Deck 11: Simulation Models

Question 1

In financial simulation models, we are typically more interested in the expected NPV of a project than in the extremes of the outcomes.

Answer 1

False

Question 2

Which of the following is the most likely characteristic of a distribution that is to be used to develop a simulation model for estimating the time until failure of a product in a simulation model?

A)Unbounded
B)Left skewed
C)Normal
D)Uniform

Answer 2

B

Question 3

A @RISK output range allows us to obtain a summary chart that shows the entire simulated range at once.

Answer 3

True

Question 4

In bidding models, the simulation output variable is the number of competitors who will bid.

Question 5

RISKTARGET is a function that allows us to determine the cumulative probability of a particular value in an output distribution, such as the probability of meeting a due date in manufacturing.

Question 6

In marketing and sales models, the primary issue is the uncertain amount of sales that can be obtained, given an assumed timing.

Question 7

Which of the following functions is not an @RISK statistical function?

A)RISKMIN
B)RISKMAX
C)RISKPERCENTILE
D)RISKSIMTABLE

Question 8

A key input variable in many marketing models of customer loyalty is the:

A)Mean profit per customer
B)Number of customers
C)Churn rate
D)Time horizon

Question 9

A tornado chart lets us see which random input has the most effect on a specified output in a financial model.

Question 10

The RISKSIMTABLE function is used to summarize the results of a single simulation of product lifetime.

Question 11

The main issue in marketing and sales models is:

A)the amount invested in marketing
B)the timing of marketing
C)the profit from sales
D)the timing of sales

Question 12

A marketing simulation model can be used to determine the expected profit under uncertain customer loyalty, but an optimization model must be used to determine the optimal amount to spend on increasing customer loyalty.

Question 13

In cash flow models, we are typically interested in investigating:

A)the value at risk (VAR)
B)the net present value (NPV)
C)the amount of loans required to maintain a minimum cash balance
D)the interest on loans taken out by a firm

Question 14

Value at risk (VAR) is an indicator of:

A)how much to bid for a project
B)the expected amount of loss for a project
C)what is nearly the worst possible outcome for a project
D)the required amount of investment required for a project

Question 15

In warranty cost models, the key input random variable is product lifetime.

Question 16

The value at risk (VAR) is typically defined as the:

A)5th percentile of NPV distribution
B)10th percentile of NPV distribution
C)90th percentile of NPV distribution
D)95th percentile of NPV distribution

Question 17

Which of the following @RISK functions can be used to find the probability of a particular value in an output distribution?

A)RISKMIN
B)RISKMAX
C)RISKPERCENTILE
D)RISKTARGET

Question 18

Suppose we compare the difference between the NPV of a financial model in which the means are entered for all input random variables and the NPV of a financial model in which the most likely values are entered for all input random variables. If we see a large difference between the NPV's, this illustrates:

A)the value at risk (VAR)
B)the effect of randomness
C)the flaw of averages
D)the bias of the analyst

Question 19

A common distribution for modeling product lifetimes is the normal distribution

Question 20

Which of the following is typically not an application of simulation models?

A)Operations models
B)Financial models
C)Marketing models
D)Logistics models

Question 21

Exhibit 11-2Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information:
∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event.
∙A unit of capacity costs $16 to build in year 1.
∙The number of units produced will equal the demand, up to capacity limits.
∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost).
∙The maintenance cost per unit of capacity is $0.40 (fixed cost).
∙The discount rate is 10%.
[Part 4] Refer to Exhibit 11-2. Are there any simulations which indicated there was a chance of getting negative NPV? Briefly explain in one sentence.

Question 22

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below:

[Part 4] Refer to Exhibit 11-1. What does the distribution of the project NPV look like?

Question 23

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below:

[Part 6] Refer to Exhibit 11-1. Given your answers to Parts 1 through 5, would you invest in this project?

Question 24

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below:

[Part 2] Refer to Exhibit 11-1. Suppose that the forecasted price levels shown in the pro forma cash flow sheet are not deterministic, but rather are expected to fluctuate due to market forces. The prices are expected to be normally distributed in each year, with the following means and standard deviations:Using the appropriate @RISK functions in the pro forma, what is the expected NPV? Would you recommend investing in this project? Explain.

Question 25

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below:

[Part 1] Refer to Exhibit 11-1. What is the deterministic next present value (NPV) of the project, including the required investment, assuming a 10% discount rate?

Question 26

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below:

[Part 5] Refer to Exhibit 11-1. What are the chances the firm could lose money on this project, given the price uncertainty?

Question 27

Exhibit 11-2Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information:
∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event.
∙A unit of capacity costs $16 to build in year 1.
∙The number of units produced will equal the demand, up to capacity limits.
∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost).
∙The maintenance cost per unit of capacity is $0.40 (fixed cost).
∙The discount rate is 10%.
[Part 2] Refer to Exhibit 11-2. Use a RISKSIMTABLE to with the following values for capacity: 20,000, 25,000, 30,000, 35,000, 40,000. Which of these capacities produces the largest expected NPV?

Question 28

Exhibit 11-2Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information:
∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event.
∙A unit of capacity costs $16 to build in year 1.
∙The number of units produced will equal the demand, up to capacity limits.
∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost).
∙The maintenance cost per unit of capacity is $0.40 (fixed cost).
∙The discount rate is 10%.
[Part 3] Refer to Exhibit 11-2. Briefly explain why designing the plant for the expected capacity is clearly not the optimal solution.

Question 29

Exhibit 11-2Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information:
∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event.
∙A unit of capacity costs $16 to build in year 1.
∙The number of units produced will equal the demand, up to capacity limits.
∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost).
∙The maintenance cost per unit of capacity is $0.40 (fixed cost).
∙The discount rate is 10%.
[Part 1] Refer to Exhibit 11-2. Perform a simulation assuming the plant will be designed to meet the expected demand. What is the net present value (NPV) in that case?

Question 30

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below:

[Part 3] Refer to Exhibit 11-1. What is the standard deviation of the NPV? What does it indicate?