978-0133423822 Chapter 13 Part 1

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Financial Management, 12e (Titman/Keown/Martin)

Chapter 13 Risk Analysis and Project Evaluation

13.1 The Importance of Risk Analysis

1) Which of the following is a reason why risk analysis is an important part of capital

budgeting?

A) The people who propose projects have no vested interest in whether or not they are

accepted.

B) Marketing managers are rarely excessively optimistic.

C) Project cash lows can be highly uncertain.

D) Financial analysts are rarely excessively pessimistic.

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk-Return Tradeof

2) Which of the following are reasons to analyze the risk of capital projects?

A) The people who propose projects have a vested interest in getting them accepted.

B) Cash lows can rarely be estimated with certainty.

C) Many of the variables in capital budgeting analysis are highly sensitive to changes in

economic conditions.

D) All of the above.

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk-Return Tradeof

3) Which of the following abilities are crucial for risk analysis?

A) A knowledge of marketing

B) A knowledge of cost accounting

C) A knowledge of economics

D) All of the above

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk-Return Tradeof

4) Which of the following are usually known with a high level of conidence at the

beginning of a project?

A) The number of units that will be sold

B) The price per unit that will result in the desired number of units sold

C) Tax rates and depreciation rates

D) None of the above

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk–Return Tradeof

5) Approximately what percentage of new businesses fail in their irst year?

A) 20%

B) 40%

C) 60%

D) 80%

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: survival rates

Principles: Principle 2: There Is a Risk–Return Tradeof

6) Approximately what percentage of new businesses survive their irst year?

A) 20%

B) 40%

C) 60%

D) 80%

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: survival rates

Principles: Principle 2: There Is a Risk–Return Tradeof

7) What is the approximate ive year survival rate for new businesses?

A) 20%

B) 40%

C) 60%

D) 80%

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: survival rates

Principles: Principle 2: There Is a Risk–Return Tradeof

8) What is the approximate failure rate for new businesses after ive years?

A) 20%

B) 40%

C) 60%

D) 80%

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: survival rates

Principles: Principle 2: There Is a Risk–Return Tradeof

9) In reality, anticipated cash lows are only estimates and are thus uncertain.

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk–Return Tradeof

10) Most of the variables used in forecasting cash lows are known with certainty.

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk–Return Tradeof

11) The consequences of excessive pessimism can be as harmful as the consequences of

excessive optimism.

Question Status: New question

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk–Return Tradeof

12) Random, unforeseeable events can a signiicant impact on future cash lows.

Question Status: New question

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk–Return Tradeof

13) A would be entrepreneur is considering buying a franchise from a national chain of

itness centers. Identify some of the risks she might face.

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk–Return Tradeof

14) Jefrey believes that if he can make a good case for opening a new store in the chain for

which he works, he will be promoted to manager. Can we be conident that Jefrey‘s sales

forecasts are accurate?

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: human factors

Principles: Principle 2: There Is a Risk–Return Tradeof

15) What are the consequences of excessive optimism or pessimism in forecasting expected

project cash lows?

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: human factors

Principles: Principle 2: There Is a Risk–Return Tradeof

16) Why is it important to perform risk analysis before accepting or rejecting major

projects?

Question Status: Previous edition

Objective: 13.1 Explain the importance of risk analysis in the capital budgeting decision making

process.

Keywords: project cash lows

Principles: Principle 2: There Is a Risk–Return Tradeof

13.2 Tools for Analyzing the Risk of Project Cash Flows

1) The simulation approach provides us with

A) a single value for the risk-adjusted net present value.

B) an approximation of the systematic risk level.

C) a probability distribution of the project’s net present value or internal rate of return.

D) a graphic exposition of the year-by-year sequence of possible outcomes.

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: simulation analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

2) ________ is a method of quantifying uncertainty without having to estimate probabilities.

A) Standard deviation

B) Sensitivity analysis

C) Coeicient of variation

D) Decision tree analysis

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: sensitivity analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

3) The form of risk analysis intended to identify the most important forces for the success

or failure of a project is known as

A) scenario analysis.

B) sensitivity analysis.

C) value driver analysis.

D) expected value analysis.

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: sensitivity analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

4) Sensitivity analysis is the form of risk analysis

A) that examines the relationship between total irm cash lows and the NPV of a particular

project.

B) that examines the volatility of NPV.

C) that examines the impact of key variables such as sales or costs in various combinations.

D) that examines the impact of key variables such as sales or costs one at a time.

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: sensitivity analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

5) The form of risk analysis which examines the efect of various combinations of value

drivers is known as

A) scenario analysis.

B) sensitivity analysis.

C) value driver analysis.

D) expected value analysis.

