Deck 6: Risk and Project Appraisal

Question 1

If NewProduct prices could be increased by 10 per cent, while keeping sales levels at the original level, what would be the NPV?

A) £71,075
B) £141.750
C) £101,750
D) £431,075

Answer 1

A

Question 2

Which type of probability can be established mathematically or from historical data.

A) Objective
B) Calculated
C) Subjective
D) Personal

Answer 2

A

Question 3

Which of thefollowing types of analysis allows for most precision in judging project viability?

A) Discount- rate analysis
B) Sensitivity analysis
C) Probability analysis
D) Scenario analysis

Answer 3

C

Question 4

Which two methods of allowing for project risk are most popular?

A) Sensitivity analysis
B) Scenario analysis
C) Discount- rate analysis
D) Probability analysis

Question 5

What is represented by the term x_i in the expression x = Σ (xipi) ? i=1

A) The mean outcome
B) The value of an outcome
C) The dispersion of the outcome
D) The probability of the outcome

Question 6

Which three of the following accurately relate to the real options approach?

A) It takes future managerial flexibility into account.
B) It allows managers to amend decisions in the light of future events.
C) It differs from the NPV approach, which does not offer future flexibility.
D) It does not allow managers to expand the plans in future.

Question 7

Which of the following statements correctly relates to the concept of risk?

A) A subjective probability can only be established mathematically or from historical data.
B) An objective probability can be established mathematically or from historical data.
C) Uncertainty only applies when it is possible to assign probabilities.
D) Risk only applies when it is possible to assign probabilities.

Question 8

Which three statements accurately describe the process of allowing for risk by raising or lowering the discount rate?

A) It is easy to understand.
B) It is an accurate, objective approach.
C) It is an easy approach to use.
D) It is susceptible to subjectivity in risk premium and risk class allocation.

Question 9

Which two of the following conditions could mean that Project X will be preferred to Project Y, under the Mean- variance rule.

A) The variance of X is equal to or less than that of Y.
B) The variance of X is less than that of Y.
C) The expected return of X is at least equal to the expected return of Y.
D) The expected return of X is less than that of Y.

Question 10

How is a rate of return calculated on the basis of the risk premium and the risk- free rate?

A) A premium is subtracted from the risk- free discount rate.
B) A risk premium is added to the risk- free discount rate.
C) The risk- free rate is discounted to create a premium.
D) The premium rate is discounted to minimise risk.

Question 11

At the break- even point which of the following expressions applies?

A) NPV > 0
B) NPV = IRR
C) NPV = 0
D) NPV < 0

Question 12

What is shown by the Z statistic?

A) The probability of all outcomes
B) The number of standard deviations from the maximum value to the value that interests you
C) The number of standard deviations from the mean to the value that interests you
D) The probability of the outcome

Question 13

Which three of the following statements correctly relate to subjective probability?

A) Decision making based on subjective probabilities will be subject to some margin of error.
B) Subjective probabilities typically involve personal judgment of the range of outcomes along with the likelihood of their occurrence.
C) They are useful where there are no past records to help in the creation of the distribution of probabilities profile.
D) Decisions based on subjective probabilities are always more reliable than those based on objective, purely numerical, information.

Question 14

Which three following statements are correct?

A) Risk averters prefer a more certain return to an alternative with an equal but more risky expected outcome.
B) Most investors in shares are risk averters.
C) Risk averters demonstrate diminishing marginal utility.
D) Risk averters expect companies to behave as risk lovers.

Question 15

A project assessment shows a positive NPV even after allowing for real option value. Which one of the following options best describes what action management should take?

A) Accept the project without further study
B) Reject the project and carry out further investigation of it
C) Reject the project
D) Accept the project and carry out further investigation

Question 16

What is meant by the term 'standard deviation'?

A) The square of the variance
B) The dispersion around the expected value
C) The square root of the sum of the probabilities
D) The square root of the sum of the probabilities of each outcome

Question 17

What term is used to describe the type of probability that involves a personal judgement of the likely range of outcomes and the likelihood of their occurrence?

