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CHAPTER 9Risk Analysis, Real Options, and Capital BudgetingMultiple Choice Questions:I.DEFINITIONSSCENARIO ANALYSISb1.An analysis of what happens to the estimate of the net present value when you examine a number of different likely situations is called _ analysis.a.forecastingb.scenarioc.sensitivityd.simulatione.break-evenDifficulty level: EasySENSITIVITY ANALYSISc2.An analysis of what happens to the estimate of net present value when only one variable is changed is called _ analysis.a.forecastingb.scenarioc.sensitivityd.simulatione.break-evenDifficulty level: EasySIMULATION ANALYSISd3.An analysis which combines scenario analysis with sensitivity analysis is called _ analysis.a.forecastingb.scenarioc.sensitivityd.simulatione.break-evenDifficulty level: EasyBREAK-EVEN ANALYSISe4.An analysis of the relationship between the sales volume and various measures of profitability is called _ analysis.a.forecastingb.scenarioc.sensitivityd.simulatione.break-evenDifficulty level: EasyVARIABLE COSTSa5.Variable costs:a.change in direct relationship to the quantity of output produced.b.are constant in the short-run regardless of the quantity of output produced.c.reflect the change in a variable when one more unit of output is produced.d.are subtracted from fixed costs to compute the contribution margin.e.form the basis that is used to determine the degree of operating leverage employed by a firm.Difficulty level: EasyFIXED COSTSb6.Fixed costs:a.change as the quantity of output produced changes.b.are constant over the short-run regardless of the quantity of output produced.c.reflect the change in a variable when one more unit of output is produced.d.are subtracted from sales to compute the contribution margin.e.can be ignored in scenario analysis since they are constant over the life of a project.Difficulty level: EasyACCOUNTING BREAK-EVENc7.The sales level that results in a projects net income exactly equaling zero is called the _ break-even.a.operationalb.leveragedc.accountingd.cashe.present valueDifficulty level: EasyPRESENT VALUE BREAK-EVENe8.The sales level that results in a projects net present value exactly equaling zero is called the _ break-even.a.operationalb.leveragedc.accountingd.cashe.present valueDifficulty level: EasyII.CONCEPTSSCENARIO ANALYSISb9.Conducting scenario analysis helps managers see the:a.impact of an individual variable on the outcome of a project.b.potential range of outcomes from a proposed project.c.changes in long-term debt over the course of a proposed project.d.possible range of market prices for their stock over the life of a project.e.allocation distribution of funds for capital projects under conditions of hard rationing.Difficulty level: EasySENSITIVITY ANALYSISb10.Sensitivity analysis helps you determine the:a.range of possible outcomes given possible ranges for every variable.b.degree to which the net present value reacts to changes in a single variable.c.net present value given the best and the worst possible situations.d.degree to which a project is reliant upon the fixed costs.e.level of variable costs in relation to the fixed costs of a project.Difficulty level: EasySENSITIVITY ANALYSISc11.As the degree of sensitivity of a project to a single variable rises, the:a.lower the forecasting risk of the project.b.smaller the range of possible outcomes given a pre-defined range of values for the input.c.more attention management should place on accurately forecasting the future value of that variable.d.lower the maximum potential value of the project.e.lower the maximum potential loss of the project.Difficulty level: MediumSENSITIVITY ANALYSISc12.Sensitivity analysis is conducted by:a.holding all variables at their base level and changing the required rate of return assigned to a project.b.changing the value of two variables to determine their interdependency.c.changing the value of a single variable and computing the resulting change in the current value of a project.d.assigning either the best or the worst possible value to each variable and comparing the results to those achieved by the base case.e.managers after a project has been implemented to determine how each variable relates to the level of output realized.Difficulty level: MediumSENSITIVITY ANALYSISd13.To ascertain whether the accuracy of the variable cost estimate for a project will have much effect on the final outcome of the project, you should probably conduct _ analysis.a.leverageb.scenarioc.break-evend.sensitivitye.cash flowDifficulty level: EasySIMULATIONd14.Simulation analysis is based on assigning a _ and analyzing the results.a.narrow range of values to a single variableb.narrow range of values to multiple variables simultaneouslyc.wide range of values to a single variabled.wide range of values to multiple variables simultaneouslye.single value to each of the variablesDifficulty level: MediumSIMULATIONe15.The type of analysis that is most dependent upon the use of a computer is _ analysis.a.scenariob.break-evenc.sensitivityd.degree of operating leveragee.simulationDifficulty level: EasyVARIABLE COSTSd16.Which one of the following is most likely a variable cost?a.office rentb.property taxesc.property insuranced.direct labor costse.management salariesDifficulty level: EasyVARIABLE COSTSa17.Which of the following statements concerning variable costs is (are) correct?I.Variable costs minus fixed costs equal marginal costs.II.Variable costs are equal to zero when production is equal to zero.III.An increase in variable costs increases the operating cash flow.a.II onlyb.III onlyc.I and III onlyd.II and III onlye.I and II onlyDifficulty level: MediumVARIABLE COSTSa18.All else constant, as the variable cost per unit increases, the:a.contribution margin decreases.b.sensitivity to fixed costs decreases.c.degree of operating leverage decreases.d.operating cash flow increases.e.net profit increases.Difficulty level: MediumFIXED COSTSc19.Fixed costs:I.are variable over long periods of time.II.must be paid even if production is halted.III.are generally affected by the amount of fixed assets owned by a firm.IV.per unit remain constant over a given range of production output.a.I and III onlyb.II and IV onlyc.I, II, and III onlyd.I, II, and IV onlye.I, II, III, and IVDifficulty level: MediumCONTRIBUTION MARGINc20.The contribution margin must increase as:a.both the sales price and variable cost per unit increase.b.the fixed cost per unit declines.c.the gap between the sales price and the variable cost per unit widens.d.sales price per unit declines.e.the sales price minus the fixed cost per unit increases.Difficulty level: MediumACCOUNTING BREAK-EVENa21.Which of the following statements are correct concerning the accounting break-even point?I.The net income is equal to zero at the accounting break-even point.II.The net present value is equal to zero at the accounting break-even point.III.The quantity sold at the accounting break-even point is equal to the total fixed costs plus depreciation divided by the contribution margin.IV.The quantity sold at the accounting break-even point is equal to the total fixed costs divided by the contribution margin.a.I and III onlyb.I and IV onlyc.II and III onlyd.II and IV onlye.I, II, and IV onlyDifficulty level: MediumACCOUNTING BREAK-EVENb22.All else constant, the accounting break-even level of sales will decrease when the:a.fixed costs increase.b.depreciation expense decreases.c.contribution margin decreases.d.variable costs per unit increase.e.selling price per unit decreases.Difficulty level: MediumPRESENT VALUE BREAK-EVENd23.The point where a project produces a rate of return equal to the required return is known as the:a.point of zero operating leverage.b.internal break-even point.c.accounting break-even point.d.present value break-even point.e.internal break-even point.Difficulty level: EasyPRESENT VALUE BREAK-EVENb24.Which of the following statements are correct concerning the present value break-even point of a project?I.The present value of the cash inflows equals the amount of the initial investment.II.The payback period of the project is equal to the life of the project.III.The operating cash flow is at a level that produces a net present value of zero.IV.The project never pays back on a discounted basis.a.I and II onlyb.I and III onlyc.II and IV onlyd.III and IV onlye.I, III, and IV onlyDifficulty level: MediumINVESTMENT TIMING DECISIONb25.The investment timing decision relates to:a.how long the cash flows last once a project is implemented.b.the decision as to when a project should be started.c.how frequently the cash flows of a project occur.d.how frequently the interest on the debt incurred to finance a project is compounded.e.the decision to either finance a project over time or pay out the initial cost in cash.Difficulty level: MediumOPTION TO WAITe26.The timing option that gives the option to wait:I.may be of minimal