Question 1

Calculating operating leverage. Coach K Sneakers Ltd had EBIT of $1,850 last year with fixed costs equal to $500 (depreciation and amortisation not included) and depreciation and amortisation equal to $150. What was Coach K's degree of accounting operating leverage?

Accepted Answer

The answer of Calculating operating leverage. Coach K Sneakers Ltd...

Question 2

Rouf-Mart has analysed a new type of all-in-one retail centre where the NPV of the project has an expected value with a distribution that yields a standard deviation of $25 million. Rouf-Mart came to this conclusion by analysing the individual input distributions for the project. This analysis is called.

Accepted Answer

This type of analysis, where individual input distributions are analysed to determine the overall distribution of project outcomes, is called a simulation analysis. Sensitivity analysis involves varying one variable at a time to see how it affects the overall outcome, while scenario analysis involves considering different possible future scenarios and their outcomes.

Question 3

The profitability index is useful in a capital rationing situation because

Accepted Answer

The profitability index measures the amount of value created per dollar invested, making it useful in a capital rationing situation where there are limited funds available for investment. By calculating the PI for each project, the company can prioritize those with the highest PI, ensuring that they are maximizing value for their investment. However, the PI does not rank projects in an absolute manner, as its usefulness is dependent on the specific situation and investment criteria.

Question 4

Variable costs, fixed costs, and project risk. Solutions Bank Textbooks had sales and operating expenses of $1 million last year. If the company had fixed costs of $300,000 on sales of 35,000 books, then what is the company's per-unit contribution?

Accepted Answer

The answer of Variable costs, fixed costs, and project risk....

Question 5

Calculating operating leverage. SunBucks Tea Supplies had EBITDA of $3,000 and EBIT of $2,750, with fixed cash expenses of $600 last year. What was SunBucks degree of accounting operating leverage?

Accepted Answer

The answer of Calculating operating leverage. SunBucks Tea Supplies had...

Question 6

Scenario analysis can help a company to

Accepted Answer

Scenario analysis can assist a company in evaluating various possible scenarios and the likelihood of them occurring, allowing them to anticipate and plan for potential outcomes. It assists in comprehending the degree of uncertainty associated with various project-affecting circumstances, but it does not entirely remove them. By identifying and developing plans to manage such uncertainties, scenario analysis can help a company mitigate risk and prepare for the impact of external factors. However, it cannot completely eliminate all uncertainties, nor can it make a risky project risk-free. Overall, scenario analysis is a valuable tool for assisting firms in making informed decisions in the face of uncertainty.

Question 7

Capital constraints can occur due to

Accepted Answer

Capital constraints can occur due to difficulties in accurately assessing the risks and returns associated with a company's projects.

Question 8

If a project holds an 80 per cent probability of high demand and a 20 per cent probability of low demand, then the expected value of the net present value of the two different demand assumptions would give us a weighted average net present value for the project. Such an analysis is called

Accepted Answer

The analysis described in the question is a scenario analysis, where different scenarios (in this case, high and low demand) are considered and their probabilities are weighed to get a weighted average. Sensitivity analysis involves changing one variable at a time to see how it affects the outcome, while simulation analysis involves creating a model to simulate different scenarios and see how they play out.

Question 9

An analysis in which each of the inputs and assumptions for a project takes on a separate assumed distribution whereby a computer draws on each of those input and assumption distributions to create a distribution for the NPV of the entire project is called

Accepted Answer

A simulation analysis involves creating a distribution for the NPV of a project based on probability distributions of each input and assumption. Sensitivity analysis involves running scenarios by changing one input at a time to see how it affects NPV, whereas scenario analysis involves creating different scenarios with a range of inputs to see how they affect NPV.

Question 10

A company is considering two distinct set of circumstances that assume high inflation and low inflation. In the high inflationary set of circumstances, the price per unit will be affected as well as the variable and fixed costs. If the low-inflation set of circumstances is considered the baseline, then the analysis concerning the high inflationary circumstances could be considered

Accepted Answer

The analysis concerning the high inflationary circumstances is a scenario analysis. This is because the company is considering two distinct sets of circumstances and analyzing the potential impact of each scenario. Sensitivity analysis involves analyzing the impact of changes in one specific variable on an outcome, while Monte Carlo simulation involves using random sampling to simulate potential outcomes.

Question 11

Which of the following project risk analyses is best able to analyse the effect of a single set of circumstances, with correlated inputs, on the NPV of a project?

Accepted Answer

Scenario analysis evaluates the effect of a specific set of circumstances, including correlated inputs, on the NPV of a project.

