Question 1

Which of the following statements is FALSE?

Accepted Answer

A) Traditionally,managers have used the equivalent annual benefit method to choose between projects of different lives. 
B) The equivalent annual benefit method ignores the value of any real options because it assumes that the projects will always be replaced at their original terms. 
C) If the future costs (or benefits)are certain with mutually exclusive projects,then we must use a real options approach to determine the correct decision. 
D) The equivalent annual benefit method accounts for the difference in project lengths by calculating the constant payment over the life of the project that is equivalent to receiving the NPV today and then selecting the project with the higher equivalent annual benefit. 
A) Traditionally,managers have used the equivalent annual benefit method to choose between projects of different lives. 
B) The equivalent annual benefit method ignores the value of any real options because it assumes that the projects will always be replaced at their original terms. 
C) If the future costs (or benefits)are certain with mutually exclusive projects,then we must use a real options approach to determine the correct decision. 
D) The equivalent annual benefit method accounts for the difference in project lengths by calculating the constant payment over the life of the project that is equivalent to receiving the NPV today and then selecting the project with the higher equivalent annual benefit. C

Question 2

Unicorn Medical Devices is developing a new technology.After initial development of the device,the company must test it.If the tests go well and the device is successful,it can be marketed immediately.If the tests do not go well,Unicorn will revise the original device and repeat the process.The outcome of the tests is on a(n)________ in a decision tree.

Accepted Answer

A) decision node 
B) information node 
C) either node;it does not matter 
D) This question cannot be answered without a graphical representation of the decision tree. 
A) decision node 
B) information node 
C) either node;it does not matter 
D) This question cannot be answered without a graphical representation of the decision tree. B

Question 3

Can value can be created by waiting for uncertainty to resolve?

Accepted Answer

Value can be created by waiting for uncertainty to resolve because once it is resolved you can make better decisions with better information.If there is no cost to waiting,investing early never makes sense.If there is a cost,the benefits must be weighed.

Question 4

Describe the two factors that affect the value of an investment timing option?

Accepted Answer

Volatility: By delaying an investment,we

Question 5

When the value of one project depends on the outcome of one or more other projects,this is known as:

Accepted Answer

A) mutually independent investments. 
B) equivalent annual investments. 
C) staged dependent investments. 
D) mutually dependent investments. 
A) mutually independent investments. 
B) equivalent annual investments. 
C) staged dependent investments. 
D) mutually dependent investments.

Question 6

Use the table for the question(s)below.
Consider the following mutually exclusive projects:  
-The equivalent annual benefit of project A is closest to:

Accepted Answer

A) $21.70. 
B) $5.05. 
C) $24.00. 
D) $3.40. 
A) $21.70. 
B) $5.05. 
C) $24.00. 
D) $3.40.

Question 7

Use the information for the question(s)below.
You own a small manufacturing plant that currently generates revenues of $2 million per year.Next year,based upon a decision on a long-term government contract,your revenues will either increase by 20% or decrease by 25%,with equal probability,and stay at that level as long as you operate the plant.Other costs run $1.6 million per year.You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.
-If you are awarded the government contract and your sales increase by 20%,then the value of your plant will be closest to:

Accepted Answer

A) $5 million. 
B) $8 million. 
C) $0. 
D) $4 million. 
A) $5 million. 
B) $8 million. 
C) $0. 
D) $4 million.

Question 8

Use the table for the question(s)below.
Consider the following mutually exclusive projects:  
-The NPV of project B is closest to:

Accepted Answer

A) $18.10. 
B) $21.70. 
C) $24.00. 
D) $16.90. 
A) $18.10. 
B) $21.70. 
C) $24.00. 
D) $16.90.

Question 9

Which of the following statements is FALSE?

Accepted Answer

A) Decision nodes are nodes in which uncertainty is involved that is out of the control of the decision maker. 
B) Most investment projects allow for the possibility of reevaluating the decision to invest at a later point in time. 
C) A decision tree is a graphical representation of future decisions and uncertainty resolution. 
D) With binomial trees the uncertainty is not under the control of the decision maker. 
A) Decision nodes are nodes in which uncertainty is involved that is out of the control of the decision maker. 
B) Most investment projects allow for the possibility of reevaluating the decision to invest at a later point in time. 
C) A decision tree is a graphical representation of future decisions and uncertainty resolution. 
D) With binomial trees the uncertainty is not under the control of the decision maker.