value if the project relates to a rapidly changing technology.II.is partially dependent upon the discount rate applied to the project being evaluated.III.is defined as the situation where operations are shut down for a period of time.IV.has a value equal to the net present value of the project if it is started today versus the net present value if it is started at some later date.a.I and III onlyb.II and IV onlyc.I and II onlyd.II, III, and IV onlye.I, II, and IV onlyDifficulty level: ChallengeOPTION TO EXPANDb27.Last month you introduced a new product to the market. Consumer demand has been overwhelming and appears that strong demand will exist over the long-term. Given this situation, management should consider the option to:a.suspend.b.expand.c.abandon.d.contract.e.withdraw.Difficulty level: EasyOPTION TO EXPANDc28.Including the option to expand in your project analysis will tend to:a.extend the duration of a project but not affect the projects net present value.b.increase the cash flows of a project but decrease the projects net present value.c.increase the net present value of a project.d.decrease the net present value of a project.e.have no effect on either a projects cash flows or its net present value.Difficulty level: MediumSENSITIVITY AND SENARIO ANALYSISd29.Theoretically, the NPV is the most appropriate method to determine the acceptability of a project. A false sense of security can be overwhelm the decision-maker when the procedure is applied properly and the positive NPV results are accepted blindly. Sensitivity and scenario analysis aid in the process by a.changing the underlying assumptions on which the decision is based. b.highlights the areas where more and better data are needed. c.providing a picture of how an event can affect the calculations. d.All of the above. e.None of the above. Difficulty level: MediumDECSION TREEa30.In order to make a decision with a decision tree a.one starts farthest out in time to make the first decision. b.one must begin at time 0. c.any path can be taken to get to the end. d.any path can be taken to get back to the beginning. e.None of the above. Difficulty level: MediumDECISION TREEc31.In a decision tree, the NPV to make the yes/no decision is dependent on a.only the cash flows from successful path. b.on the path where the probabilities add up to one. c.all cash flows and probabilities. d.only the cash flows and probabilities of the successful path. e.None of the above. Difficulty level: MediumDECISION TREEe32.In a decision tree, caution should be used in analysis because a.early stage decisions are probably riskier and should not likely use the same discount rate. b.if a negative NPV is actually occurring, management should opt out of the project and minimize their loss. c.decision trees are only used for planning, not actually daily management. d.Both A and C. e.Both A and B. Difficulty level: MediumSENSITIVITY ANALYSISd33.Sensitivity analysis evaluates the NPV with respect to a.changes in the underlying assumptions. b.one variable changing while holding the others constant. c.different economic conditions. d.All of the above. e.None of the above. Difficulty level: MediumSENSITIVITY ANALYSISd34.Sensitivity analysis provides information on a.whether the NPV should be trusted, it may provide a false sense of security if all NPVs are positive. b.the need for additional information as it tests each variable in isolation. c.the degree of difficulty in changing multiple variables together. d.Both A and B. e.Both A and C. Difficulty level: MediumFIXED COSTSb35.Fixed production costs are a.directly related to labor costs. b.measured as cost per unit of time. c.measured as cost per unit of output. d.dependent on the amount of goods or services produced. e.None of the above. Difficulty level: MediumVARIABLE COSTSd36.Variable costs a.change as the quantity of output changes. b.are zero when production is zero. c.are exemplified by direct labor and raw materials. d.All of the above. e.None of the above. Difficulty level: EasySENSITIVITY ANALYSISb37.An investigation of the degree to which NPV depends on assumptions made about any singular critical variable is called a(n) a.operating analysis. b.sensitivity analysis. c.marginal benefit analysis. d.decision tree analysis. e.None of the above. Difficulty level: EasySENSITIVITY AND SCENARIOS ANALYSISb38.Scenario analysis is different than sensitivity analysis a.as no economic forecasts are changed. b.as several