Question 1

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)total revenue is large enough to recapture depreciation expense.

Accepted Answer

The accounting break-even point occurs when total revenue equals total cost. Therefore, the correct choice is C, where the total revenue line cuts the total cost line.

Question 2

The 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 the company $500 to produce and can be sold at $1500 per package to tourists.This tour package will last 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.Round to the nearest 1,000.)
A)1,000
B)2,000
C)3,000
D)4,000First,find the annual cash flow that justifies a $3 million investment using the equivalent annual cost (EAC)method.The 5-year annuity factor @ 20% equals 2.9906.EAC = $3 million/2.9906 = $1.00 million.The tour must net this amount of cash flow each year.Given $1M of annual fixed costs,let X = the annual sales rate: (X)× (1500 - 500)- 1,000,000 = 1,000,000.X (1000)= 2,000,000;

Accepted Answer

Using the equivalent annual cost (EAC) method, we found that the annual cash flow needed to justify the $3 million investment is $1 million. With the given fixed costs of $1 million per year, we can solve for the break-even number of tourists per year as follows:

(X) x (1500-500) - 1,000,000 = 1,000,000
X = 2,000

Therefore, the company needs to sell tour packages to 2,000 tourists per year to break even on the investment. Round to the nearest 1,000, the answer is B (2,000).

Question 3

All else equal,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 IV only
B)III and IV only
C)II and III only
D)I and II only

Accepted Answer

An increase in fixed costs increases both the break-even point based on NPV and the accounting break-even point because it raises the total amount of revenue needed to cover all costs.

Question 4

Petroleum Inc.(PI)controls offshore oil leases.It is considering the construction of a deep-sea oil rig at a cost of $500 million.The price of oil is $100/bbl.and extraction costs are $50/bbl.PI expects costs to remain constant.The rig will produce an estimated 1,200,000 bbl.per year forever.The risk-free rate is 10% per year,which is also the cost of capital.(Ignore taxes).Suppose that oil prices are uncertain and are equally likely to be $120/bbl.or $80/bbl.next year.Calculate today's NPV of the project if it were postponed by one year.
A)+$100 million
B)+$154 million
C)+$170 million
D)+$187 million

Accepted Answer

If the project were postponed for a year, the oil rig would not be operational for another year. Therefore, we would not receive any cash flow in the first year. In the second year, there is an equal chance that the oil price would be $120 or $80 per barrel. Therefore, the expected revenue in the second year would be:

Expected Revenue = 0.5 x 1,200,000 x $120 - $50 x 1,200,000 x 0.5 + 0.5 x 1,200,000 x $80 - $50 x 1,200,000 x 0.5
Expected Revenue = $66 million

Therefore, the total expected revenue over two years would be:

Total Expected Revenue = $0 + $66 million
Total Expected Revenue = $66 million

The NPV of the project can be calculated as follows:

NPV = - $500 million + ($66 million / 1.1)
NPV = - $500 million + $60 million
NPV = -$440 million

This is the NPV if the project is postponed for a year. To calculate the NPV if the project is undertaken immediately, we can use the expected revenue in the first year, which is $60 million (based on an oil price of $100 per barrel). Therefore, the NPV of the project if undertaken immediately would be:

NPV = - $500 million + ($60 million / 1.1) + ($66 million / 1.1^2)
NPV = - $500 million + $54.55 million + $57.22 million
NPV = -$388.23 million

Comparing the two NPVs, the NPV if the project is postponed for a year is worse than if the project is undertaken immediately. Therefore, the best choice is to undertake the project immediately, and the answer is B.

Question 5

The 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 will last for five years.The manufacturing cost per hammer is $1 and each hammer sells for $6.The cost of capital is 20%.Calculate the break-even sales volume per year.(Ignore taxes.Round to the nearest 1,000.)
A)500,000 units
B)600,000 units
C)450,000 units
D)550,000 unitsFirst,find the annual cash flow that justifies a $6 million investment using the equivalent annual cost (EAC)method.The 5-year annuity factor @ 20% equals 2.9906.EAC = 6/2.9906 = 2 million.The equipment must net this amount of cash flow each year.Given $0.5M of annual fixed costs,let X = the annual sales rate:X (6 - 1)- 500,000 = 2,000,000;

Accepted Answer

Using the calculation from the given solution, we can now solve for X:

X(6-1)-500,000 = 2,000,000
5X=2,500,000
X=500,000

Therefore, the break-even sales volume per year is 500,000 units. The answer is A, 500,000 units.

Question 6

The Financial Calculator Company proposes to invest $12 million in a new calculator-making plant that will depreciate on a straight-line basis.Fixed costs are $3 million per year.A financial calculator costs $10 per unit to manufacture and sells for $30 per unit.If the plant lasts for four years and the cost of capital is 20%,what is the accounting break-even level of annual sales? (Assume no taxes.)
A)300,000 units
B)150,000 units
C)381,777 units
D)750,000 units

Accepted Answer

The answer of The Financial Calculator Company proposes to invest...

