Deck 13: Risk Analysis and Project Evaluation

Question 1

A would be entrepreneur is considering buying a franchise from a national chain of fitness centers.Identify some of the risks she might face.

Answer 1

Competition: other franchises or even another franchisee in the same chain might locate nearby.The demographics of the area in which she locates might change.Her business might be sensitive to employment and economic conditions.Traffic patterns could change making her location more or less accessible.In short,the cash flows from her business could be highly unpredictable.

Question 2

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

A)scenario analysis.
B)sensitivity analysis.
C)value driver analysis.
D)expected value analysis.

Answer 2

B

Question 3

The simulation approach provides us with:

A)a single value for the risk-adjusted net present value.
B)an approximation of the systematic risk level.
C)a probability distribution of the project's net present value or internal rate of return.
D)a graphic exposition of the year-by-year sequence of possible outcomes.

Answer 3

C

Question 4

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

A)Standard deviation
B)Sensitivity analysis
C)Coefficient of variation
D)Decision tree analysis

Question 5

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

A)20%
B)40%
C)60%
D)80%

Question 6

Most of the variables used in forecasting cash flows are known with certainty.

Question 7

Scenario analysis is the form of risk analysis:

A)that examines the relationship between total firm cash flows and the NPV of a particular project.
B)that examines the volatility of NPV.
C)that examines the impact of key variables such as sales or costs in various combinations.
D)that examines the impact of key variables such as sales or costs one at a time.

Question 8

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

A)scenario analysis.
B)sensitivity analysis.
C)value driver analysis.
D)expected value analysis.

Question 9

Sensitivity analysis is the form of risk analysis:

A)that examines the relationship between total firm cash flows and the NPV of a particular project.
B)that examines the volatility of NPV.
C)that examines the impact of key variables such as sales or costs in various combinations.
D)that examines the impact of key variables such as sales or costs one at a time.

Question 10

Approximately what percentage of new businesses survive their first year?

A)20%
B)40%
C)60%
D)80%

Question 11

Which of the following abilities are crucial for risk analysis?

A)A knowledge of marketing
B)A knowledge of cost accounting
C)A knowledge of economics
D)All of the above

Question 12

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

A)20%
B)40%
C)60%
D)80%

Question 13

What are the consequences of excessive optimism or pessimism in forecasting expected project cash flows?

Question 14

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?

Question 15

Why is it important to perform risk analysis before accepting or rejecting major projects?

Question 16

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

A)20%
B)40%
C)60%
D)80%

Question 17

Which of the following is a reason why risk analysis is an important part of capital budgeting?

A)The people who propose projects have no vested interest in whether or not they are accepted.
B)Marketing managers are rarely excessively optimistic.
C)Project cash flows can be highly uncertain.
D)Financial analysts are rarely excessively pessimistic.

Question 18

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

Question 19

Which of the following are usually known with a high level of confidence at the beginning of a project?

A)The number of units that will be sold.
B)The price per unit that will result in the desired number of units sold.
C)Tax rates and depreciation rates.
D)None of the above.

Question 20

Which of the following are reasons to analyze the risk of capital projects?

A)The people who propose projects have a vested interest in getting them accepted.
B)Cash flows can rarely be estimated with certainty.
C)Many of the variables in capital budgeting analysis are highly sensitive to changes in economic conditions.
D)All of the above.

Question 21

________ is a risk analysis technique in which the best- and worst-case net present values are compared with the project's expected net present value.

A)Project standing alone risk
B)Decision tree analysis
C)Scenario analysis
D)Pure play method

Question 22

What is the expected free cash flow for the worst case scenario?

A)$153,973
B)$43,972
C)$84,910
D)$383,240

Question 23

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 ________.

A)$37,500
B)$150,000
C)$187,500
D)$250,000

Question 24

There is a 20% probability that the NPV of a project will be $20 million,a 50% probability that it will be sold for $45 million and a 30% probability that it will be for $15 million.What is the expected NPV of the project?

A)$17.5 million
B)$45 million
C)$31 million
D)$26.67 million

Question 25

What is the expected net operating profit after tax (NOPAT)if the most likely estimates are used?

A)$493,500
B)$330,000
C)$300,000
D)$124,500

Question 26

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 sales will fall by 50,000 croissants.Free cash flow will increase or decrease by:

A)$131,250 increase.
B)$37,500 increase.
C)$75,000 decrease.
D)$250,000 increase.

Question 27

There is a 30% probability that an office building will be sold after 5 years for $30 million,a 50% probability that it will be sold for $20 million and a 20% probability that it will be sold for $10 million.What is the expected value of the office building in 5 years?

