Deck 9: Risk Analysis, Real Options, and Capital Budgeting

Question 1

To ascertain whether the accuracy of the variable cost estimate for a project will have much effect on the final outcome of the project,you should probably conduct _____ analysis.

A)cash flow
B)sensitivity
C)break-even
D)scenario
E)leverage

Answer 1

sensitivity

Question 2

An analysis of what happens to the estimate of net present value when only one variable is changed is called _____ analysis.

A)break-even
B)scenario
C)simulation
D)sensitivity
E)forecasting

Answer 2

sensitivity

Question 3

Which one of the following is most likely a variable cost?

A)Management salaries
B)Property taxes
C)Direct labor costs
D)Property insurance
E)Office rent

Answer 3

Direct labor costs

Question 4

Sensitivity analysis is conducted by:

A)holding all variables at their base level and changing the required rate of return assigned to a project.
B)changing the value of two variables to determine their interdependency.
C)changing the value of a single variable and computing the resulting change in the net present value of a project.
D)assigning either the best or the worst possible value to each variable and comparing the results to those achieved by the base case.
E)managers after a project has been implemented to determine how every variable relates to the level of output realized.

Question 5

Fixed costs:
I.are variable over long periods of time.
II.must be paid even if production is halted.
III.are generally affected by the amount of fixed assets owned by a firm.
IV.per unit remain constant over a given range of production output.

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

Question 6

Variable costs:

A)are subtracted from fixed costs to compute the contribution margin.
B)reflect the change in a variable when one more unit of output is produced.
C)are constant in the short-run regardless of the quantity of output produced.
D)change in direct relationship to the quantity of output produced.
E)form the basis that is used to determine the degree of operating leverage employed by a firm.

Question 7

Conducting scenario analysis helps managers see the:

A)impact of an individual variable on the outcome of a project.
B)potential range of outcomes from a proposed project.
C)changes in long-term debt over the course of a proposed project.
D)possible range of market prices for their stock over the life of a project.
E)distribution of funds for capital projects under conditions of hard rationing.

Question 8

Monte Carlo simulation is based on assigning a _____ and analyzing the results.

A)single value to each of the variables
B)wide range of values to multiple variables simultaneously
C)wide range of values to a single variable
D)narrow range of values to multiple variables simultaneously
E)narrow range of values to a single variable

Question 9

Which of the following statements concerning variable costs is (are)correct?
I.Variable costs minus fixed costs equal marginal costs.
II.Variable costs are equal to zero when production is equal to zero.
III.An increase in variable costs increases the operating cash flow.

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

Question 10

An analysis of what happens to the estimate of the net present value when you examine a number of different likely situations is called _____ analysis.

A)forecasting
B)break-even
C)simulation
D)sensitivity
E)scenario

Question 11

Sensitivity analysis helps you determine the:

A)range of possible outcomes given possible ranges for every variable.
B)degree to which the net present value reacts to changes in a single variable.
C)net present value given the best and the worst possible situations.
D)degree to which a firm is reliant multiple economic factors changing at the same time.
E)level of variable costs in relation to the fixed costs of a project.

Question 12

Fixed costs:

A)are constant over the short-run regardless of the quantity of output produced.
B)change as the quantity of output produced changes.
C)are subtracted from sales to compute the contribution margin.
D)reflect the change in a variable when one more unit of output is produced.
E)can be ignored in scenario analysis since they are constant over the life of a project.

Question 13

Assuming price greater than cost per unit,the contribution margin must increase as:

A)both the sales price and variable cost per unit increase.
B)sales price per unit declines.
C)the sales price minus the fixed cost per unit increases.
D)the fixed cost per unit declines.
E)the gap between the sales price and the variable cost per unit widens.

Question 14

An analysis which combines scenario analysis with sensitivity analysis is called:

A)sensitivity analysis
B)Monte Carlo simulation
C)forecasting analysis
D)forecasting simulation
E)break-even analysis

Question 15

The sales level that results in a project's net present value exactly equaling zero is called the _____ break-even.

A)leveraged
B)operational
C)accounting
D)present value
E)cash

Question 16

The type of analysis that is most dependent upon the use of a computer is _____ analysis.

A)Monte Carlo simulation
B)degree of operating leverage
C)sensitivity
D)break-even
E)scenario

Question 17

An analysis of the relationship between the sales volume and various measures of profitability is called _____ analysis.

