Question 1

After research into where to place a new restaurant, Burger Billies, a small fast-food chain, plans to open a new store near a small college. The anticipated customer base is students attending the college. They learn that a major fast food chain will be opening a franchise within the college, which leads the owners of Burger Billies to revise their estimate of sales to one below the break-even point. Which of the following is most likely the best real option for Burger Billies to take with regard to the proposed restaurant site?

Accepted Answer

With the major fast-food chain opening a franchise within the college, Burger Billies has revised their estimate of sales to below the break-even point. Therefore, the best real option for Burger Billies would be to abandon the proposed restaurant site as it is not financially feasible. Delaying or expanding the plans would not solve the issue of competition from the major fast-food chain, and switching the location may not guarantee a better customer base.

Question 2

An exploration of the effect of changing multiple project parameters on net present value (NPV) is called ________.

Accepted Answer

Scenario analysis involves changing multiple project parameters to understand how each scenario would impact the NPV. It helps in identifying the most favorable and unfavorable scenarios, and it is used to evaluate the risk associated with a project. Internal rate of return (IRR) analysis calculates the rate that makes the NPV zero, while accounting break-even analysis determines the level of sales required to break even. Sensitivity analysis evaluates the impact of changing one variable on the overall NPV. While all of these analysis methods are important in project evaluation, scenario analysis specifically addresses the effect of changing multiple project parameters on NPV.

Question 3

Which of the following statements regarding real options is NOT correct?

Accepted Answer

The answer of Which of the following statements regarding real...

Question 4

What is the major difference between scenario analysis and sensitivity analysis?

Accepted Answer

The answer of What is the major difference between scenario...

Question 5

Which of the following will cause the EBIT Break-Even for sales to increase?

Accepted Answer

The answer of Which of the following will cause the...

Question 6

Jim owns a farm that he wants to sell. He learns that a highway will be built near the farm in the future, giving access to the farmland from a nearby city and thus making the land attractive to housing developers. Expecting the net present value (NPV) of the sale to be greater after the highway is built, he decides not to sell at this time. What real option is Jim taking?

Accepted Answer

Jim is taking the real option to delay the sale of his farm until the highway is built, which he expects will increase the NPV of the sale. By delaying, he is preserving the flexibility to wait and sell at a more opportune time in the future. This is an example of a real option, which allows for flexibility in decision-making and takes into account the uncertainty of future events.

Question 7

An analysis that breaks the net present value (NPV) calculation into its component assumptions and shows how the net present value (NPV) varies as one of the underlying assumptions changes is called ________.

Accepted Answer

Sensitivity analysis involves changing one underlying assumption of a financial model at a time and observing how the output (such as NPV) changes accordingly. This helps to identify which assumption has the greatest impact on the output and enables decision-makers to better understand the risks and uncertainties associated with the project. Scenario analysis involves changing multiple assumptions simultaneously to explore different possible outcomes, while IRR analysis calculates the discount rate at which the NPV would be zero. Accounting break-even analysis determines the minimum level of sales required to cover all costs and achieve a zero profit.

Question 8

A real option is the obligation to take a particular business action.

Accepted Answer

A real option provides the right, but not the obligation, to undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project.

Question 9

A manufacturer of peripheral devices for PCs decides to try and capture some of the PC gaming market by creating gaming versions of its traditional peripheral devices. It decides to start with a gaming version of its standard keyboard, increasing the number of macro keys, adding a small LCD screen to display game data, and giving the user the ability to backlight keys in different colors. If this device is a success, the manufacturer plans to release gaming versions of its trackballs and other peripherals. What option is the manufacturer gaining by the release of the new keyboard?

Accepted Answer

By releasing the new gaming keyboard, the manufacturer is gaining the option to expand into the gaming market with other gaming versions of its peripherals if the device is successful.

Question 10

The difference between scenario analysis and sensitivity analysis is ________.

Accepted Answer

Scenario analysis considers the effect on net present value (NPV) of changing multiple project parameters, while sensitivity analysis only allows us to change estimated inputs of net present value (NPV) analysis. Option A and D are incorrect because both scenario analysis and sensitivity analysis can be used with either IRR or NPV. Option B is incorrect because sensitivity analysis does allow us to change estimated inputs of NPV analysis but does not consider the effect of changing multiple project parameters.

Question 11

Why does the option to abandon a project have value?

Accepted Answer

The answer of Why does the option to abandon a...

Quiz 9: Fundamentals of Capital Budgeting