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

Question 1

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

Answer 1

accounting

Question 2

The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500 (including depreciation). Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario What is the amount of the fixed cost per unit under the pessimistic case scenario?

A) $4.55
B) $5.00
C) $5.83
D) $6.02
E) $6.55

Answer 2

$5.83

Question 3

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

A) operating analysis.
B) sensitivity analysis.
C) marginal benefit analysis.
D) decision tree analysis.

Answer 3

sensitivity analysis.

Question 4

Fixed production costs are:

A) directly related to labor costs.
B) measured as cost per unit of time.
C) measured as cost per unit of output.
D) dependent on the amount of goods or services produced.

Question 5

The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario What is the sales revenue under the optimistic case scenario?

A) $40,000
B) $43,120
C) $44,000
D) $44,880
E) $48,400

Question 6

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 project is reliant upon the fixed costs.

Question 7

The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $17. Using this value, the earnings before interest and taxes will be:

A) $4,000.
B) $6,000.
C) $8,500.
D) $10,000.
E) $18,500.

Question 8

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

A) 68.00 units/year.
B) 113.89 units/year.
C) 84.42 units/year.
D) 75 units/year.

Question 9

Scenario analysis is different than sensitivity analysis because:

A) no economic forecasts are changed.
B) several variables are changed together.
C) scenario analysis deals with actual data versus sensitivity analysis which deals with a forecast.
D) it is short and simple.

Question 10

Sensitivity analysis is conducted by:

A) holding all variables at their base level and changing the required rate of return.
B) changing the value of two variables to determine their interdependency.
C) changing the value of a single variable and computing the change in the project's NPV.
D) assigning either the best or the worst possible value to every variable and comparing the results to those achieved by the base case.
E) reviewing a project after implementation to determine how the actual results are comparing to the predicted results.

Question 11

In order to make a decision with a decision tree:

A) one starts furthest out in time to make the first decision.
B) One must begin at time 0.
C) Any path can be taken to get to the end.
D) Any path can be taken to get back to the beginning.

Question 12

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

Question 13

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) more attention management should place on accurately forecasting the future value of that variable.
D) lower the maximum potential value of the project.

Question 14

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

A) determine the opportunity cost of investment.
B) allocate depreciation over the life of the project.
C) allocate the initial investment at its opportunity cost over the life of the project.
D) determine the contribution margin to fixed costs.

Question 15

The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario What is the contribution margin under the expected case scenario?

A) $2.67
B) $3.00
C) $7.92
D) $8.00
E) $8.72

Question 16

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

A) 68.00 units/year.
B) 103.03 units/year.
C) 113.33 units/year.
D) 25.00 units/year.

Question 17

The accounting profit break-even point occurs when:

A) the total revenue curve cuts the total cost curve.
B) the total revenue curve cuts the fixed cost curve.
C) the variable cost curve cuts the total cost curve.
D) the total revenue curve cuts the variable cost curve.

Question 18

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

A) only the cash flows from successful path.
B) on the path where the probabilities add up to one.
C) all cash flows and probabilities.
D) only the cash flows and probabilities of the successful path.

Question 19

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, which the accounting break-even does not.
E) present value break-even covers the variable costs of production, which the accounting break-even does not.

Question 20

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

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

Question 21

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

A) 88 units/year.
B) 161 units/year.
C) 143 units/year.
D) 100 units/year.

Question 22

All else equal, the contribution margin must increase as:

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

Question 23

Given the following information, calculate the present value break-even point. Fixed costs: $2000/year. (Initial investment $2000).
Variable costs: $6/unit.
Depreciation: $250/year.
Price: $20/unit.
Discount rate: 10%.
Project life: 4 years.
Tax rate: 34%.

A) 100 units/year.
B) 143 units/year.
C) 202 units/year.
D) 286 units/year.

Question 24

The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5% range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity analysis on the expected case scenario. The company conducts a sensitivity analysis using a variable cost of $9. The total variable cost estimate will be:

A) $21,375.
B) $22,500.
C) $23,625.
D) $24,125.
E) $24,750.

Question 25

From the information below, calculate the impact of discount rate changes on the present-value break-even point. Fixed costs are $2500/year. (Initial investment is $2000.)
Variable costs: $8/unit.
Depreciation: $500/year.
Price: $25/unit.
Initial Discount rate: 10%.
Project life: 4 years.
Tax rate: 34%.
If the discount rate were 15% and 5% what would be the present-value break-even points. How sensitive is the break-even to the discount rate change (show your results).

Question 26

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

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

Question 27

Sensitivity analysis is a method which allows for evaluation of the NPV given a series of changes to the underlying assumptions. Discuss why and how scenario analysis is used in addition to sensitivity analysis.

Question 28

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 net present value of a project.
C) decrease the net present value of a project.
D) have no effect on either a project's cash flows or its net present value.

Question 29

The Marx Brewing Company recently installed a new bottling machine. The machine's initial cost is $2,000, and can be depreciated on a straight line basis to a zero salvage in 5 years. The machine's per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is $1.50. Marx's tax rate is 34%, and it uses a 16% discount rate. If Marx sells 2500 units what is the accounting profit and contribution margin for Marx Brewing?

Question 30

Consider the following statement by a project analyst: "I analyzed my project using scenarios for the base case, best case, and worst case. I computed break-evens and degrees of operating leverage. I did sensitivity analysis and simulation analysis. I computed NPV, IRR, payback, AAR, and PI. In the end, I have over a hundred different estimates and am more confused than ever. I would have been better off just sticking with my first estimate and going by my gut reaction." Critique this statement.

Question 31

The option to wait:

A) increases in value as the project's sensitivity to new technology increases.
B) is independent of the project's discount rate.
C) is valueless when a project is profitable given immediate implementation.
D) decreases the net present value of a project.
E) may have value even if a project currently does not.

Question 32

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) expand.
C) abandon.
D) contract.
E) withdraw.

Question 33

The market value of an investment project should be viewed as the sum of the standard NPV and the value of managerial options. Explain two different options that management may have, what they are, and how they would influence market value.

Question 34

The Marx Brewing Company recently installed a new bottling machine. The machine's initial cost is $2,000, and can be depreciated on a straight line basis to a zero salvage in 5 years. The machine's per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is $1.50. Marx's tax rate is 34%, and it uses a 16% discount rate. Calculate the accounting break-even point on the new machine, as well as the present value break-even point on the new machine.

Question 35

Your company has a new project to be considered. You are given the following information on the best guess of related outcomes for the project. The cost of developing and market testing the product over the next year is $225 million. If the test is successful, which is expected to be 65%, the company will spend another $800 million to put the productive capabilities in place. The expected cashflows after tax for a successful project are $225 million each year for the next six years with a probability of.8; there is a 20% chance of a zero NPV. If the tests fail the cashflows associated with continuing through the sixth year is $125 million per year after tax. The company uses a 12% discount rate for these types of projects. Determine the net present value if the tests are a success. Determine the net present value and the decision to undertake testing or not.
A._12,6] = .65{[-800 + (225)4.1114].8 + .2(0)} = .65(100.52) = 65.34
NPV₀ = -225 + 65.34/1.12 = -166.66; Do not invest.