A)$20 million
B)$21 million
C)$30 million
D)$10 million

Question 28

Pederson Home Heating Inc.anticipates that cash flows from home heating fuel sales next year will be $800,000 if the winter is mild,$1,000,000 if winter is average,and $1,500,000 if winter is exceptionally cold.The probability of an average winter is 60%,while the probability of either a mild or an exceptionally cold winter is 20%.What is Pederson's expected cash flow from fuel sales next winter?

A)$1,060,000
B)$1,100,000
C)$1,000,000
D)$1,150,000

Question 29

When Quineboag Textile's sales revenue increased from $5.0 million to $5.25 million,net operation income increased from $500,000 to $575,000.Quineboag's degree of operating leverage (DOL)is ________.

A).015
B).33
C)3.00
D)10

Question 30

Enchanted Hearth expects to sell 1,200 wood pellet stoves in 2011 at an average price of $2,400 each.It believes that unit sales will grow between -5% and +5% per year and prices will rise or fall by as much as 5% per year.Forecast sales revenue for 2013 if both price and the number of units sold increase by 5% per year.

A)$3,492,720
B)$3,500,658
C)$3,333,960
D)$3,175,200

Question 31

What is the expected free cash flow if the most likely estimates are used?

A)$156,750
B)$266,750
C)$237,500
D)$383,240

Question 32

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

A)simulation
B)sensitivity analysis
C)scenario analysis
D)either A or C

Question 33

Enchanted Hearth expects to sell 1,200 wood pellet stoves in 2011 at an average price of $2,400 each.It believes that unit sales will grow between -5% and +5% per year and prices will rise or fall by as much as 5% per year.Forecast sales revenue for 2013 if the number of units sold increases by 5% per year and prices remain flat.

A)$2,880,000
B)$3,168,000
C)$3,333,960
D)$3,175,200

Question 34

Lemminburg Plastics estimates a 60% probability that sales of pink flamingo lawn ornaments in the summer of 2011 will be 45,000 units,about the same as in 2010.They believe there is a 20% probability that they will go viral and potential sales would be 90,000.There is also a 20% probability that restrictive zoning ordinances will limit sales to 30,000 units.Expected unit sales of the pink flamingos are ________.

A)55,000
B)51,000
C)67,500
D)60,000

Question 35

What is the expected net operating profit after tax (NOPAT)for the best case scenario?

A)$493,500
B)$330,000
C)$394,500
D)$124,500

Question 36

Which of the following results in a probability distribution for possible project outcomes rather than a dollar estimate?

A)Sensitivity analysis
B)Simulation
C)Value driver analysis
D)Scenario analysis

Question 37

What is the expected net operating profit after tax (NOPAT)for the worst case scenario?

A)$300,000
B)$223,500
C)$174,000
D)$124,500

Question 38

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

A)Currency fluctuations
B)Inflation
C)Political risk
D)Lack of available betas

Question 39

What is the expected free cash flow for the best case scenario?

A)$414,400
B)$330,000
C)$394,500
D)$383,240

Question 40

When Charles River Publisher's sales revenue increased from $25 million to $27.5 million,net operation income increased from $3,750,000 to $3,937,500.Quineboag's degree of operating leverage (DOL)is ________.

A).5
B)2
C)6.67
D).05

Question 41

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

Question 42

Klaus Nicholas plans to sell Christmas trees from a vacant lot in downtown Springfield.The trees will cost him $12 each.It will cost Klaus $1,500 to rent the lot from November 1 through December 30.If Klaus sells the trees for $20 each,how many trees must he sell to break even? Assume that he makes an initial,non-refundable purchase of 200 trees but can buy more trees in any quantity after that for $12 each.

A)$1,500/($20-$12)= 188 trees with a very small profit on the last tree
B)$3,900/$20 = 195 trees
C)All 200 trees
D)The Christmas tree project can never break even.

Question 43

When using simulation to analyze a large capital project,the decision rule is:

A)There is no clear cut decision rule,but the probabilities will produce a more informed decision.
B)Accept the project if the probability of a positive NPV is greater than 50%.
C)Reject the project if the probability of a negative NPV is greater than 5%
D)Reject the project if the probability of a negative NPV is greater than 16%

Question 44

Webster Footwear believes that a new line of foul weather footwear they are planning to introduce this year will result in an NPV of $500,000 if the winter weather is exceptionally cold and wet,$400,000 if weather is normal,and $200,000 if winter is relatively warm and dry.The probability of a hard winter is 30%,an average winter is 50%,and a mild winter 20%.Compute the project's expected NPV.

