Exam 12: Risk and Refinements in Capital Budgeting

Real options are opportunities that are embedded in capital budgeting projects that enable managers to alter their cash flows and risks in a way that affects project acceptability.

The breakeven cash inflow is the minimum level of cash inflow necessary for a project to be acceptable.

A firm is evaluating two mutually exclusive projects that have unequal lives. The firm must evaluate the projects using the annualized net present value approach and recommend which project they should select. The firm's cost of capital has been determined to be 18 percent, and the projects have the following initial investments and cash flows:

Behavioral approaches for dealing with risk include adjusted net present value and risk-adjusted discount rates.

In international capital budgeting decisions, political risks can be minimized using all of the following strategies EXCEPT

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)

In selecting the best group of unequal-lived projects, if the projects are mutually exclusive, the length of the projects lives is not critical.

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.

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)

In selecting the best group of unequal-lived projects, if the projects are independent, the length of the projects lives is not critical.

Major types of real options include all of the following EXCEPT the

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

Breakeven cash inflow refers to

Table 12.2 A firm is considering investment in a capital project which is described below. The firm's cost of capital is 18 percent and the risk-free rate is 6 percent. The project has a risk index of 1.5. The firm uses the following equation to determine the risk adjusted discount rate, RADR, for each project: RADR = Rf + Risk Index (Cost of capital - Rf) -It has been found that the value of the stock of corporations whose shares are traded publicly in an efficient marketplace is

The ordering of capital expenditure projects on the basis of some predetermined measure such as the rate of return is called

The risk-adjusted discount rate approach to evaluating projects with unequal lives converts the net present value of unequal-lived, mutually exclusive projects into an equivalent annual amount.

In the context of capital budgeting, risk generally refers to

The IRR approach to capital rationing involves graphically plotting project IRRs in descending order against total dollar investment on ________ graph.

Scenario analysis is an approach that uses a number of possible values for a given variable in order to assess its impact on a firm's return.

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.