A)forecasting
B)scenario
C)sensitivity
D)simulation
E)break-even

Question 18

All else constant,as the variable cost per unit increases,the:

A)net profit increases.
B)degree of operating leverage decreases.
C)sensitivity to fixed costs decreases.
D)operating cash flow increases.
E)contribution margin decreases.

Question 19

As the degree of sensitivity of a project to a single variable rises,the:

A)lower the forecasting risk of the project.
B)smaller the range of possible outcomes given a pre-defined range of values for the input.
C)lower the maximum potential loss of the project.
D)lower the maximum potential value of the project.
E)more attention management should place on accurately forecasting the future value of that variable.

Question 20

The sales level that results in a project's net income exactly equaling zero is called the _____ break-even.

A)operational
B)leveraged
C)accounting
D)cash
E)present value

Question 21

Last month you introduced a new product to the market.Consumer demand has been overwhelming and it appears that strong demand will exist over the long-term.Given this situation,management should consider the option to:

A)suspend.
B)contract.
C)withdraw.
D)expand.
E)abandon.

Question 22

In order to make a decision with a decision tree:

A)any path can be taken to get to the end.
B)any path can be taken to get back to the beginning.
C)one starts farthest out in time to make the first decision.
D)one must begin at time 0.
E)None of the above.

Question 23

Variable costs:

A)change as the quantity of output changes.
B)are zero when production is zero.
C)are exemplified by direct labor and raw materials.
D)All of the above.
E)None of the above.

Question 24

All else constant,the accounting break-even level of sales will decrease when the:

A)fixed costs increase.
B)depreciation expense decreases.
C)contribution margin decreases.
D)variable costs per unit increase.
E)selling price per unit decreases.

Question 25

An investigation of the degree to which NPV depends on assumptions made about any singular critical variable is called a(n):

A)operating analysis.
B)sensitivity analysis.
C)marginal benefit analysis.
D)decision tree analysis.
E)None of the above.

Question 26

Including the option to expand in your project analysis will tend to:

A)extend the duration of a project but not affect the project's net present value.
B)increase the cash flows of a project but decrease the project's net present value.
C)increase the net present value of a project.
D)decrease the net present value of a project.
E)have no effect on either a project's cash flows or its net present value.

Question 27

Sensitivity analysis evaluates the NPV with respect to:

A)changes in the underlying assumptions.
B)one variable changing while holding the others constant.
C)different economic conditions.
D)All of the above.
E)None of the above.

Question 28

The point where a project produces a rate of return equal to the required return is known as the:

A)present value break-even point.
B)accounting break-even point.
C)internal break-even point.
D)point of zero operating leverage.
E)external break-even point.

Question 29

Fixed production costs are:

A)measured as cost per unit of time.
B)directly related to labor costs.
C)dependent on the amount of goods or services produced.
D)measured as cost per unit of output.
E)None of the above.

Question 30

In a decision tree,the NPV to make the yes/no decision is dependent on:

A)the path where the probabilities add up to one.
B)only the cash flows from successful path.
C)only the cash flows and probabilities of the successful path.
D)all cash flows and probabilities.
E)None of the above.

Question 31

Scenario analysis is different than sensitivity analysis:

A)as no economic forecasts are changed.
B)as several variables are changed together.
C)because scenario analysis deals with actual data versus sensitivity analysis which deals with a forecast.
D)because it is short and simple.
E)because it is a "by the seat of the pants" technique.

Question 32

The investment timing decision relates to:

A)how long the cash flows last once a project is implemented.
B)how frequently the cash flows of a project occur.
C)the decision as to when a project should be started.
D)how frequently the interest on the debt incurred to finance a project is compounded.
E)the decision to either finance a project over time or pay out the initial cost in cash.

Question 33

In a decision tree,caution should be used in analysis because:

A)early stage decisions are probably riskier and likely should not use the same discount rate.
B)if a negative NPV is actually occurring,management should opt out of the project and minimize the firm's loss.
C)decision trees are only used for early project planning,not actually daily management.
D)Both A and C.
E)Both A and B.

Question 34

The present value break-even point is superior to the accounting break-even point because:

A)present value break-even is more complicated to calculate.
B)present value break-even covers the economic opportunity costs of the investment.
C)present value break-even is the same as sensitivity analysis.
D)present value break-even covers the fixed costs of production, while the accounting break-even does not.
E)present value break-even covers the variable costs of production, while the accounting break-even does not.

Question 35

The timing option that gives the option to wait:
I.may be of minimal value if the project relates to a rapidly changing technology.
II.is partially dependent upon the discount rate applied to the project being evaluated.
III.is defined as the situation where operations are shut down for a period of time.
IV.has a value equal to the net present value of the project if it is started today versus the
Net present value if it is started at some later date.