A) Subjective
B) Personal
C) Calculated
D) Objective

Question 18

Which value is calculated using the expression i=n
Σ (xipi) ?
I=1

A) Expected return
B) Standard return
C) Discounted return
D) Total return

Question 19

Which statement best describes the concept of risk?

A) Risk describes a situation where there is not just one possible outcome, but an array of potential returns.
B) Under risk situations there can only be one possible outcome, but with array of potential returns.
C) Under uncertain situations, future outcomes can be expected to have only one value.
D) Under a situation of risk, future outcomes can be expected to have only one value.

Question 20

The NewProduct project involves an initial investment of £400,000. The predicted annual cash flow is £150,000 for a four year period, after which the product will be replaced. The required rate of return is 15 per cent. What is the net present value?

A) - £25,750
B) £200,000
C) £35,750
D) £28,250

Question 21

What term is used for the concept that "The additional utility from consumption diminishes as consumption increases."

A) Increasing marginal utility
B) Utilised marginal increase
C) Diminishing marginal utility
D) Utilised marginal diminution

Question 22

Evaluation of two projects has shown for Project X a return of £10m with a 0.8 probability and a return of 0 with probability 0.2, while Project Y has a return of £20m with a probability of 0.5 and a return of 0 with the same probability. What is the expected return?

A) £21m
B) £18m
C) £30m
D) £2m

Question 23

A sensitivity graph shows % deviation of the variable from expectation on the x- axis and NPV on the y- axis. Variables may be represented by straight lines on the graph. Which variable will have the largest negative effect on NPV?

A) Large upward gradient
B) Small downward gradient
C) Large downward gradient
D) Small upward gradient

Question 24

In probability analysis, what technique is used to calculate the expected return?

A) Weight each of the possible outcomes by the probability of occurrence, and then calculate the arithmetic average of the weighted outcomes
B) Calculate the mean of the various possible outcomes
C) Calculate the weighted mean of all the possible outcomes
D) Identify the outcome that is most likely to occur

Question 25

Which technique considers a project's NPV under alternative assumed values of variables, changed one at a time?

A) Probability analysis
B) Sensitivity analysis
C) Scenario analysis
D) Discount- rate analysis

Question 26

What is meant by the term 'sensitivity analysis'?

A) An assessment of the effect of objective changes on the accuracy of inputs
B) A calculation of what changes are needed in inputs to create a specified change in output
C) Calculation of the dependence of NPV on levels of risk
D) A series of 'what- if' analyses to assess the effects of future changes of predicted profits and other key variables

Question 27

A concert promoter assesses that the probability of a concert being a success is 0.4. The initial cash cost will be £50,000. A success will create a present value of all cash flows of £250,000 and a flop will lose £100,000. What is the expected NPV, using a conventional approach?

A) £10,000
B) £74,000
C) - £10,000
D) £0

Question 28

Which three types of information are most useful when a manager summarises the findings of a project appraisal?

A) The likely outcomes of each project considered
B) Statement of to what extent probabilities were objective or subjective
C) Assessment of the probability of each outcome actually occurring
D) A clear focus on the most profitable outcome

Question 29

What does the symbol µ represent in the formula: Z = X - µ ? a

A) The deviation from the mean of the outcomes
B) The weighted mean of the possible outcomes
C) The weighted mean of all outcomes
D) The mean of the possible outcomes

Question 30

What would be the NPV of NewProduct if the discount rate was changed from 15 per cent to 18 per cent?

A) £73,570
B) £23,750
C) - £23,750
D) £43,850

Question 31

If NewProduct sales are 5 per cent below the expected levels, cash flow per unit falls by 33.3 per cent. What will be the NPV?

A) - £114,500
B) £14,500
C) - £154,500
D) £145,000

Question 32

Which technique considers a project's NPV when a number of variables have been changed simultaneously?

A) Scenario analysis
B) Probability analysis
C) Discount- rate analysis
D) Sensitivity analysis

Question 33

Which two methods do firms have for allowing for different levels of risk?

A) Raising the discount rate
B) Lowering the discount rate
C) Issuing bonds
D) Issuing more shares

Question 34

Which three of the statements are advantages of using sensitivity analysis?

