Exam 13: Risk Analysis and Project Evaluation

Real options are traded on both the American Exchange and Chicago Board Options Exchange (CBOE).

Accounting break-even means that the company is able to pay its interest expense and also the dividends shareholders were expecting.

Use the following information to answer the following question(s). Enrico,the owner of a pizza parlor near a large university campus,is considering opening a shop specializing in quick,inexpensive take-out meals that are low in fat and calories.He will use a vacant space adjacent to the pizza parlor.Assume that the project requires an initial cash outlay of $100,000.Finance students from the university have taken on the project as a course assignment.They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity).On the other hand,there is a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity.If the restaurant is modestly successful,Enrico will keep it open,but not expand.If it is well received,he will immediately open 2 more shops at sites close to the sprawling campus.The additional shops would have approximately the same cash flow as the first.Cash flows will be discounted at 10%. -What is the expected NPV of the project with the option to expand if the probability of modest success is revised to 70% and great success to 30%?

Miniature Molding is planning to introduce a valve for use in medical implants.Variable costs per unit are $250.The maximum price MM could charge is $325.Fixed costs associated with this product are $20,000,000.Depreciation expense of $2,500,000 are included in fixed costs.The worst case forecast calls for sales of 240,000 valves,the best case for $290,400.Will MM reach cash break-even in the worst case scenario?

Brookfield Heavy Equipment is considering a project that will produce after tax cash of $40,000 per year for 5 years.The project will require an initial investment of $144,191.At what discount rate will the project reach break-even NPV?

Use the following information to answer the following question(s). Enrico,the owner of a pizza parlor near a large university campus,is considering opening a shop specializing in quick,inexpensive take-out meals that are low in fat and calories.He will use a vacant space adjacent to the pizza parlor.Assume that the project requires an initial cash outlay of $100,000.Finance students from the university have taken on the project as a course assignment.They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity).On the other hand,there is a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity.If the restaurant is modestly successful,Enrico will keep it open,but not expand.If it is well received,he will immediately open 2 more shops at sites close to the sprawling campus.The additional shops would have approximately the same cash flow as the first.Cash flows will be discounted at 10%. -What is the expected NPV of the project with the option to expand?

Net present value break-even is reached

Sensitivity analysis is the form of risk analysis

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

Use the following information to answer the following question(s). Enrico,the owner of a pizza parlor near a large university campus,is considering opening a shop specializing in quick,inexpensive take-out meals that are low in fat and calories.He will use a vacant space adjacent to the pizza parlor.Assume that the project requires an initial cash outlay of $100,000.Finance students from the university have taken on the project as a course assignment.They believe that there is a 50% chance that the project will have modest success and return $11,000 per year for the foreseeable future (a perpetuity).On the other hand,there is a 50% chance that the project will be highly successful and produce returns of $20,000 per year in perpetuity.If the restaurant is modestly successful,Enrico will keep it open,but not expand.If it is well received,he will immediately open 2 more shops at sites close to the sprawling campus.The additional shops would have approximately the same cash flow as the first.Cash flows will be discounted at 10%. -What is the project's NPV if success is modest and it is not expanded?

The form of risk analysis which examines the effect of various combinations of value drivers is known as

Jake's Tree farm is evaluating a proposal to plant 5,000 ornamental trees at an initial cost of $10,000.The trees will be sold in 5 years.What is the minimum after tax cash flow from selling the trees that will allow the tree planting project to reach break even NPV? Use a discount rate of 12%.

List at least four typical value drivers that could seriously impact the outcome of a project.

Use the following information to answer the following question(s). An alternative energy project will cost $300,000.Depending on the price of electricity,the project will create after-tax savings of either $100,000 per year for 5 years or $75,000 per year for 5 years.If first year savings are only $75,000,the project can be sold at the end of the first year for $250,000.Use a discount rate of 10%. -What is the expected NPV of the project if the option to abandon is considered?

Briefly distinguish between sensitivity analysis,scenario analysis,and simulation.

An appropriate tool to analyze the interaction of various value drivers for Destroya Extermination Services would be

Why is it important to consider real options in the capital budgeting process? Give two specific examples.

An appropriate tool to analyze the interaction of various value drivers for Orange Electronics would be

If a project reaches the accounting break-even point in every year of its life,it must also have a positive NPV.

What is the approximate failure rate for new businesses after five years?