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

Question 36

Which of the following statements are correct concerning the present value break-even point of a project?
I.The present value of the cash inflows equals the amount of the initial investment.
II.The payback period of the project is equal to the life of the project.
III.The operating cash flow is at a level that produces a net present value of zero.
IV.The project never pays back on a discounted basis.

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

Question 37

In the present-value break-even the EAC is used to:

A)allocate depreciation over the life of the project.
B)determine the opportunity cost of investment.
C)determine the contribution margin to fixed costs.
D)allocate the initial investment at the opportunity cost over the life of the project.
E)None of the above.

Question 38

Theoretically,the NPV is the most appropriate method to determine the acceptability of a project.A false sense of security can overwhelm the decision-maker when the procedure is applied properly and the positive NPV results are accepted blindly.Sensitivity and scenario analysis aid in the process by:

A)changing the underlying assumptions on which the decision is based.
B)highlighting the areas where more and better data are needed.
C)providing a picture of how an event can affect the calculations.
D)All of the above.
E)None of the above.

Question 39

Which of the following statements are correct concerning the accounting break-even point?
I.The net income is equal to zero at the accounting break-even point.
II.The net present value is equal to zero at the accounting break-even point.
III.The quantity sold at the accounting break-even point is equal to the total fixed costs plus depreciation divided by the contribution margin.
IV.The quantity sold at the accounting break-even point is equal to the total fixed costs divided by the contribution margin.

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

Question 40

Sensitivity analysis provides information on:

A)whether the NPV should be trusted,although it may provide a false sense of security if all NPVs are positive.
B)the need for additional information as it tests each variable in isolation.
C)the degree of difficulty in changing multiple variables together.
D)Both A and B.
E)Both A and C.

Question 41

What is the sales revenue under the optimistic case scenario?

A)$50,000
B)$53,120
C)$54,000
D)$54,880
E)$58,905

Question 42

The approach that further attempts to model real word uncertainty by analyzing projects the way one might analyze gambling strategies is called:

A)Monte Carlo simulation.
B)blackjack approach.
C)gambler's approach.
D)sensitivity analysis.
E)scenario analysis.

Question 43

What is the earnings before interest and taxes under the expected case scenario?

A)$18,000
B)$24,000
C)$36,000
D)$48,000
E)$54,000

Question 44

At a production level of 6,000 units a project has total costs of $120,000.The variable cost per unit is $14.50.What is the amount of the total fixed costs?

A)$25,165
B)$28,200
C)$30,570
D)$32,000
E)$33,000

Question 45

A project has earnings before interest and taxes of $5,750,fixed costs of $50,000,a selling price of $13 a unit,and a sales quantity of 11,500 units.Depreciation is $7,500.What is the variable cost per unit?

A)$6.75
B)$7.00
C)$7.25
D)$7.50
E)$7.75

Question 46

At a production level of 5,600 units a project has total costs of $85,000.The variable cost per unit is $10.20.What is the amount of the total fixed costs?

A)$24,126
B)$25,480
C)$26,200
D)$27,880
E)$28,626

Question 47

What is the contribution margin for a sensitivity analysis using a variable cost per unit of $8?

A)$3
B)$4
C)$5
D)$6
E)$7

Question 48

Which of the following are hidden options in capital budgeting?

A)Option to expand.
B)Timing option.
C)Option to abandon.
D)All of the above.
E)None of the above.

Question 49

The company conducts a sensitivity analysis using a variable cost of $11.The total variable cost estimate will be:

A)$31,375
B)$32,500
C)$33,625
D)$38,500
E)$44,750

Question 50

What is the contribution margin under the expected case scenario?

A)$2.67
B)$3.00
C)$8.00
D)$8.65
E)$8.72

Question 51

The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $18.Using this value,the earnings before interest and taxes will be:

A)$14,000
B)$16,000
C)$18,500
D)$20,000
E)$28,500

Question 52

Monte Carlo simulation is:

A)a very simple formula.
B)the most widely used N-A-W-H by executives.
C)the oldest capital budgeting technique.
D)is more complex than sensitivity or scenario analysis.
E)None of the above.

Question 53

The potential decision to abandon a project has option value because:

A)abandonment can occur at any future point in time.
B)a project may be worth more dead than alive.
C)management is not locked into a negative outcome.
D)All of the above.
E)None of the above.

Question 54

What is the earnings before interest and taxes under the optimistic case scenario?