variables are changed together. c.because scenario analysis deals with actual data versus sensitivity analysis which deals with a forecast. d.because it is short and simple. e.because it is by the seat of the pants technique. Difficulty level: MediumEQUIVALENT ANNUAL COSTc39.In the present-value break-even the EAC is used to a.determine the opportunity cost of investment. b.allocate depreciation over the life of the project. c.allocate the initial investment at its opportunity cost over the life of the project. d.determine the contribution margin to fixed costs. e.None of the above. Difficulty level: MediumBREAK-EVENb40.The present value break-even point is superior to the accounting break-even point because a.present value break-even is more complicated to calculate. b.present value break-even covers the economic opportunity costs of the investment. c.present value break-even is the same as sensitivity analysis. d.present value break-even covers the fixed costs of production, which the accounting break-even does not. e.present value break-even covers the variable costs of production, which the accounting break-even does not. Difficulty level: EasyABANDONMENTd41.The potential decision to abandon a project has option value because a.abandonment can occur at any future point in time. b.a project may be worth more dead than alive. c.management is not locked into a negative outcome. d.All of the above. e.None of the above. Difficulty level: EasyTYPES OF BREAK-EVEN ANALYSISd42.Which of the following are types of break-even analysis? a.present value break-even b.accounting profit break-even c.market value break-even d.Both A and B. e.Both A and C. Difficulty level: EasyMONTE CARLO SIMULATIONc43.The approach that further attempts to model real word uncertainty by analyzing projects the way one might analyze gambling strategies is called a.gamblers approach. b.blackjack approach. c.Monte Carlo simulation. d.scenario analysis. e.sensitivity analysis. Difficulty level: MediumMONTE CARLO SIMULATIONc44.Monte Carlo simulation is a.the most widely used by executives. b.a very simple formula. c.provides a more complete analysis that sensitivity or scenario. d.the oldest capital budgeting technique. e.None of the above. Difficulty level: EasyOPTIONS IN CAPITAL BUDGETINGd45.Which of the following are hidden options in capital budgeting? a.option to expand. b.timing option. c.option to abandon. d.All of the above. e.None of the above. Difficulty level: EasyIII.PROBLEMSUse this information to answer questions 46 through 50.The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take 10 percent. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost estimates are considered accurate within a plus or minus 5 percent range. The depreciation expense is $4,000. The sale price is estimated at $16 a unit, give or take 2 percent. The company bases their sensitivity analysis on the expected case scenario.SCENARIO ANALYSISd46.What is the sales revenue under the optimistic case scenario?a.$40,000b.$43,120c.$44,000d.$44,880e.$48,400Difficulty level: MediumSCENARIO ANALYSISd47.What is the contribution margin under the expected case scenario?a.$2.67b.$3.00c.$7.92d.$8.00e.$8.72Difficulty level: MediumSCENARIO ANALYSISc48.What is the amount of the fixed cost per unit under the pessimistic case scenario?a.$4.55b.$5.00c.$5.83d.$6.02e.$6.55Difficulty level: MediumSENSITIVITY ANALYSISb49.The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $17. Using this value, the earnings before interest and taxes will be:a.$4,000b.$6,000c.$8,500d.$10,000e.$18,500Difficulty level: MediumSENSITIVITY ANALYSISb50.The company conducts a sensitivity analysis using a variable cost of $9. The total variable cost estimate will be:a.$21,375b.$22,500c.$23,625d.$24,125e.$24,750Difficulty level: MediumUse this information to answer questions 51 through 55.The Can-Do Co. is analyzing a proposed project. The company expects to sell 12,000 units, give or take 4 percent. The expected variable cost per unit is $7 and the expected fixed cost is $36,000. The fixed and variable cost estimates are considered accurate within a plus or minus 6 percent range. The depreciation expense is $30,000. The tax rate is 34 percent. The sale price is estimated at $14 a unit, give or take 5 percent. The company bases their sensitivity analysis on the expected case scenario.SCENARIO ANALYSISa51.What is the earnings before intere
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