starting next year). There is an equal chance that it will be a hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the first year's cash flows are in. You have to spend $80 million immediately for equipment and the rights to produce the figure. If you can sell your equipment for $60 million once the first year's cash flows are received, calculate the value of the abandonment option. (The discount rate is 10%)

A) -9.15
B) +13.99
C) +23.14
D) None of the above

Question 45

Projects with high fixed costs have lower break-even points.

Question 46

In drawing a decision tree, it is important to include all possible eventualities.

Question 47

Firms that use break-even on an accounting basis are really losing the opportunity cost of capital on their investments.

Question 48

KMW Inc. sells a finance textbook for $150 each. The variable cost per book is $30 and the fixed cost per year is $30,000. The process of creating a textbook costs $150,000 and the average book has a life span of 3 years. Using straight line depreciation and a tax rate of 25%, what is the economic or present value break even number of books that must be sold given a discount rate of 12%?

A) 582
B) 667
C) 805
D) 953

Question 49

The following options associated with a project increases managerial flexibility:
I. Option to expand
II. Option to abandon
III. Production options
IV. Timing options

A) I only
B) II only
C) I, II, III, and IV
D) IV only

Question 50

Monte Carlo simulation should be used to get the distribution of NPV values for a project.

Question 51

Option to abandon a project is a:

A) Call option
B) Put option
C) Stock option
D) Swap

Question 52

The Consumer- Mart Company is going to introduce a new consumer product. If brought to market without research about consumer tastes the firm believes that there is a 60% chance that the product will be successful. If successful, the project has a NPV = $500,000. If the product is a failure (40%) and withdrawn from the market, then NPV = -$100,000. A consumer survey will cost $60,000 and delay the introduction by one year. If the survey is successful, then there is an 80% chance of consumer acceptance, in which case the NPV =
$500,000. If, on the other hand the survey is a failure, then NPV = -$100,000. The discount rate is 10%. By how much does the marketing survey change the expected net present value of the project? (approximately)

A) Increase the NPV by $25,455
B) decrease the NPV by $5950
C) decrease the NPV by $8955
D) decrease the NPV by $25,455

Question 53

The break-even point in terms of NPV is usually lower than the break-even point on an accounting basis.

Question 54

In drawing a decision tree, a square represents a decision point, and a triangle represents a decision point for fate.

Question 55

Most firms keep track of the progress of projects by conducting postaudits shortly after the projects have begun to operate.

Question 56

You are planning to produce a new action figure called "Hillary". However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50 million per year for 3 years (starting next year). If it fails, you will only have net cash flows of $10 million per year for 2 years (starting next year). There is an equal chance that it will be a hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the first year's cash flows are in. You have to spend $80 million immediately for equipment and the rights to produce the figure. If the discount rate is 10%, calculate the NPV without the abandonment option.

A) -9.15
B) +13.99
C) +9.15
D) -14.4

Question 57

Monte Carlo simulation is a tool for considering all possible combinations of variables.

Question 58

Given the following net future values for harvesting trees (one time harvest): If the cost of capital is 15%, calculate the optimal year to harvest:
$$\begin{array} { l c c c c c c } \text { Year } & 0 & 1 & 2 & 3 & 4 & 5 \\\text { Net Future Value } & 100 & 125 & 150 & 175 & 195 & 210\end{array}$$

A) Year 1
B) Year 2
C) Year 3
D) Year 4

Question 59

You are planning to produce a new action figure called "Hillary". However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50 million per year for 3 years (starting next year). If it fails, you will only have net cash flows of $10 million per year for 2 years (starting next year). There is an equal chance that it will be a hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the first year's cash flows are in. You have to spend $80 million immediately for equipment and the rights to produce the figure. If you can sell your equipment for $60 million once the first year's cash flows are received, calculate the NPV with the abandonment option. (The discount rate is 10%)

A) -9.1
B) +9.1
C) +13.99
D) -14.4

Question 60

Tangible assets usually have higher abandonment value than intangible ones.

Question 61

Indicate some of the problems associated with capital investment process.

Question 62

Briefly explain timing options.

Question 63

Why is sensitivity analysis less realistic than Monte Carlo Simulation?

Question 64

Briefly discuss the usefulness of Monte Carlo simulation in project analysis.

Question 65

Briefly describe sensitivity analysis used for project analysis.

Question 66

Briefly discuss various real options associated with capital budgeting projects.

Question 67

Define the term "abandonment value."

Question 68

Discuss the importance of conducting post audits.

Question 69

How do managers supplement the NPV analysis of a project to gain better understanding of a project?

Question 70

Briefly explain the term "real options."

Question 71

In almost al cases the present value break even quantity is higher than the accounting break even quantity.

Question 72

Explain the usefulness of decision trees in project analysis.