A)$22,694.40
B)$24,854.40
C)$37,497.60
D)$52,694.40
E)$67,947.60

Question 55

What is the net income under the pessimistic case scenario?

A)-$566.02
B)-$422.40
C)-$278.78
D)$3,554.50
E)$5,385.60

Question 56

What is the operating cash flow for a sensitivity analysis using total fixed costs of $32,000?

A)$14,520
B)$16,520
C)$22,000
D)$44,520
E)$52,000

Question 57

A firm is reviewing a project with labor cost of $9.90 per unit,raw materials cost of $22.63 a unit,and fixed costs of $8,000 a month.Sales are projected at 10,000 units over the three-month life of the project.What are the total variable costs of the project?

A)$246,300
B)$287,300
C)$325,300
D)$343,300
E)$389,300

Question 58

Wilson's Meats has computed its fixed costs to be $.60 for every pound of meat it can sell given an average daily sales level of 500 pounds.It charges $3.79 per pound of top-grade ground beef.The variable cost per pound is $2.99.What is the contribution margin per pound of ground beef sold?

A)$.30
B)$.80
C)$.90
D)$2.99
E)$3.89

Question 59

What is the amount of the fixed cost per unit under the pessimistic case scenario?

A)$3.55
B)$4.00
C)$4.17
D)$5.02
E)$5.55

Question 60

Which of the following are types of break-even analysis?

A)Present value break-even
B)Accounting profit break-even
C)Market value break-even
D)Both A and B.
E)Both A and C.

Question 61

If the company has a discount rate of 17%,should management decide to invest?

A)yes, NPV = $2.2 million
B)yes, NPV = $21.6 million
C)no, NPV = $-1.9 million
D)yes, NPV = $8.6 million
E)No, since more than one branch is NPV = 0 or negative you must reject.

Question 62

The Mini-Max Company has the following cost information on its new prospective project.Calculate the accounting break-even point. Initial investment:
$700
Fixed costs:
$200 per year
Variable costs:
$3 per unit
Depreciation:
$140 per year
Price:
$8 per unit
Discount rate:
12%
Project life:
5 years
Tax rate:
34%

A)25 units per year
B)68 units per year
C)103 units per year
D)113 units per year
E)None of the above.

Question 63

You are considering a project which has been assigned a discount rate of 8 percent.If you start the project today,you will incur an initial cost of $480 and will receive cash inflows of $350 a year for three years.If you wait one year to start the project,the initial cost will rise to $520 and the cash flows will increase to $385 a year for three years.What is the value of the option to wait?

A)$15.23
B)$17.08
C)$18.67
D)$20.20
E)$50.20

Question 64

You are considering a new project.The project has projected depreciation of $720,fixed costs of $6,000,and total sales of $12,760.The variable cost per unit is $6.04.What is the accounting break-even level of production?

A)1,000 units
B)1,334 units
C)1,372 units
D)1,889 units
E)1,910 units

Question 65

If the company has a discount rate of 17%,what is the value closest to time 1 net present value?

A)$48.6 million
B)$80.9 million
C)$108.2 million
D)$181.4 million
E)None of the above.

Question 66

Ralph and Emma's is considering a project with total sales of $17,500,total variable costs of $9,800,total fixed costs of $3,500,and estimated production of 400 units.The depreciation expense is $2,400 a year.What is the contribution margin per unit?

A)$4.50
B)$10.50
C)$14.14
D)$19.09
E)$19.25

Question 67

At stage 2 of the decision tree it shows that if a project is successful,the payoff will be $53,000 with a 2/3 chance of occurrence.There is also the 1/3 chance of a $-24,000 payoff.The cost of getting to stage 2 (1 year out)is $44,000.The cost of capital is 15%.What is the NPV of the project at stage 1?

A)$-13,275
B)$-20,232
C)$2,087
D)$7,536
E)Can not be calculated without the exact timing of future cash flows.

Question 68

Given the following information,calculate the present value break-even point. Initial investment:
$2,000
Fixed costs:
$2,000 per year
Variable costs:
$6 per unit
Depreciation:
$250 per year
Price:
$20 per unit
Discount rate:
10%
Project life:
4 years
Tax rate:
34%

A)100 units per year
B)143 units per year
C)202 units per year
D)286 units per year
E)None of the above.

Question 69

A project has an accounting break-even point of 2,000 units.The fixed costs are $4,200 and the depreciation expense is $400.The projected variable cost per unit is $23.10.What is the projected sales price?