Question 7

Monte Carlo simulation involves the following steps:
I.Step 1: Modeling the project;
II.Step 2: Specifying probabilities;
III.Step 3: Simulating cash flows;
IV.Step 4: Calculating 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

Accepted Answer

All four steps are involved in Monte Carlo simulation. In step 1, the project is modeled, in step 2, probabilities are specified, in step 3, cash flows are simulated, and in step 4, present value is calculated. Therefore, all four steps are necessary for a complete Monte Carlo simulation.

Question 8

After completing a project analysis,an analyst should rely on which tool to make a final recommendation on the project?
A)sensitivity analysis
B)break-even analysis
C)decision trees
D)NPV

Accepted Answer

NPV (Net Present Value) is the most suitable tool for making a final recommendation on the project as it takes into account the time value of money, inflows, and outflows of cash, and provides a clear and quantifiable measure of the project's financial viability. Sensitivity analysis, break-even analysis, and decision trees are useful tools for analyzing different aspects of the project, but they do not provide a final recommendation based on the project's overall financial feasibility.

Question 9

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)the present value of inflows cuts the total cost line.

Accepted Answer

The NPV break-even point occurs when the present value of inflows line cuts the present value of outflows line. This represents the point where the project's net present value is equal to zero, indicating that the project is neither profitable nor unprofitable.

Question 10

Project analysis,beyond simply calculating NPV,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

Accepted Answer

Project analysis beyond NPV includes sensitivity analysis, break-even analysis, Monte Carlo simulation, and scenario analysis. All four procedures are necessary for a comprehensive analysis of a project's viability under different conditions and assumptions. Sensitivity analysis examines how changes in inputs affect the project's outcomes, break-even analysis determines the point where revenue equals costs, Monte Carlo simulation tests the project's robustness under random variables, and scenario analysis evaluates possible outcomes under different scenarios. Therefore, the best choice is D - I, II, III, and IV.

Question 11

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 will last for five years.The manufacturing cost per hammer is $1 and each hammer sells for $6.The cost of capital is 20%.Calculate the break-even sales volume per year.(Ignore taxes.Round to the nearest 1,000.)
A)500,000 units
B)550,000 units
C)600,000 units
D)650,000 unitsFirst,find the annual cash flow that justifies a $6 million investment using the equivalent annual cost (EAC)method.The 5-year annuity factor @ 20% equals 2.9906.EAC = 6/2.9906 = 2 million.The equipment must net this amount of cash flow each year.Given $1.0M of annual fixed costs,let X = the annual sales rate:X (6 - 1)- 1,000,000 = 2,000,000;

Accepted Answer

The break-even sales volume is calculated by solving the equation: X(6 - 1) - 1,000,000 = 2,000,000, which results in X = 600,000 units.

Question 12

Petroleum Inc.(PI)controls offshore oil leases.It is considering the construction of a deep-sea oil rig at a cost of $500 million.The price of oil is $100/bbl.and extraction costs are $50/bbl.PI expects prices and costs to remain constant.The rig will produce an estimated 1,200,000 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)+100,000,000
B)+80,000,000
C)+60,000,000
D)+40,000,000Easiest to do computations in $M.

Accepted Answer

The NPV is calculated as the present value of perpetual cash flows minus the initial investment. The annual cash flow is (100 - 50) * 1,200,000 = $60 million. The present value of these cash flows is $60 million / 0.10 = $600 million. The NPV is $600 million - $500 million = $100 million.

Question 13

Which of the following does NOT represent an option to expand a project?
A)A firm leases more office space than it forecasts it will need.
B)A company engages in test marketing for a new product.
C)Your university builds an administrators' parking garage having more parking spaces than administrators.
D)A dry cleaner purchases equipment that can be readily sold to other dry cleaners.

Accepted Answer

Purchasing equipment that can be readily sold to other dry cleaners does not represent an expansion option; it is more about flexibility or exit strategy rather than expanding the project.

Question 14

Monte Carlo simulation is likely to be most useful:
A)for very complex projects.
B)for projects of moderate complexity.
C)for very simple projects.
D)regardless of the project's complexity.

Accepted Answer

Monte Carlo simulation is most useful for very complex projects, as it is a probabilistic method that can help to account for uncertainty and risk in projects with multiple variables and interdependencies. It may not be as necessary for simpler projects with fewer variables and uncertainties.

Question 15

One can employ simulation models to:
i.understand the project better; II)better understand forecasted cash flows; III)assess the project risk
A)I only
B)II only
C)III only
D)I,II,and III

Accepted Answer

Simulation models can be used for all three purposes listed in the question - understanding the project better, better understanding forecasted cash flows and assessing project risk. Therefore, all three choices (I, II and III) are correct.

