13)
Year 0 Year 1 Year 2 Year 3
Revenues
363,688.342
363,688.342
363,688.342
– Cost of Goods Sold -150,000 -150,000 -150,000
– Depreciation -80,000 -80,000 -80,000
= EBIT
133,688.342
133,688.342
133,688.342
– Taxes (35%)
-46,790.9196
-46,790.9196
-46,790.919
6
= Unlevered net income
86,897.4221
86,897.4221
86,897.4221
+ Depreciation 80,000 80,000 80,000
– Additions to Net Working
Capital -20,000 -20,000 -20,000
– Capital Expenditures -300,000
= Free Cash Flow
146,897.422
146,897.422
146,897.422
Visby Rides, a livery car company, is considering buying some new luxury cars. After
extensive research, they come up with the above estimates of free cash low from this
project. By how much could the discount rate rise before the net present value (NPV) of
this project is zero, given that it is currently 10%?
A) 12%
B) 17%
C) 27%
D) 22%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
47
14)
Year 0 Year 1 Year 2 Year 3
Revenues 475,000 475,000 475,000
– Cost of Goods Sold -150,000 -150,000 -150,000
– Depreciation -85,000 -85,000 -85,000
= EBIT
240,000 240,000 240,000
– Taxes (35%)
-84,000 -84,000 -84,000
= Unlevered net income
156,000 156,000 156,000
+ Depreciation
85,000 85,000 85,000
– Additions to Net Working
Capital
-20,000 -20,000 -20,000
– Capital Expenditures
-325,000
= Free Cash Flow 221,000 221,000
221,000
Visby Rides, a livery car company, is considering buying some new luxury cars. After
extensive research, they come up with the above estimates of free cash low from this
project. Visby learns that a competitor is thinking of ofering similar services, thus reducing
Visby’s sales. By how much could sales fall before the net present value (NPV) was zero,
given that the cost of capital is 8%, and that cost of goods sold is 45% of revenues?
A) 28%
B) 34%
C) 45%
D) 56%
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
48
15) Which of the following statements is FALSE?
A) The break-even level of an input is the level for which the investment has an internal
rate of return (IRR) of zero.
B) The most diicult part of capital budgeting is deciding how to estimate the cash lows
and the cost of capital.
C) When evaluating a capital budgeting project, inancial managers should make the
decision that maximizes net present value (NPV).
D) Sensitivity analysis reveals those aspects of the project which are most critical when we
are actually managing the project.
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Revised
16) Which of the following statements is FALSE?
A) Sensitivity analysis allows us to explore the efects of errors in our estimated inputs in
our net present value (NPV) analysis for the project.
B) To compute the net present value (NPV) for a project, you need to estimate the
incremental cash lows and choose a discount rate.
C) Estimates of the cash lows and cost of capital are often subject to signiicant
uncertainty.
D) When we are certain regarding the input to a capital budgeting decision, it is often
useful to determine the break-even level of that input.
AACSB Objective: Relective Thinking Skills
Author: JN
Question Status: Revised
17) Which of the following statements is FALSE?
A) We can use scenario analysis to evaluate alternative pricing strategies for our project.
B) Scenario analysis considers the efect on net present value (NPV) of changing multiple
project parameters.
C) The diference between the internal rate of return (IRR) of a project and the cost of
capital tells you how much error in the cost of capital it would take to change the
investment decision.
D) Scenario analysis breaks the net present value (NPV) calculation into its component
assumptions and shows how the net present value (NPV) varies as each one of the
underlying assumptions changes.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
49
18) The diference between scenario analysis and sensitivity analysis is ________.
A) scenario analysis is based upon the internal rate of return (IRR) and sensitivity analysis
is based upon net present value (NPV)
B) only sensitivity analysis allows us to change estimated inputs of net present value (NPV)
analysis
C) scenario analysis considers the efect on net present value (NPV) of changing multiple
project parameters
D) only scenario analysis breaks the net present value (NPV) calculation into its component
assumptions
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
19) An exploration of the efect of changing multiple project parameters on net present
value (NPV) is called ________.
A) scenario analysis
B) internal rate of return (IRR) analysis
C) accounting break-even analysis
D) sensitivity analysis
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
20) An analysis that breaks the net present value (NPV) calculation into its component
assumptions and shows how the net present value (NPV) varies as one of the underlying
assumptions changes is called ________.
A) scenario analysis
B) internal rate of return (IRR) analysis
C) accounting break-even analysis
D) sensitivity analysis
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
50
21) Which of the following will cause the EBIT Break-Even for sales to increase?
A) a decrease in the sales price
B) a decrease in depreciation expense
C) a decrease in selling, general, and administrative expenses
D) a decrease in the number of units sold
AACSB Objective: Analytic Skills
Author: WC
Question Status: Revised
22) What is the major diference between scenario analysis and sensitivity analysis?
AACSB Objective: Analytic Skills
Author: WC
Question Status: Revised
9.6 Real Options in Capital Budgeting
1) A real option is the obligation to take a particular business action.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Previous Edition
2) Jim owns a farm that he wants to sell. He learns that a highway will be built near the
farm in the future, giving access to the farmland from a nearby city and thus making the
land attractive to housing developers. Expecting the net present value (NPV) of the sale to
be greater after the highway is built, he decides not to sell at this time. What real option is
Jim taking?
A) option to delay
B) option to expand
C) option to abandon
D) option to switch
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Revised
3) After research into where to place a new restaurant, Burger Billies, a small fast-food
chain, plans to open a new store near a small college. The anticipated customer base is
students attending the college. They learn that a major fast food chain will be opening a
franchise within the college, which leads the owners of Burger Billies to revise their
estimate of sales to one below the break-even point. Which of the following is most likely
the best real option for Burger Billies to take with regard to the proposed restaurant site?
A) option to delay
51
B) option to expand
C) option to abandon
D) option to switch
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Revised
4) A manufacturer of peripheral devices for PCs decides to try and capture some of the PC
gaming market by creating gaming versions of its traditional peripheral devices. It decides
to start with a gaming version of its standard keyboard, increasing the number of macro
keys, adding a small LCD screen to display game data, and giving the user the ability to
backlight keys in diferent colors. If this device is a success, the manufacturer plans to
release gaming versions of its trackballs and other peripherals. What option is the
manufacturer gaining by the release of the new keyboard?
A) option to delay
B) option to expand
C) option to abandon
D) option to switch
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Revised
5) Which of the following statements regarding real options is NOT correct?
A) Real options should only be exercised when they increase the NPV of a project.
B) Real options enhance the forecast of a project’s expected future cash lows by
incorporating, at the start of the project, the efect of decisions that will be made at a later
date.
C) Real options give owners the right, but not the obligation, to exercise these
opportunities at a later date.
D) Real options build greater lexibility into a project and thus increase its net present
value (NPV).
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Revised
6) Why does the option to abandon a project have value?
AACSB Objective: Relective Thinking Skills
Author: WC
Question Status: Revised
52