A)$20.80
B)$21.00
C)$21.20
D)$25.40
E)$25.60

Question 70

Kurt Neal and Son is considering a project with a discounted payback just equal to the project's life.The projections include a sales price of $12,variable cost per unit of $8.50,and fixed costs of $5,500.The operating cash flow is $7,200.What is the break-even quantity?

A)1,800 units
B)2,480 units
C)3,629 units
D)3,750 units
E)4,280 units

Question 71

The Mini-Max Company has the following cost information on its new prospective project.Calculate the present value break-even point. Initial investment:
$700
Fixed costs are $200 per year
Variable costs:
$3 per unit
Depreciation:
$140 per year
Price:
$8 per unit
Discount rate:
12%
Project life:
3 years
Tax rate:
34%

A)68 units per year
B)75 units per year
C)84 units per year
D)114 units per year
E)None of the above.

Question 72

Wilson's Antiques is considering a project that has an initial cost today of $10,000.The project has a two-year life with cash inflows of $6,500 a year.Should Wilson's decide to wait one year to commence this project,the initial cost will increase by 5 percent and the cash inflows will increase to $7,500 a year.What is the value of the option to wait if the applicable discount rate is 10 percent?

A)$1,006.76
B)$1,235.54
C)$1,509.28
D)$1,606.76
E)$1,735.54

Question 73

A proposed project has fixed costs of $3,700,depreciation expense of $1,600,and a sales quantity of 1,400 units.What is the contribution margin if the projected level of sales is the accounting break-even point?

A)$3.56
B)$3.79
C)$4.15
D)$4.36
E)$5.00

Question 74

Your firm is considering a project with a five-year life and an initial cost of $120,000.The discount rate for the project is 12 percent.The firm expects to sell 2,100 units a year.The cash flow per unit is $20.The firm will have the option to abandon this project after three years at which time it expects it could sell the project for $50,000.You are interested in knowing how the project will perform if the sales forecast for years four and five of the project are revised such that there is a 50% chance that the sales will be either 1,400 or 2,500 units a year.What is the net present value of this project given your sales forecasts?

A)$23,617
B)$23,719
C)$25,002
D)$26,877
E)$28,746

Question 75

Your firm is considering a project with a five-year life and an initial cost of $120,000.The discount rate for the project is 12 percent.The firm expects to sell 2,100 units a year.The cash flow per unit is $20.The firm will have the option to abandon this project after three years at which time it expects it could sell the project for $45,000.At what level of sales should the firm be willing to abandon this project?

A)420 units
B)1,332 units
C)1,479 units
D)1,618 units
E)2,500 units

Question 76

Thompson & Son has been busy analyzing a new product.Management has determined that an operating cash flow of $16,700 will result in a zero net present value,which is a company requirement for project acceptance.The fixed costs are $12,378 and the contribution margin is $6.20.Management feels that they can realistically capture 10 percent of the 50,000 unit market for this product.Should the company develop the new product? Why or why not?

A)yes; because 5,000 units of sales exceeds the quantity required for a zero net present value
B)yes; because the internal break-even point is less than 5,000 units
C)no; because the firm cannot generate sufficient sales to obtain at least a zero net present value
D)no; because the project has an expected internal rate of return of negative 100 percent
E)no; because the project will not pay back on a discounted basis

Question 77

The accounting break-even production quantity for a project is 7,425 units.The fixed costs are $51,600 and the contribution margin is $9.What is the projected depreciation expense?

A)$7,600
B)$9,050
C)$10,025
D)$12,053
E)$15,225

Question 78

A project has a contribution margin of $5,projected fixed costs of $13,000,projected variable cost per unit of $12,and a projected present value break-even point of 5,500 units.What is the operating cash flow at this level of output?

A)$1,000
B)$12,000
C)$13,000
D)$14,500
E)$23,000

Question 79

From the information below,calculate the accounting break-even point. Initial investment:
$2,000
Fixed costs are $2,000 per year
Variable costs:
$6 per unit
Depreciation:
$250 per year
Price:
$20 per unit
Discount rate:
10%
Project life:
4 years
Tax rate:
34%

A)88 units per year
B)100 units per year
C)143 units per year
D)161 units per year
E)None of the above.

Question 80

Margerit is reviewing a project with projected sales of 1,500 units a year,a cash flow of $40 a unit and a three-year project life.The initial cost of the project is $95,000.The relevant discount rate is 15 percent.Margerit has the option to abandon the project after one year at which time she feels she could sell the project for $70,000.At what level of sales should she be willing to abandon the project?

A)899 units
B)923 units
C)967 units
D)1,077 units
E)1,206 units