Question 45

The Oviedo Thespians are planning to present performances of their Florida Revue on 2 consecutive nights in January.It will cost them $5,000 per night for theater rental,event insurance and professional musicians.The theater will also take 10% of gross ticket sales.How many tickets must they sell at $10.00 per ticket to break even?

A)1000 tickets
B)1,112 tickets
C)1,223 tickets
D)There is not enough information

Question 46

The end result of a simulation analysis is:

A)a probability distribution of project cash flows.
B)a clear decision on whether or not a project should be accepted.
C)a probability distribution of possible NPV's.
D)a list of value drivers and their probabilities.

Question 47

Accounting break-even analysis solves for the level of sales that will result in:

A)IRR=Cost of Capital.
B)net income = $0.00.
C)Free cash flow = $0.00.
D)NPV = $0.00.

Question 48

Using simulation provides the financial manager with a probability distribution of an investment's net present value or internal rate of return.

Question 49

Accounting break-even analysis uses:

A)free cash flows over the entire life of a project.
B)sales,variable costs and fixed costs over the entire life of a project.
C)sales,variable costs and fixed costs for a single period.
D)free cash flows for a single period.

Question 50

In capital-budgeting decisions,simulation analysis gives a probability distribution only for cash flows.

Question 51

Klaus Nicholas plans to sell Christmas trees from a vacant lot in downtown Springfield.The trees will cost him $1200 per 100 tress.They can only be purchased in lots of 100.It will cost Klaus $1,500 to rent the lot from November 1 through December 30.If Klaus sells the trees for $20 each,how many trees must he sell to break even? Assume that he purchases makes an initial,non-refundable purchase of 300 trees.

A)$1,500/($20-$12)= 188 trees with a very small profit on the last tree.
B)All 300 trees because he must purchase them in lots of 100.
C)At least 255 trees because all costs are fixed once the trees are purchased.
D)The Christmas tree project can never break even.

Question 52

Which of the following costs is NOT covered in an accounting break-even analysis?

A)Shareholders expected rate of return
B)Variable production costs
C)Interest expense
D)Depreciation expense

Question 53

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

Question 54

Sensitivity analysis shows how the distribution of possible net present values is affected by a change in one input variable.

Question 55

The Oviedo Thespians are planning to present performances of their Florida Revue on 2 consecutive nights in January.It will cost them $5,000 per night for theater rental,event insurance and professional musicians.The theater will also take 10% of gross ticket sales.How many tickets must they sell at $10.00 per ticket to raise $1,000 for their organization?

A)1000 tickets
B)1,112 tickets
C)1,223 tickets
D)There is not enough information

Question 56

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

A)simulation
B)scenario analysis
C)sensitivity analysis
D)either A or B

Question 57

Natick Nurseries has used scenario analysis to evaluate the purchase of a former dairy to use for nursery stock.The best case scenario produced a very favorable NPV of $4,000,000;the NPV of the most likely case was $2,000,000,but the worst case scenario resulted in an NPV of $(3,000,000)which would bring the company close to bankruptcy.Natick could improve its decision by:

A)using sensitivity analysis.
B)using simulation analysis.
C)simply accepting the best case scenario and rejecting the other outcomes.
D)weighting the favorable scenarios more heavily to increase the expected NPV.

Question 58

Cranston Plastic Packaging Solutions has run a simulation on a large project to produce eco-friendly packaging for personal hygiene products.The mean NPV is an impressive $8,000,000,but there is a 16% probability of a negative NPV and a 5% probability of an NPV worse than ($6,000,000).

A)Cranston should reject the project.It is too risky.
B)Cranston should accept the project.The odds are in their favor.
C)Cranston should explore options to reduce the likelihood of very unfavorable outcomes.
D)Cranston should change the probabilities used in the simulation to reduce the likelihood of a negative NPV.

Question 59

One advantage of simulation is that it can differentiate between unsystematic and systematic risk.

Question 60

February sales for Ted's Variety Store equal $100,000,variable costs equal $60,000,fixed costs,including depreciation of $20,000,total $60,000.

A)Teds' Variety Store broke even with respect to net income.
B)Teds' Variety Store broke even with respect to cash.
C)Ted's Variety fell $20,000 short of cash break-even.
D)Teds' Variety Store broke even with a $20,000 surplus.

Question 61

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.The worst case forecast calls for sales of 240,000 valves,the best case for $290,400.Will MM reach accounting break-even in the worst case scenario?

A)Sales will fall short of break even by $8,666,667.
B)The product will exactly break even.
C)Sales will fall short of break even by $5,000,025.
D)Sales will exceed break even $58,000,000.

