Question 1

An analysis in which a firm would like to know the effect of a price change on the NPV of a project, holding all other variables and forecasts constant, is one type of sensitivity analysis.

Accepted Answer

This is a correct statement. Sensitivity analysis involves analyzing the effect of changes in one variable on the overall outcome of a project, while holding all other variables constant. In this case, the analysis is focused on the effect of a price change on the project's net present value (NPV).

Question 2

Depreciation and amortization are treated like fixed costs

Accepted Answer

Depreciation and amortization are non-cash expenses, and in the calculation of the degree of pretax cash flow operating leverage, they are treated like fixed costs because they do not vary with the level of production or sales.

Question 3

The accounting operating profit (EBIT) break-even point tells us how many units must be sold to avoid an accounting operating loss.

Accepted Answer

The accounting operating profit break-even point is the number of units that must be sold to generate enough revenue to cover all accounting operating costs, resulting in an operating profit of zero. Therefore, it tells us how many units must be sold to avoid an accounting operating loss.

Question 4

If a firm knows that a price change will have an effect on a number of other forecast variables, such as the sales forecast, then the firm might require scenario analysis rather than sensitivity analysis.

Accepted Answer

This is true, because in scenario analysis the firm considers the impact of a price change on multiple variables and develops multiple scenarios to assess the potential outcomes. Sensitivity analysis, on the other hand, only looks at the impact of a single variable on the outcome.

Question 5

EBITDA stands for

Accepted Answer

EBITDA stands for earnings before interest, taxes, depreciation, and amortization.

Question 6

The cross-over level of unit sales is the level at which one fixed/variable cost combination of production will begin to generate higher levels of operating cash flows than another fixed/variable cost combination of production.

Accepted Answer

This definition accurately describes the concept of cross-over level.

Question 7

The accounting operating profit break-even points are smaller than the corresponding pretax operating cash flow break-even points for a project with positive costs.

Accepted Answer

The accounting operating profit break-even point typically includes both fixed and variable costs, while the pretax operating cash flow break-even point primarily focuses on covering variable costs and the cash fixed costs, excluding non-cash expenses like depreciation. Therefore, the cash flow break-even point can be reached before the accounting profit break-even point, especially in projects with significant non-cash expenses.

Question 8

If a firm is about to operate in an environment in which there will be a great deal of variability in the level of revenues, then the firm

Accepted Answer

When operating in an environment with high revenue variability, it is better for a firm to have low fixed costs and higher per unit variable costs. This structure allows the firm to adjust costs in response to changes in revenue, minimizing losses during periods of low revenue and increasing profits during periods of high revenue. A high fixed cost structure with higher total variable costs would make it difficult for the firm to adjust costs during low revenue periods, potentially leading to significant losses.

Question 9

Simulation analysis has the benefit of providing a pinpoint accurate forecast of a project's NPV.

Accepted Answer

While simulation analysis can estimate the range of possible outcomes and their probabilities, it does not provide a pinpoint accurate forecast of a project's NPV as it involves uncertainty and assumptions.

Question 10

Revenue minus variable and fixed costs best describes

Accepted Answer

The answer of Revenue minus variable and fixed costs best...

Question 11

___________ is a measure of the sensitivity of EBITDA or EBIT to changes in revenue.

Accepted Answer

Operating leverage is a measure of how much a company's revenue affects its EBITDA or EBIT. It is calculated as the percentage change in EBITDA or EBIT divided by the percentage change in revenue. A higher operating leverage means that a company's EBITDA or EBIT will be more sensitive to changes in revenue, indicating a higher level of risk for the business. Total leverage (A) and financial leverage (B) are different metrics that measure a company's overall debt and how much of that debt is made up of financial obligations, respectively.

Question 12

Gilligan's Boat Tours finds that if it were to increase its price by 10 percent, it would have a 6 percent reduction in the NPV of its new 3-Hour Tour. Gilligan's analysis could be described as

Accepted Answer

Gilligan's analysis involves changing one specific variable (the price) to see how it affects the NPV. This is an example of sensitivity analysis, which examines how changes in one variable impact outcomes. Monte Carlo simulation involves creating multiple scenarios with different variables, and scenario analysis involves examining specific combinations of variables. Therefore, neither A nor B are the best choices for this situation.

Question 13

Within a simulation analysis, the firm will need to come up with some distributional assumptions concerning the forecast inputs, such as the mean and variance of the sales forecast.

Accepted Answer

Within a simulation analysis, it is necessary to make distributional assumptions about forecast inputs such as the mean and variance of the sales forecast.

Question 14

If the degree of accounting leverage is 1.3 for a firm, then a 10 percent increase in revenue should drive a

Accepted Answer

The degree of accounting leverage (DAL) is a measure of a firm's operating leverage, which indicates the percentage change in EBIT (earnings before interest and taxes) resulting from a 1% change in sales revenue. DAL is calculated as follows:

DAL = % change in EBIT / % change in sales revenue

If DAL = 1.3, then a 10% increase in sales revenue should result in a 13% increase in EBIT:

DAL = 0.13 / 0.1 = 1.3

Question 15

The process of identifying the bundle of projects that creates the greatest total value and allocates the available capital to these projects is called capital asset pricing.

Accepted Answer

The process described in the statement is actually capital budgeting, not capital asset pricing. Capital asset pricing is a model used to determine the expected return of an asset based on its level of risk.

Question 16

If the firm is in a capital rationing situation, then it becomes necessary for the firm to identify the bundle or combination of positive-NPV projects that crates the greatest total value for stockholders.

Accepted Answer

In a capital rationing situation, the firm has limited funds to allocate to different investment projects. Therefore, the firm must prioritize and select the projects that will generate the highest return on investment and add the most value to shareholders. This involves identifying the bundle or combination of positive-NPV (Net Present Value) projects that creates the greatest total value for stockholders.

Question 17

The cross-over level of unit sales can be calculated for any two alternatives that have the same level of operating leverage.

Accepted Answer

The crossover level of unit sales is calculated to compare two alternatives, focusing on their fixed and variable costs, not specifically on their operating leverage. Operating leverage can influence the analysis, but the key is comparing fixed and variable costs to find where the total costs of both alternatives are equal.

Question 18

Another name for EBITDA is

Accepted Answer

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a measure of a company's financial performance that excludes the effects of financing and accounting decisions. Therefore, pretax operating cash flow is the most appropriate synonym for EBITDA as it measures the company's cash flow from operations before considering the effects of interest and taxes.

Question 19

The degree of pretax cash flow operating leverage provides us with

Accepted Answer

The degree of pretax cash flow operating leverage measures the sensitivity of pretax operating cash flows to changes in revenue, making option A the correct choice. Option B refers to accounting operating profits, which is a different measure than pretax cash flow operating leverage. Option C references NOPAT, which is also a different measure than pretax cash flow operating leverage. Therefore, options B and C are not correct.

Question 20

A firm with a higher proportion of fixed costs will create

Accepted Answer

A firm with a higher proportion of fixed costs will have a higher degree of sensitivity of EBITDA to a change in revenues because any change in revenue will directly impact the fixed costs, leading to a higher impact on EBITDA.

Quiz 12: Evaluating Project Economics and Capital Rationing