Question 1

In general, exchange rate risk is easier to protect against than political risk.

Accepted Answer

This is because there are various financial instruments like forwards, options, and futures that can be used to hedge against exchange rate risk. On the other hand, political risk can be complex and difficult to predict, making it challenging to protect against. Additionally, political risk can take various forms such as expropriation, changes in laws and regulations, and political violence, which can be challenging to mitigate.

Question 2

The danger that an unexpected change in the exchange rate between the dollar and the currency in which a project's cash flows are denominated can increase the market value of that project's cash flow.

Accepted Answer

An unexpected change in the exchange rate between the dollar and the currency in which a project's cash flows are denominated can actually decrease the market value of that project's cash flow. This is because if the local currency weakens against the dollar, the dollar-denominated cash flows will decrease. On the other hand, if the local currency strengthens against the dollar, the dollar-denominated cash flows will increase. Therefore, unexpected changes in exchange rates can create risk and uncertainty for projects with cash flows denominated in foreign currencies.

Question 3

The importance and widespread use of transfer pricing in international trade makes capital budgeting in MNCs very difficult unless the transfer prices used accurately reflect actual costs and incremental cash flows.

Accepted Answer

Transfer pricing plays a significant role in the determination of the profitability of a multinational corporation's (MNC) individual units. As a result, capital budgeting exercises require accurate transfer pricing to determine the true costs of a project or investment, as well as the incremental cash flows generated by it. Failing to account for transfer pricing accurately can result in wrong investment decisions and reduced profitability for the MNC.

Question 4

In case of international capital budgeting, a U.S. company can minimize its political risk by creating a joint venture with a competent and well-connected local partner.

Accepted Answer

Creating a joint venture with a competent and well-connected local partner can help the U.S. company navigate the local political landscape and minimize political risk. Local partners are likely to have a better understanding of cultural, legal, and political factors that can impact venture success.

Question 5

In international trade, transfer prices are prices that subsidiaries charge each other for the goods and services traded between them.

Accepted Answer

Transfer prices are indeed prices charged by subsidiaries to each other for goods and services traded between them in international trade. This is done to determine profits, taxation, and other financial considerations.

Question 6

Tangshan Mining Company, with a cost of capital of 10 percent, is considering investing in project A, with an initial investment of $1,000,000. Project A is expected to provide equal cash inflows over its 15 year useful life. Based on this information, the breakeven cash inflow for the project is

Accepted Answer

The breakeven cash inflow is the amount of cash inflow needed to recover the initial investment of $1,000,000 at a 10% cost of capital. To calculate this, we can use the formula for present value of an annuity: PV = C * [1 - (1+r)^-n] / r, where PV is the present value, C is the cash inflow, r is the cost of capital, and n is the number of periods.

Solving for C, we get: C = PV * r / [1 - (1+r)^-n] = 1,000,000 * 0.1 / [1 - (1+0.1)^-15] = $131,474. Therefore, the breakeven cash inflow for Project A is $131,474 per year for 15 years.

Question 7

Table 12.1
A corporation is assessing the risk of two capital budgeting proposals. The financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows which are given in the following table. The firm's cost of capital is 10 percent. 
-The range of the annual cash inflows for Project A is ________. (See Table 12.1)

Accepted Answer

The range of annual cash inflows for Project A is the difference between the pessimistic and optimistic estimates, which is $150,000 - $140,000 = $10,000. Project B only has one estimate, so the range is 0. The best choice(s) cannot be determined from the information given.

Question 8

One type of simulation program made popular by the widespread use of personal computers is called

Accepted Answer

Monte Carlo Simulation is a type of simulation program that uses random variables to model and simulate various scenarios. Its widespread use became possible because of the availability of personal computers.

Question 9

Table 12.1
A corporation is assessing the risk of two capital budgeting proposals. The financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows which are given in the following table. The firm's cost of capital is 10 percent. 
-The expected net present value of project A if the outcomes are equally probable and the project has five-year life is ________. (See Table 12.1)

Accepted Answer

The expected net present value (NPV) is calculated by taking the average of all possible outcomes, weighted by their probabilities. If the outcomes are equally probable, the NPV is the simple average of the given values.

Question 10

The three basic types of risk associated with international cash flows are 1) business and financial risks, 2) inflation and foreign exchange risks, and 3) political risks.

Accepted Answer

The statement is correct. These are the three basic types of risk associated with international cash flows.

Question 11

International capital budgeting differs from domestic capital budgeting because (1) cash inflows and outflows occur in a foreign currency, and (2) foreign investments potentially face significant political risk.

Accepted Answer

International capital budgeting involves dealing with foreign currencies and potential political risks, whereas domestic capital budgeting deals with a single currency and typically has lower political risk.

Question 12

Exchange rate risk is the the risk that an unexpected change in exchange rates will reduce the market value of a project's cash flows.

Accepted Answer

Exchange rate risk refers to the possibility of unexpected fluctuations in exchange rates that may result in a reduction in the value of cash flows associated with a project. This risk is a significant concern for businesses that operate across borders or invest in foreign markets. Therefore, the given statement is true.

Question 13

Table 12.1
A corporation is assessing the risk of two capital budgeting proposals. The financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows which are given in the following table. The firm's cost of capital is 10 percent. 
-If the projects have five-year lives, the range of the net present value for Project B is approximately ________. (See Table 12.1)

Accepted Answer

The answer of Table 12.1
A corporation is assessing the risk...

Question 14

Simulation analysis is a behavioral approach that evaluates the impact on the firm's return of simultaneous changes in a number of variables.

Accepted Answer

The answer of Simulation analysis is a behavioral approach that...

Question 15

Breakeven cash inflow refers to

Accepted Answer

Breakeven cash inflow refers to the point at which the present value of cash inflows from a project equals the initial investment. When the present value of cash inflows is equal to the initial investment, the NPV is equal to zero, which is the minimum level of cash inflow necessary for a project to be acceptable. Thus, option A is the correct choice.

Question 16

In case of international capital budgeting, long-term currency risk can be minimized by at least partly financing the foreign investment with a dollar-denominated capital contribution from the parent company rather than in the local capital markets.

Accepted Answer

Financing a foreign investment with a dollar-denominated capital contribution from the parent company does not minimize long-term currency risk; it actually exposes the investment to currency risk if the local currency depreciates against the dollar.

Question 17

Foreign direct investment is the transfer of capital, managerial, and technical assets to a foreign country.

Accepted Answer

Foreign direct investment involves the transfer of various assets, including capital, managerial expertise, and technical knowledge, to a foreign country. Therefore, the statement is true.

Question 18

The advantage of using simulation in the capital budgeting process is

Accepted Answer

The answer of The advantage of using simulation in the...

Question 19

A behavioral approach that evaluates the impact on the firm's return of simultaneous changes in a number of project variables is called

Accepted Answer

Scenario analysis evaluates the impact on the firm's return by considering simultaneous changes in multiple project variables, assessing different possible future scenarios.

Question 20

Behavioral approaches for dealing with project risk

Accepted Answer

The answer of Behavioral approaches for dealing with project risk
...

Quiz 12: Risk and Refinements in Capital Budgeting