Question 1

The risk assessment technique that considers the impact of simultaneous changes in key variables on the desirability of an investment project is ____.
A) sensitivity analysis
B) simultaneous equations
C) scenario analysis
D) RADR analysis

Accepted Answer

The risk assessment technique that considers the impact of simultaneous changes in key variables is scenario analysis. Sensitivity analysis focuses on the impact of changes in one variable at a time, while simultaneous equations involve solving for multiple variables at once. RADR analysis is not a commonly used risk assessment technique.

Question 2

A project has an expected net present value of $50,000 with a standard deviation of the net present value of $20,000. Assume that NPV is normally distributed. What is the probability that the project will have a negative NPV?
A) 99.38%
B) 0.62%
C) 34.5%
D) 49.38%

Accepted Answer

Solution:
z = (0 - $50,000)/$20,000 = - 2.50 From Table V, p(z < -2.5) = .0062 or 0.62%

Question 3

A project has an expected NPV of $50,000 with a standard deviation of the NPV of $20,000. Assume that NPV is normally distributed. What is the probability that the project will have a net present value greater than $60,000?
A) 1915%
B) 69.15%
C) 0.13%
D) 30.85%

Accepted Answer

Solution:
z = ($60,000 - $50,000)/$20,000 = +0.50
From Table V p(z >+0.5) = 0.3085 or 30.85%

Question 4

SCAN is a multi-divisional utility company. SCAN has four divisions with the following betas and proportions of the firm's total assets: 
What is the firm's weighted average beta?
A) 1.01
B) 1.53
C) 0.93
D) 1.13

Accepted Answer

Solution:
Beta = 0.6(0.85) + 0.10(0.95) + 0.25(1.40) + 0.05(1.15) = 1.01

Question 5

Faris currently has a capital structure of 40 percent debt and 60 percent equity, but is considering a new product that will be produced and marketed by a separate division. The new division will have a capital structure of 70 percent debt and 30 percent equity. Faris has a current beta of 1.1, but is not sure what the beta for the new division will be. AMX is a firm that produces a product similar to the product under consideration by Faris. AMX has a beta of 1.6, a capital structure of 40 percent debt and 60 percent equity and a marginal tax rate of 40 percent. If Faris' tax rate is 40 percent, estimate the levered beta for the new product division?
A) 2.44
B) 1.14
C) 2.74
D) 3.88

Accepted Answer

Solution: β_u= 1.6/[1+.6(0.4/0.6)] = 1.14 β₁ = 1.14[1+.6(0.7/0.3)] = 2.74

Question 6

The ____ approach is widely used by firms that attempt to consider differential project risk in their capital budgeting procedures.
A) net present value
B) internal rate of return
C) risk-adjusted discount rate
D) certainty equivalent

Accepted Answer

The risk-adjusted discount rate approach involves adjusting the discount rate used in capital budgeting to reflect the project's level of risk. It is a widely used approach by firms to account for differential project risk, as projects with higher risk will have a higher risk-adjusted discount rate, resulting in a lower net present value (NPV) and lower internal rate of return (IRR). The certainty equivalent approach is another way to address risk, but it is not as widely used as the risk-adjusted discount rate approach.

Question 7

When evaluating a capital expenditure to be made in a foreign country, the parent firm must be concerned with the
A) exchange rate risk
B) cash flows that can be expected to be received by the parent
C) greater uncertainty associated with tax rates in the host country
D) all the above

Accepted Answer

Evaluating a capital expenditure in a foreign country requires considering all of the above factors - exchange rate risk, cash flows expected to be received by the parent company, and uncertainty surrounding tax rates in the host country. The parent company needs to analyze the potential impact of exchange rate movements on their investment, estimate the expected cash flows from the investment, and assess the tax implications of the investment in the host country. Only by considering all of these factors can the parent company make an informed decision about whether to proceed with the investment.

