Question 1

An aircraft company has signed a contract to sell a plane for $20 million.The firm buying the plane will pay for it in 5 annual payments (at year end)of $4 million.If the firm's cost of capital is 6%,what is the net present value of this payment?

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Question 2

What are the major sources of risk for the firm?

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Question 3

The Widget Company has estimated the following revenue possibilities for the year:
$\begin{array} { l l } 
\text { Sales } & \text { Probability } \
100 & 0.15 \
150 & 0.20 \
220 & 0.30 \
290 & 0.20 \
310 & 0.15
\end{array}$
a.Find expected revenue.
b.Find the standard deviation.
c.Find the coefficient of variation.

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The answer of The Widget Company has estimated the following...

Question 4

Describe the Capital Asset Pricing Model (CAPM)and how it is used in capital budgeting decisions.

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Question 5

The difference between sensitivity analysis and scenario analysis is

Accepted Answer

Sensitivity analysis focuses on the impact of a change in one variable while holding all other variables constant, while scenario analysis considers how changes in multiple variables may impact overall results. Therefore, C accurately differentiates between the two methods. A and B are not accurate statements about the differentiating factor between sensitivity and scenario analysis.

Question 6

The use of real options in capital budgeting

Accepted Answer

The use of real options in capital budgeting may raise the NPV of a capital project by considering the potential future flexibility and value of the project, which can result in a higher NPV. Real options analysis also requires more complex analysis and forecasting, and may actually take longer to make decisions. Real options analysis does not eliminate the need for calculating the project's risk-adjusted discount rate.

Question 7

A firm must spend $10 million today on a project that is expected to bring in annual revenues of $1.5 million for the next 10 years (beginning at the end of year 1).
a.If the firm's cost of capital is 5%,what is the NPV of this project?
b.If the firm's cost of capital is 10%,what is the NPV of this project?
c.What is the internal rate of return?

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The answer of A firm must spend $10 million today...

Question 8

You start working at age 20 and you plan to deposit $5,000 in a savings account every year for the next 45 years.
a.At the end of this time,how much money will you have if the interest rate is 5%?
b.You decide that's not enough money.How much will you have to save every year if you wish to have $1,000,000 when you retire?

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Question 9

You deposit $10,000 in a savings account today.If the interest rate is 3%,what is the value in 20 years?

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Question 10

A drawback in the use of sensitivity analysis in capital budgeting decisions is that it doesn't

Accepted Answer

Sensitivity analysis focuses on measuring how changes in variables impact the outcome of a decision. While it provides insights on the key drivers of a project's success, it doesn't assign probabilities to potential outcomes or generate alternative scenarios. Therefore, option C is the correct answer to the question.

Question 11

Explain what is meant by the "weighted cost of capital" and how it is used in capital budgeting.

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Question 12

An aircraft company has signed a contract to deliver a plane 3 years from now.The price they will receive at the end of 3 years is $20 million.If the firm's cost of capital is 6%,what is the present value of this payment?

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Question 13

If a company's stock is perceived to be more risky than average,what will happen to their equity cost of capital? Explain using the capital asset pricing model.

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Question 14

What additional complexities arise when multinational corporations consider capital projects on a global basis?

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Question 15

You buy a lottery ticket for $1.If you win,you receive $3 million.The odds of your numbers coming up are 1:10,000,000.What is the expected value of this gamble?

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Question 16

You win the $20 million state lottery,and you have a choice of taking an amount of money per year for the next 20 years or a flat payment now.The flat payment that the state offers you is $9.82 million.
a.What discount rate is the state using?
b.Should you take the money or the annuity?

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The answer of You win the $20 million state lottery,and...

Question 17

The use of sensitivity analysis will generally result in

Accepted Answer

Sensitivity analysis involves testing different scenarios with varying input parameters to observe the effect on the output. The result often includes a best case, base case, and worst-case scenario, providing management with a range of potential outcomes based on different assumptions. While sensitivity analysis can inform a certainty equivalent NPV or demonstrate the coefficient of variation, these are not the primary outcomes of the process. Calculating the probability of maximum profit is not directly related to sensitivity analysis.

Question 18

Project C has an expected value of $500 and a standard deviation of 50.Project D has an expected value of $300 and a standard deviation of 10.Comment on the desirability of these projects.

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Question 19

If an expansion proposal is accepted,allowing an otherwise idle (and useless)machine with a market value and book value of $2,000 to be utilized,should it be recorded as a cash outflow,and if so,how much?

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Question 20

Inc.'s stock is currently $50.The last dividend that they paid was $1.If dividends are expected to increase at a 10% annual rate,what is the firm's equity cost of capital?

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Quiz 12: Capital Budgeting and Risk