Exam 10: Project Analysis

The following are real options except

You obtain the following data for year 1: Revenue = $43; Variable costs = $30; Depreciation = $3; Tax rate = 21 percent. Calculate the operating cash flow for the project for year 1.

Monte Carlo simulation is a tool intended to consider all possible combinations of variables.

Discounted cash-flow (DCF)analysis generally I.assumes that firms hold assets passively when it invests in a project; II.considers opportunities to expand a project if the project is successful; III.considers opportunities to abandon a project if the project is a failure

The Solar Calculator Company proposes to invest $5 million in a new calculator-making plant that will depreciate on a straight-line basis. Fixed costs are $2 million per year. A calculator costs $5 per unit to manufacture and sells for $20 per unit. If the plant lasts for three years and the cost of capital is 12 percent, what is the accounting break-even level of annual sales? (Assume no taxes.)

Petroleum Inc. (PI)controls offshore oil leases. It is considering the construction of a deep-sea oil rig at a cost of $500 million. The price of oil is $100/bbl. and extraction costs are $50/bbl. PI expects costs to remain constant. The rig will produce an estimated 1,200,000 bbl. per year forever. The risk-free rate is 10 percent per year, which is also the cost of capital. (Ignore taxes). Suppose that oil prices are uncertain and are equally likely to be $120/bbl. or $80/bbl. next year. Calculate today's NPV of the project if it were postponed by one year.

Briefly discuss the usefulness of Monte Carlo simulation in project analysis.

Monte Carlo simulation is mostly an advanced version of scenario analysis.

Monte Carlo simulation is likely to be most useful

A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0). You expect the project to produce sales revenue of $120,000 per year for three years. You estimate manufacturing costs at 60 percent of revenues. (Assume all revenues and costs occur at year-end [i.e., t = 1, t = 2, and t = 3]). The equipment depreciates using straight-line depreciation over three years. At the end of the project, the firm can sell the equipment for $10,000 and also recover the investment in net working capital. The corporate tax rate is 21 percent and the cost of capital is 12 percent. Calculate the NPV of the project.

Generally, Monte Carlo models, for project analysis, use which device to generate simulations?

The option to wait is a type of abandonment option.

A project requires an initial investment of $150. Your research generates the following estimates of revenues and costs (there are no taxes): The cost of capital equals 10 percent. Assume that the cash flows occur in perpetuity. Conduct a sensitivity analysis of the project's NPV to variations in costs. (Answers appear in order: [Pessimistic, Most Likely, Optimistic].)

Which of the following statements most appropriately describes scenario analysis?

The accounting break-even point occurs when

The Financial Calculator Company proposes to invest $12 million in a new calculator-making plant that will depreciate on a straight-line basis. Fixed costs are $3 million per year. A financial calculator costs $10 per unit to manufacture and sells for $30 per unit. If the plant lasts for four years and the cost of capital is 20 percent, what is the accounting break-even level of annual sales? (Assume no taxes.)

Which of the following does not represent an option to expand a project?

One can employ simulation models to I.understand the project better; II.better understand forecasted cash flows; III.assess the project risk

The Consumer-Mart Company is going to introduce a new consumer product. If it is brought to market without research about consumer tastes, the firm believes that there is a 60 percent chance that the product will be successful. If successful, the project has a NPV = $500,000. If the product is a failure (40 percent)and withdrawn from the market, then NPV = −$100,000. A consumer survey will cost $60,000 and delay the introduction by one year. With a survey, there is an 80 percent chance of consumer acceptance, in which case the NPV = $500,000. If, on the other hand, the product is a failure (20 percent)and withdrawn from the market, then NPV = −$100,000. The discount rate is 10 percent. By how much does the marketing survey change the expected net present value of the project?

Projects with higher fixed costs have lower break-even points.