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: scenario analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

6) Scenario analysis is the form of risk analysis

A) that examines the relationship between total irm cash lows and the NPV of a particular

project.

B) that examines the volatility of NPV.

C) that examines the impact of key variables such as sales or costs in various combinations.

D) that examines the impact of key variables such as sales or costs one at a time.

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: scenario analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

7) Which of the following is considered the major risk when analyzing projects in a

multinational environment?

A) Currency luctuations

B) Inlation

C) Political risk

D) Lack of available betas

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: value drivers

Principles: Principle 2: There Is a Risk–Return Tradeof

8) Which of the following results in a probability distribution for possible project outcomes

rather than a dollar estimate?

A) Sensitivity analysis

B) Simulation

C) Value driver analysis

D) Scenario analysis

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: simulation analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

9) ________ is a risk analysis technique in which the best- and worst-case net present values

are compared with the project’s expected net present value.

A) Project standing alone risk

B) Decision tree analysis

C) Scenario analysis

D) Pure play method

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: scenario analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

10) There is a 30% probability that an oice building will be sold after 5 years for $30

million, a 50% probability that it will be sold for $20 million and a 20% probability that it

will be sold for $10 million. What is the expected value of the oice building in 5 years?

A) $20 million

B) $21 million

C) $30 million

D) $10 million

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: expected value

Principles: Principle 2: There Is a Risk–Return Tradeof

11) Economists at PHE Llc estimate a 20% probability of a recession next year, a 50%

probability of an average economy, and a 30% probability of a rapid expansion. If there is a

recession, the NPV of project O will be $20 million; if the economy is average, it will be $45

million and in case of a rapid expansion, it will be $75 million. What is the expected NPV of

the project?

A) $57.5 million

B) $49 million

C) $46.67 million

D) $45 million

Question Status: New question

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: expected value

Principles: Principle 2: There Is a Risk–Return Tradeof

12) Pederson Home Heating Inc. anticipates that cash lows from home heating fuel sales

next year will be $800,000 if the winter is mild, $1,000,000 if winter is average, and

$1,500,000 if winter is exceptionally cold. The probability of an average winter is 60%,

while the probability of either a mild or an exceptionally cold winter is 20%. What is

Pederson’s expected cash low from fuel sales next winter?

A) $1,060,000

B) $1,100,000

C) $1,000,000

D) $1,150,000

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: expected value

Principles: Principle 2: There Is a Risk–Return Tradeof

13) Lemminburg Plastics estimates a 60% probability that sales of pink lamingo lawn

ornaments in the summer of 2011 will be 45,000 units, about the same as in 2010. They

believe there is a 20% probability that they will go viral and potential sales would be

90,000. There is also a 20% probability that restrictive zoning ordinances will limit sales to

30,000 units. Expected unit sales of the pink lamingos are

A) 55,000.

B) 51,000.

C) 67,500.

D) 60,000.

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: expected value

Principles: Principle 2: There Is a Risk–Return Tradeof

14) Enchanted Hearth expects to sell 1,200 wood pellet stoves in 2011 at an average price

of $2,400 each. It believes that unit sales will grow between -5% and +5% per year and

prices will rise or fall by as much as 5% per year. Forecast sales revenue for 2013 if the

number of units sold increases by 5% per year and prices remain lat.

A) $2,880,000

B) $3,168,000

C) $3,333,960

D) $3,175,200

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: scenario analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

15) Enchanted Hearth expects to sell 1,200 wood pellet stoves in 2011 at an average price

of $2,400 each. It believes that unit sales will grow between -5% and +5% per year and

prices will rise or fall by as much as 5% per year. Forecast sales revenue for 2013 if both

price and the number of units sold increase by 5% per year.

A) $3,492,720

B) $3,500,658

C) $3,333,960

D) $3,175,200

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: scenario analysis

Principles: Principle 2: There Is a Risk–Return Tradeof

16) When Quineboag Textile’s sales revenue increased from $5.0 million to $5.25 million,

net operation income increased from $500,000 to $575,000. What is Quineboag’s degree of

operating leverage (DOL)?

A) .015

B) .33

C) 3.00

D) 10

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: degree of operating leverage (DOL)

Principles: Principle 2: There Is a Risk–Return Tradeof

17) When Charles River Publisher’s sales revenue increased from $25 million to $27.5

million, net operating income increased from $3,750,000 to $3,937,500. What is

Quineboag’s degree of operating leverage (DOL)?

A) .5

B) 2

C) 6.67

D) .05

Question Status: Previous edition

Objective: 13.2 Use sensitivity, scenario and simulation analyses to investigate the determinants of

project cash lows.

Keywords: degree of operating leverage (DOL)

Principles: Principle 2: There Is a Risk–Return Tradeof