Question 8

The risk-adjusted discount rate approach is used in the analysis of projects for which ____ is the applicable risk measure.
A) total project risk
B) beta (systematic) risk
C) unsystematic risk
D) both total project and beta risk

Accepted Answer

The answer of The risk-adjusted discount rate approach is used...

Question 9

A simulation analysis for a new acquisition has indicated that the expected NPV is $50 million with a standard deviation of $40 million. Assume that NPV is normally distributed. What is the probability that the project will be unacceptable?
A) 89.44%
B) 10.56%
C) 39.44%
D) 21.19%

Accepted Answer

Solution:
z = (0 - $50,000)/$40,000 = -1.25
From Table V, p(z < -1.25) = .1056 or 10.56%

Question 10

SCAN is a multi-divisional utility company. SCAN has four divisions with the following betas and proportions of the firm's total assets: 
The risk-free rate is 8 percent and the market risk premium is 5 percent. If SCAN is considering a residential development, what should the firm use as its cost of equity in evaluating this project?
A) 13.05%
B) 16.20%
C) 12.25%
D) 15.00%

Accepted Answer

Solution: k_e = 0.08 + 1.40(0.05) = 0.15 or 15%

Question 11

With the risk adjusted discount rate approach, in the context of total risk, the discount rates used in evaluating cash flows are determined ____.
A) objectively
B) subjectively
C) using regression analysis
D) objectively and by using regression analysis

Accepted Answer

The risk adjusted discount rate approach involves subjective determination of discount rates based on the level of risk in a particular investment. It takes into account both systematic (market) risk and unsystematic (company-specific) risk. Regression analysis may be used as a tool in determining appropriate discount rates, but ultimately the decision is subjective. Therefore, the answer is B, subjectively.

Question 12

The certainty equivalent factors used in capital budgeting analysis are equal to the ____ divided by ____.
A) certain return; risky return
B) risky return; certain return
C) certain return; beta
D) beta, risky return

Accepted Answer

The certainty equivalent factor is the amount of certain return that an investment must generate in order for investors to be indifferent between that return and the risky return being considered. Therefore, the certainty equivalent factor is equal to the certain return (what investors would be guaranteed to receive) divided by the risky return (what investors may actually receive).

Question 13

Technico plans to start a new product division that will have a capital structure of 70 percent debt and 30 percent equity. The levered beta for this division has been estimated to be 2.02. What will be Technico's weighted cost of capital for this new division if the after-tax cost of debt is 7 percent, the risk-free rate is 8 percent, and the market risk premium is 5 percent?
A) 14.77%
B) 10.33%
C) 18.1%
D) 1.03%

Accepted Answer

Solution: k_e = 0.08 + 2.02(0.05) = 0.181 k_* = 0.7(0.07) + 0.3(0.181) = 0.1033 or 10.33%

Question 14

Calco is a multi-divisional firm with a weighted cost of capital of 14 percent and a risk-adjusted discount rate for its can division of 17 percent. A planned expansion in the can division requires a net investment of $170,000 and results in expected cash inflows of $42,000 a year for seven years. Should Calco invest in this expansion?
A) Yes, NPV = $10,096
B) Yes, NPV = $ 9,896
C) No, NPV = -$5,276
D) No, NPV = -$9,896

Accepted Answer

Solution:
NPV = $42,000(3.922) - $170,000 = -$5,276

Question 15

The DMT Company is financed entirely with equity. DMT has a beta of 1.20 and the current risk-free rate is 9.5 percent. If the expected market return is 14 percent, what rate of return should DMT require on a project of average risk?
A) 14.9%
B) 15.4%
C) 14.0%
D) 12.0%

Accepted Answer

Solution: k_e = 0.095 + 1.20(0.14 - 0.095) = 0.149 or 14.9%

Question 16

The net present value of a project is normally distributed with an expected value of $52,000 and a standard deviation of $31,515. Determine the probability that the project will have a net present value of less than zero.
A) 1.65%
B) 95.1%
C) 4.95%
D) cannot be determined

