Deck 13: Risk Analysis and Project Evaluation

Question 1

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

Answer 1

D

Question 2

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

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

Answer 2

B

Question 3

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.

Answer 3

D

Question 4

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

Question 5

________ 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 6

An important value driver for an automobile dealership would be

A) depreciation.
B) inventory turnover.
C) tax rates.
D) debt to equity ratios.

Question 7

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 8

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

Question 9

Employees who propose capital projects often have a vested interest in getting them accepted.

Question 10

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

Question 11

Approximately what percentage of new businesses survive their first year?

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

Question 12

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

Question 13

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 14

Which of the following events might negatively affect a project's net present value?

A) Rules change to allow for faster depreciation of plant and equipment.
B) Tax rates go down, which lowers the value of the tax shelter from depreciation.
C) Projected sales over the life of the project remain the same, but they are higher in the early years and lower in the later years.
D) Interest rates go up requiring an increase in the required rate of return.

Question 15

Random, unforeseeable events can have a significant impact on future cash flows.

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

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 19

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

Question 20

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.

Question 21

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 22

________ 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 23

Economists at PHE Llc estimate a 20% probability of a recession next year, a 50% probability of an average economy, and a 30% probability of a rapid expansion. If there is a recession, the NPV of project O will be $20 million; if the economy is average, it will be $45 million and in case of a rapid expansion, it will be $75 million. What is the expected NPV of the project?

A) $57.5 million
B) $49 million
C) $46.67 million
D) $45 million

Question 24

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 25

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 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 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 27

Bay State Tubing has a large manufacturing facility in Central America is particularly concerned that a tariff of unknown size will be imposed on goods reimported from that region. The type of risk analysis that accounts for various levels of tariff is

A) sensitivity analysis.
B) political risk analysis.
C) scenario analysis.
D) exchange rate analysis.

Question 28

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 29

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 30

Boulangerie Bouffard expects to sell 1.25 million croissants next year for $1.50 each. Variable cost of a croissant is $0.80. Fixed costs are $150,000, depreciation $200,000 and the tax rate is 34%. If the bakery can increase the price of a croissant to $1.75 sales will fall by 50,000 croissants. All other things equal, operating cash flow will increase or decrease by

A) $300,000 increase.
B) $148,500 increase.
C) $148,500 decrease.
D) $174,900 increase.

Question 31

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 32

Mork Pharmaceuticals believes that changes in health insurance may increase demand by as much as 10%, but also lower prices by as much as 10%. It is also concerned that the cost of materials may increase as much as 10% and the company may or may not be able to pass these higher costs on to its customers. To estimate expected, best case and worst case results, Mork should use

A) sensitivity analysis.
B) scenario analysis.
C) political risk analysis.
D) probability analysis.

Question 33

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 34

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 35

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 36

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 37

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 38

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 39

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 40

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 41

Simulation analysis is basically a form of scenario analysis in which a great many scenarios are examined to produce a probability distribution of possible outcomes.

Question 42

A company that was most concerned about the impact of price changes in raw materials would use sensitivity analysis.

Question 43

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

Question 44

Angie's Sub Shop expects to sell 200,000 subs next year at an average price of $5.00. Variable cost of a sub is $3.00. Cash fixed costs are $85,000, depreciation $95,000 and the tax rate is 25%. If the price increases to $5.50 and all other variables remain the same, how much will free cash flow increase?

Question 45

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 46

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

Question 47

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 48

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 49

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 50

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 51

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

Question 52

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 53

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 number of croissants sold increases by 10%, and all other variables remain the same, how much will free cash flow increase?

Question 54

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

Question 55

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 56

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 57

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

Question 58

Briefly describe the 5 steps in performing a simulation analysis.

Question 59

The expected NPV of a project is the arithmetic average of best case, most likely case, and worst case scenarios.

Question 60

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 61

Betty Gilmore plans to sell berry pies at a local farmer's market. The permit and space rental will cost her $2,000 for the June through August season. The pies will sell for $7.00. Ingredients and overhead average $4.00 per pie. She also has to pay five percent of her gross sales to the markets's organizers. How many pies will she need to sell to cover her fixed costs and realize a $3,000 profit?

A) 752
B) 1,667 pies
C) 1,887 pies.
D) 1,250 pies

Question 62

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 63

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 64

Betty Gilmore plans to sell berry pies at a local farmer's market. The permit and space rental will cost her $2,000 for the June through August season. The pies will sell for $7.00. Ingredients and overhead average $4.00 per pie. She also has to pay five percent of her gross sales to the markets's organizers. How many pies will she need to sell to cover her fixed costs?

A) 755 pies with a very small profit on the last pie.
B) 667 pies with a very small profit on the last pie.
C) 301 pies
D) She can never break even.

Question 65

At the break-even NPV point

A) the present value of operating cash flows equals the initial amount invested.
B) The NPV of the project is equal to zero.
C) the project's IRR is equal to the project's required rate of return.
D) all of the above

Question 66

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.

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

Question 67

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 68

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 69

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 70

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 71

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 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

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 74

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 75

Excom Fiberoptics is bidding on contracts to sell micro test tubes for biotechnology research. in sets of 1,000 tubes. Fixed costs including depreciation associated with the project are $2,000,000, variable cost per set is $16. Excom expects to sell 250,000 sets. What is the minimum price it can charge and reach the accounting break-even point?

A) $8
B) $12
C) $24
D) $20

Question 76

Project Zeta is expected to produce after-tax cash flows of $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 77

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

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

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 80

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