A) It provides information for decision making.
B) It can be used when making contingency plans.
C) It identifies the relationships between various unpredictable variables.
D) It may lead to an indication of where further investigation might be worthwhile.

Question 35

Which three of the following statements accurately relate to scenario analysis?

A) It is essentially a 'what- if' analysis in which a number of variables may be changed at the same time.
B) It uses a series of calculations to build up a picture of the nature of the risks facing the project and their impact on project profitability.
C) It is used by managers to analyse how projects have been affected by decisions made by their predecessors.
D) It can identify the extent to which variables may change allowing management to consider possible actions to be taken before a negative NPV is produced.

Question 36

NPV analysis on a new project has been carried out to identify the crude NPV and the NPV of the expansion option. Which other three types of analysis should be carried out?

A) NPV of taking no action
B) NPV of the abandonment option
C) NPV of the timing option
D) NPV of other option possibilities

Question 37

A project is predicted to have a return of - £16m in a recession, and the probability of a recession is estimated to be 0.25. In a growth period the return would be 16m (with probability 0.50) and in a boom the return would be £24m (with probability 0.25). What is the expected return?

A) £80m
B) £24m
C) £50m
D) £10m

Question 38

Which three the following steps would you complete when adjusting for risk through the discount rate?

A) Add a premium to the risk- free discount rate
B) Calculate net present value, based solely on the premium adjustment
C) Use the risk- adjusted discount rate to calculate net present value
D) Make decisions, based on a subjective judgement of the risk

Question 39

Which two of the following best describe the real options approach?

A) Managers are obliged to take certain actions in the future.
B) Managers are given the possibility to take an action in the future.
C) Managers are not obliged to take particular actions in the future.
D) Managers must refer potential changes to the original managers who made the decisions.

Question 40

Which of the following should a management team carry out to get a complete picture of a project?

A) Sensitivity analysis and break- even NPV calculations
B) Sensitivity analysis, break- even NPV calculations and scenario analysis
C) Sensitivity analysis and scenario analysis
D) Break- even NPV calculations and scenario analysis

Question 41

Which three of the following are difficulties of real option analysis?

A) The inevitably short lifetime of the option
B) The difficulties of measuring uncertainty
C) The risk of over optimism
D) The complexity of the valuation process

Question 42

A firm knows that it will go bankrupt if it loses more than £10m on a project. The expected NPV is £16m, with a standard deviation of £13m. What is the Z- factor of the bankruptcy event?

A) +2
B) +7.5
C) - 2
D) - 0.31

Question 43

A concert promoter assesses that the probability of a concert being a success is 0.4. The initial cash cost to take out an option to organise the concert will be £50,000. A success will create a present value of all cash flows of £250,000 and a flop will lose £100,000. The promoter can make a final decision at a later date before making any further payments. What is the expected NPV, using an options approach?

A) £50,000
B) £14,000
C) £10,000
D) - £10,000

Question 44

Which approach enables analysts to assess how sensitive NPV is to changes in component values?

A) Probability analysis
B) If- What calculations
C) Sensitivity analysis
D) Discount cash flow calculations

Question 45

Which three of the following problems is most likely to result from using probability analysis?

A) The investigation is too complicated for managers to understand.
B) Projects may be viewed in isolation.
C) Too much faith is placed in quantified subjective probabilities.
D) The analysis does not offer information on the likely outcomes and the associated probabilities.

Question 46

Which of the following options highlights a key benefit of scenario analysis when compared with sensitivity analysis?

A) It considers situations in which many variables change at the same time.
B) It highlights factors that managers may previously not have considered.
C) It calculates the probability of various outcomes.
D) It focuses on the effect of changes in a single variable.

Question 47

Which three of the following are drawbacks of the risk- adjusted discount rate method?

A) Risk perception is inevitably susceptible to personal bias.
B) There is a high level of arbitrariness in the selection of risk premiums.
C) Investors tend to consider risk of less importance than project managers.
D) It is extremely difficult to allocate projects to risk classes.

Question 48

The expected return of Project Y is at least equal to the expected return of Project X, and the variance of Y is less than that of X. Using the mean variance rule, what would you do?

A) Reject both projects
B) Accept both projects
C) Prefer Project X
D) Prefer Project Y