Question 12

The capital market may not be able to fund all of a company's positive NPV project because

Accepted Answer

Outside investors may find it challenging to accurately assess the risks and returns of a company's projects, leading to potential underfunding despite positive NPV.

Question 13

Calculating operating leverage. Marvellous Company has a degree of cash flow operating leverage equal to 1.25. If the company's EBITDA was $1,000 last year while its depreciation and amortisation expense was $50 in the same year, then what was the company's degree of accounting operating leverage?

Accepted Answer

The degree of accounting operating leverage is calculated as (EBIT + Depreciation and amortization expense) / EBIT. In this case, EBIT = EBITDA - Depreciation and amortization expense = $1,000 - $50 = $950. Therefore, the degree of accounting operating leverage = ($950 + $50) / $950 = 1.32.

Question 14

If a company is interested in the distribution of the NPV for a project that it is considering, then the company should be most interested in

Accepted Answer

A simulation analysis would provide the full distribution of NPV for the project, taking into account all possible uncertainties and their potential impact on the project's profitability. Sensitivity and scenario analyses would only consider specific variations on key assumptions or inputs, and would not provide a comprehensive view of the possible range of outcomes.

Question 15

The process of identifying the bundle of projects that creates the greatest total value and allocating the available capital to the projects is known as

Accepted Answer

The process described in the question is called capital rationing, which involves prioritizing and selecting a bundle of projects that will create the highest total value within the constraints of a limited capital budget. Risk analysis may be part of the decision-making process, but it is not specifically mentioned in the question as the primary focus. Budgeting is a broader term that encompasses various financial planning and management activities, but it does not specifically relate to identifying and allocating capital to specific projects. Rationing, in general, refers to limiting the availability of resources or goods, but it does not necessarily involve the process of selecting a bundle of projects for investment.

Question 16

A change in sales price of a product sold by a company will probably involve a reduction in the number of units sold, as well as the possibility of a change in the cost structure of the company's product in question. If a company were interested in the entire price change effect on the NPV of a project, then it would be interested in

Accepted Answer

Scenario analysis is the best choice because it involves analyzing the impact of various scenarios or situations, including changes in sales price, on the NPV of a project. It considers the potential changes in the cost structure and the number of units sold in response to changes in price, providing a comprehensive overview of the overall effect on the project's profitability. Sensitivity analysis and simulation analysis may help to identify potential risks and uncertainties, but they do not specifically address the impact on NPV due to changes in sales price.

Question 17

At times, when a company is considering an alternative such that a set of variables affecting a project are interrelated, then analysis that considers this interrelation could be performed. This is called

Accepted Answer

A scenario analysis is used to evaluate the possible outcomes of a decision when multiple interrelated variables are at play. It involves imagining multiple possible scenarios and measuring the effect that each scenario would have on the project. Sensitivity analysis is used to determine how changes in one variable would affect the overall outcome of the project, and a Monte Carlo simulation is used to model the possible outcomes of a decision. However, in this case, the question specifically mentions interrelated variables, which suggests the need for a scenario analysis. Therefore, the best choice is B.

Question 18

If a company wanted to find the effect of a change in the variable cost per unit of production on the net present value of a project, then the company might perform

Accepted Answer

A sensitivity analysis is a technique used to determine how changes in an input variable will affect the output variable. In this case, the input variable is the variable cost per unit of production and the output variable is the net present value of the project. A sensitivity analysis will help the company determine how sensitive the net present value is to changes in the variable cost per unit of production.

Question 19

Calculating operating leverage. Potter Company has a degree of cash flow operating leverage equal to 1.266. If the company's EBITDA was $1,500 last year while its depreciation and amortisation expense was $100 in the same year, then what was the company's degree of accounting operating leverage?

Accepted Answer

The degree of accounting operating leverage is calculated as (EBIT + Depreciation and amortization expense) / EBIT. In this case, the degree of accounting operating leverage is ($1,500 + $100) / $1,500 = 1.36.

Question 20

Which of the following project risk analyses is best able to analyse the effect of a single input, uncorrelated with other inputs, on the NPV of a project?

Accepted Answer

Sensitivity analysis is the best choice for analysing the effect of a single input, uncorrelated with other inputs, on the net present value (NPV) of a project. It helps in identifying the most critical factors that affect the project's outcome by varying one input at a time and observing how it affects the NPV. Scenario analysis and simulation analysis are suitable for analysing the impact of several inputs and their interdependencies.

Quiz 12: Evaluating Project Economics and Capital Rationing