Question 62

Net present value break-even is reached:

A)after the time period when NPV finally turns from negative to positive.
B)at the discount rate that produces an NPV of $0.00.
C)at the level of sales over the life of the project that results in free cash flow of $0.000 for a given period.
D)at the level of sales over the life of the project that results in an NPV of $0.00.

Question 63

In the 4th year of project M,expected revenues will be $4,750,000,variable costs will be $4,000,000,depreciation expense $180,000,and fixed cash costs $570,000.Which of the following is true?

A)Accounting income equals $0.00
B)Free cash flow equals $180,000
C)Free cash flow equals 0
D)Both A and B are true.

Question 64

Dudster company's DOL is 2.If sales increase by 10%,NOI will increase by 5%.

Question 65

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?

A)Sales will fall short of cash break even by $8,666,667.
B)The product will exactly break even.
C)Sales will fall short of cash break even by $2,000,025.
D)Sales will exceed cash break even by $2,166,667.

Question 66

Excom Fiberoptics sell micro test tubes for biotechnology research in sets of 10,000 tubes.Fixed costs associated with the project are $2,000,000,variable cost per set is $120.Excom expects to sell 25,000 sets.What is the minimum price must it can charge and reach the accounting break-even point?

A)$80
B)$120
C)$240
D)$200

Question 67

Miller River Light that manufactures the project 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?

A)$70,000.00
B)$97,093.41
C)$92,329.12
D)$86,690.54

Question 68

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%.

A)$12,000.00
B)$5,674.26
C)$17,623.42
D)$17,958.56

Question 69

Charlestown Marina's forecasts indicate that if slip rentals equal $500,000,net operating income will be $25,000 and if rentals equal $525,000,net operating income will be $37,500.What is Charletown's degree of operating leverage?

A)2
B)10
C).05
D).10

Question 70

Project Zeta is expected to produce after-tax cash flows $30 million in year 1,$40 million in year 2,and $50 million in year 3.If the company uses a 12% required rate of return,what is the most it can invest in this project and break even with respect to NPV?

A)$69.03 million
B)$94.26 million
C)$1,11 million
D)$120 million

Question 71

Break-even NPV means that the expected rate of return on a project is equal to the required rate of return.

Question 72

Variable cost for Light.com's fluorescent tubes is $12.50,the tubes are sold over the internet to businesses and organizations for $20.00 each.Fixed costs are $7,500,000.What is the break-even quantity for the fluorescent tubes?

A)600,000
B)1,000,000
C)375,000
D)7,500,000

Question 73

Garcia Developers will erect a small office building at a cost of $4,500,000.They have a client who will lease the space for 5 years at a price that will produce free cash flows of $150,000 per year.For approximately how much would they need to sell the building for at the end of the 5th year to reach break-even NPV? Garcia uses a discount rate of 10% for projects of this type.

A)$3,750,000
B)$5,755,936
C)$6,331,530
D)$6,964,683

Question 74

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

Question 75

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:

A)15%.
B)17.5%.
C)1.43%.
D)3.5%.

Question 76

Variable cost for Light.com's fluorescent tubes is $12.50,the tubes are sold over the internet to businesses and organizations for $20.00 each.Fixed costs are $7,500,000.$500,000 in depreciation expense is included in fixed costs.What is the cash break-even quantity for the fluorescent tubes?

A)933,333
B)1,000,000
C)375,000
D)1,066,667

Question 77

If Untel Inc.decides to manufacture a new generation of computer chips with a brief 2 year product life cycle,it expects to sell 1 million units each year.Variable cost per unit will be $75,fixed costs $5 million,and depreciation $3 million.The initial investment will be $22.91 million.Untel uses a discount rate of 10%;its marginal tax rate is 40%.To reach break-even NPV,UNTEL must sell the chips for at least ________ each.

A)$87
B)$105
C)$100
D)$1,000

Question 78

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?

A)8%
B)10%
C)12%
D)11.11%

Question 79

Chevre Imported Cheese Inc.forecasts that if sales revenue for next year is $1,250,000,net operating income will be $100,000 and if sales revenue is $1,000,000,net operating income will be $80,000.Chevre's degree of operating leverage is:

A)2.
B)10.
C).5.
D)1.

Question 80

DNATECH has developed a hair growth treatment at a cost of $10 million.They can license the technology to another company for a period of 10 years.What is the minimum annual free cash flow they could accept in order to reach break-even NPV on this product? Use a discount rate of 8%.

A)$1,490,295
B)$1,639,324
C)$1,108,000
D)$1,000,000