Accepted Answer

Solution:
P(NPV < $0) = P ( Z < ($0 - $52,000)/$31,515)
= P ( Z < - 1.65) = 4.95% from Table V

Question 17

The Chris-Kraft Co. is financed entirely with equity and the firm has a beta of 1.6. The current risk-free rate is 9.5 percent and the expected market return is 16 percent. What rate of return should Chris-Kraft require on a project of average risk?
A) 25.6%
B) 14.9%
C) 10.4%
D) 19.9%

Accepted Answer

Solution: k_e = 0.095 + 1.6(0.16 - 0.095) = 0.199 or 19.9%

Question 18

The most expensive method of adjusting for total project risk in the evaluation of capital budgeting projects is the
A) sensitivity analysis method
B) simulation approach
C) net present value/payback method
D) risk-adjusted discount rate approach

Accepted Answer

The simulation approach, often involving complex computer models to simulate a wide range of possible outcomes, is typically the most expensive method for adjusting for total project risk in capital budgeting evaluations due to its need for extensive data, computational resources, and time.

Question 19

With the ____ approach, the decision maker adjusts separately each period's cash flows to account for the specific risk of those cash flows.
A) risk-adjusted discount rate
B) NPV/payback
C) certainty equivalent
D) economic life

Accepted Answer

The certainty equivalent approach involves adjusting the cash flows themselves to reflect their risk, rather than adjusting the discount rate. This method directly modifies each period's cash flows to a "certain" equivalent value that the decision maker would be indifferent to receiving instead of the risky cash flow.

Question 20

The ____ of a firm is a weighted average of the ____ of the individual assets in the firm.
A) systematic risk; systematic risk
B) unsystematic risk; unsystematic risk
C) total risk; total risk
D) systematic risk, total risk

Accepted Answer

The answer of The ____ of a firm is a...

Quiz 11: Capital Budgeting and Risk

The risk assessment technique that considers the impact of simultaneous changes in key variables on the desirability of an investment project is ____.

A project has an expected net present value of $50,000 with a standard deviation of the net present value of $20,000. Assume that NPV is normally distributed. What is the probability that the project will have a negative NPV?

A project has an expected NPV of $50,000 with a standard deviation of the NPV of $20,000. Assume that NPV is normally distributed. What is the probability that the project will have a net present value greater than $60,000?

SCAN is a multi-divisional utility company. SCAN has four divisions with the following betas and proportions of the firm's total assets: What is the firm's weighted average beta?

The ____ approach is widely used by firms that attempt to consider differential project risk in their capital budgeting procedures.

When evaluating a capital expenditure to be made in a foreign country, the parent firm must be concerned with the

The risk-adjusted discount rate approach is used in the analysis of projects for which ____ is the applicable risk measure.

A simulation analysis for a new acquisition has indicated that the expected NPV is $50 million with a standard deviation of $40 million. Assume that NPV is normally distributed. What is the probability that the project will be unacceptable?

With the risk adjusted discount rate approach, in the context of total risk, the discount rates used in evaluating cash flows are determined ____.

The certainty equivalent factors used in capital budgeting analysis are equal to the divided by .

The DMT Company is financed entirely with equity. DMT has a beta of 1.20 and the current risk-free rate is 9.5 percent. If the expected market return is 14 percent, what rate of return should DMT require on a project of average risk?

The net present value of a project is normally distributed with an expected value of $52,000 and a standard deviation of $31,515. Determine the probability that the project will have a net present value of less than zero.

The Chris-Kraft Co. is financed entirely with equity and the firm has a beta of 1.6. The current risk-free rate is 9.5 percent and the expected market return is 16 percent. What rate of return should Chris-Kraft require on a project of average risk?

The most expensive method of adjusting for total project risk in the evaluation of capital budgeting projects is the

With the ____ approach, the decision maker adjusts separately each period's cash flows to account for the specific risk of those cash flows.

The of a firm is a weighted average of the of the individual assets in the firm.