Exam 13: Risk Analysis and Project Evaluation

Boulangerie Bouffard expects to sell 1 million croissants next year for $1.25 each.Variable cost of a croissant is $0.75.Fixed costs are $150,000,depreciation $200,000 and the tax rate is 25%.If the bakery can increase the price of a croissant to $1.50 and all other variables remain the same,free cash flow will increase by

In reality,anticipated cash flows are only estimates and are thus uncertain.

The form of risk analysis intended to identify the most important forces for the success or failure of a project is known as

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

Use the following information to answer the following question(s). Orange Electronics projects sales of its new O-Phones for next year at 10,000 units priced at $150 each.The variable costs of an O-Phone are expected to be $75.Fixed cash costs are expected to be $150,000 and depreciation $100,000.The tax rate is 40%.Orange believes that any of its forecasts including fixed costs,but not depreciation or the tax rate which are known for certain,could be high or low by as much as 10%. -What is the expected net operating profit after tax (NOPAT)for the best case scenario?

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

Jeffrey 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 confident that Jeffrey's sales forecasts are accurate?

What is the approximate five-year survival rate for new businesses?

Projects may appear to have less risk when real options are considered.

Real options are derivative securities that derive their value from the value of the underlying projects.

Miller River Light is evaluating a project that will require an initial investment of $350,000.Miller River uses a 12% discount rate for capital projects of this type.What level of operating cash flows over a period of 5 years will cause the project to reach break-even NPV? Assume cash flows come in the form of an end-of-the-year annuity.

Approximately what percentage of new businesses fail in their first year?

Which of the following is considered the major risk when analysing projects in a multinational environment?

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 NPV of the project if first year savings are only $75,000 and the project is not sold?

Use the following information to answer the following question(s). Enrico,the owner of a pizza shop near a large university campus,is considering opening a shop specialising in quick,inexpensive take-away meals that are low in fat and calories.He will use a vacant space adjacent to the pizza shop.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 that examines the effect of various combinations of value drivers is known as

Use the following information to answer the following question(s). Tropical Soft Drinks is evaluating a proposal to install solar panels on the roof of its factory near Wollongong.The panels will cost $150,000 per set.Depending on the price of electricity and the efficiency of the panels,the project will increase operating cash flows by either $50,000 per year or $75,000 per year.The useful life of the panels is 5 years.If early results indicate savings of $75,000 per year,four additional sets of panels will be installed immediately at the same cost with the same projected savings.The probability of either outcome is 50%.Use a discount rate of 10%. -What is the expected NPV of the project if the option to expand is considered?

Real options can have the effect of

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

Gardner Furniture Co.has calculated its degree of operating leverage as 3.5.If Gardner can increase sales revenue by 5%,net operating income should increase by