Question 16

Petroleum Inc.(PI)controls off-shore oil leases.It is considering the construction of a deep-sea oil rig at a cost of $500 million.The price of oil is $100/bbl.and extraction costs are $50/bbl.PI expects costs to remain constant.The rig will produce an estimated 1,200,000 bbl.per year forever.The risk-free rate is 10% per year,which is also the cost of capital.(Ignore taxes).Suppose that oil prices are uncertain and are equally likely to be $120/bbl.or $80/bbl.next year.
Suppose that PI has the option to postpone the project by one year.Calculate the value of the real option to postpone the project for one year.
A)+$30 million
B)+$50 million
C)+$54 million
D)+$70 million

Accepted Answer

To calculate the value of the real option to postpone the project for one year, we need to calculate the expected future cash flows in both scenarios (high oil price and low oil price) and discount them back to the present value using the risk-free rate, and then compare them to the cash flows if we exercise the option to proceed with the project next year.

If we postpone the project for one year, we will lose the cash flows for this year (1,200,000 bbl. x ($100 - $50) = $60 million) but we will have the option to decide whether to proceed next year or not. If the oil price is $120/bbl. next year, the cash flows will be 1,200,000 bbl. x ($120 - $50) = $840 million. If the oil price is $80/bbl. next year, the cash flows will be 1,200,000 bbl. x ($80 - $50) = $360 million. The expected future cash flows if we postpone the project for one year are therefore:

Expected future cash flows = 0.5 x $840 million + 0.5 x $360 million = $600 million

Discounting these cash flows back to the present value using the risk-free rate of 10%, we get:

Present value of expected future cash flows = $600 million / (1 + 0.1) = $545.45 million

If we exercise the option to proceed with the project this year, the cash flows will be $60 million + 1,200,000 bbl. x ($100 - $50) = $120 million. Discounting these cash flows back to the present value using the risk-free rate of 10%, we get:

Present value of cash flows if we proceed this year = $120 million / (1 + 0.1) = $109.09 million

The value of the real option to postpone the project for one year is therefore:

Value of the real option = Present value of expected future cash flows - Present value of cash flows if we proceed this year
= $545.45 million - $109.09 million
= $436.36 million

Therefore, the best choice is C.

Question 17

The following are real options EXCEPT:
A)stock options.
B)timing options.
C)options to expand.
D)options to abandon.

Accepted Answer

While stock options are commonly used in finance, they are not considered real options in the traditional sense. Real options refer to strategic investment opportunities that provide businesses with flexibility and the ability to adapt to changing market conditions. Timing options, options to expand, and options to abandon are all examples of real options that businesses can utilize to improve their financial position.

Question 18

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's:
A)sales.
B)internal rate of return.
C)cash flows.
D)profits.

Accepted Answer

The distribution of cash flows is the most useful and easy to interpret simulation output because it provides insight into the timing and amount of expected cash inflows and outflows throughout the project's duration. This information is crucial for decision-making, particularly regarding financing needs and profitability. Sales, IRR, and profits are also valuable outputs, but they are narrower and less insightful than cash flows.

Question 19

The Solar Calculator Company proposes to invest $5 million in a new calculator-making plant that will depreciate on a straight-line basis.Fixed costs are $2 million per year.A calculator costs $5 per unit to manufacture and sells for $20 per unit.If the plant lasts for three years and the cost of capital is 12%,what is the accounting break-even level of annual sales? (Assume no taxes.)
A)133,334 units
B)272,117 units
C)244,444 units
D)466,666 unitsFixed costs and depreciation equal $2M and $1.67M per year,respectively.Let X = the annual sales rate.Given a price of $20 and variable cost of $5,

Accepted Answer

Accounting break-even point can be calculated using the following formula:
Fixed costs + Depreciation = (Price - Variable cost) * X

Substituting the given values, we get:
$2M + ($5M/3 years) = ($20 - $5) * X
$2M + $1.67M = $15 * X
$3.67M = $15X
X = 244,444 units

Therefore, the accounting break-even level of annual sales is 244,444 units. The answer is option C.

Question 20

Generally,Monte Carlo models,for project analysis,use which device to generate simulations?
A)pair of dice
B)roulette wheel
C)computer
D)pack of cards

Accepted Answer

Monte Carlo models require complex simulations, which can only be efficiently generated using a computer. Therefore, the correct choice is C. Pairs of dice, roulette wheels, and packs of cards are all random number generators as well, but they are much less efficient and accurate for project analysis.

Quiz 10: Project Analysis

The accounting break-even point occurs when:

All else equal,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

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

After completing a project analysis,an analyst should rely on which tool to make a final recommendation on the project?

The NPV break-even point occurs when:

Project analysis,beyond simply calculating NPV,includes the following procedures: I.sensitivity analysis; II.break-even analysis; III.Monte Carlo simulation; IV.scenario analysis

Which of the following does NOT represent an option to expand a project?

Monte Carlo simulation is likely to be most useful:

One can employ simulation models to: i.understand the project better; II) better understand forecasted cash flows; III) assess the project risk

The following are real options EXCEPT:

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's:

Generally,Monte Carlo models,for project analysis,use which device to generate simulations?