Question 10

Use the following information to answer the question(s)below.
Rearden Metal can invest in a risk-free technology that requires an up-front investment of $1 million.Rearden's managers are hesitant to invest because of uncertainty over future interest rates.Suppose that all interest rates will be either 8% or 4% in one year and remain there forever.The risk-neutral probability that interest rates will drop to 4% is 40%.The one-year risk-free interest rate is 5% and today's rate on a risk-free perpetual bond is 6%.The rate on an equivalent perpetual bond that is repayable at any time (the callable annuity rate)is 7.65%.
-Assuming that this project will provide Rearden with perpetual annual cash flows of $65,000,the NPV of investing in the project next year is closest to:

Accepted Answer

A) -$281,000. 
B) +$46,000. 
C) +$83,000. 
D) +$143,000. 
E) +$238,000. 
A) -$281,000. 
B) +$46,000. 
C) +$83,000. 
D) +$143,000. 
E) +$238,000.

Question 11

Use the information for the question(s)below.
Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing.The pilot production and test marketing phase will last for one year and cost $500,000.Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike.If the test-marketing phase is successful,then Kinston Industries will invest $3 million in year one to build a plant that will generate expected annual after-tax cash flows of $400,000 in perpetuity beginning in year two.If the test marketing is not successful,Kinston can still go ahead and build the new plant,but the expected annual after-tax cash flows would be only $200,000 in perpetuity beginning in year two.Kinston has the option to stop the project at any time and sell the prototype mountain bike to an overseas competitor for $300,000.Kinston's cost of capital is 10%.
-Assume that Kinston has the ability to ignore the pilot production and test marketing and to go ahead and build their manufacturing plant immediately and that the probability of high or low demand would still be 50%.What is the value of the option to do pilot production and test marketing?

Accepted Answer

The NPV of going ahead and building toda

Question 12

The callable annuity rate can be calculated as:

Accepted Answer

A)    × Hurdle Rate. 
B)    × Hurdle Rate. 
C)    × Cost of Capital. 
D)    . 
A)    × Hurdle Rate. 
B)    × Hurdle Rate. 
C)    × Cost of Capital. 
D)    .

Question 13

Use the information for the question(s)below.
DM Skateboard company is planning to develop a new electric skateboard.In order for the project to be successful,the company must develop a new deck to accommodate a lightweight battery and a remote that is easy to operate while moving in an open environment.The company estimates the following costs,times,and probabilities of success for each component of the new skateboard:   All three risks are idiosyncratic and the risk-free rate of interest is 5%.The company does not have the resources to develop all the components at the same time.Therefore,management needs to decide in what order to develop the technologies.
-What is the failure cost index of the deck technology?

Accepted Answer

A) 0.00500 
B) 0.98500 
C) 0.98536 
D) 0.00536 
A) 0.00500 
B) 0.98500 
C) 0.98536 
D) 0.00536

Question 14

Use the information for the question(s)below.
You own a small manufacturing plant that currently generates revenues of $2 million per year.Next year,based upon a decision on a long-term government contract,your revenues will either increase by 20% or decrease by 25%,with equal probability,and stay at that level as long as you operate the plant.Other costs run $1.6 million per year.You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.
-If you are not awarded the government contract and your sales decrease by 25%,then the value of your plant will be closest to:

Accepted Answer

A) -$1 million. 
B) $5 million. 
C) $8 million. 
D) $0. 
A) -$1 million. 
B) $5 million. 
C) $8 million. 
D) $0.

Question 15

Which of the following statements is FALSE?

Accepted Answer

A) If there is a lot of uncertainty,the benefit of waiting is diminished. 
B) In the real option context,the dividends correspond to any value from the investment that we give up by waiting. 
C) By delaying an investment,we can base our decision on additional information. 
D) Given the option to wait,an investment that currently has a negative NPV can have a positive value. 
A) If there is a lot of uncertainty,the benefit of waiting is diminished. 
B) In the real option context,the dividends correspond to any value from the investment that we give up by waiting. 
C) By delaying an investment,we can base our decision on additional information. 
D) Given the option to wait,an investment that currently has a negative NPV can have a positive value.

Question 16

Which of the following statements is FALSE?

Accepted Answer

A) The profitability index rule of thumb raises the bar on the NPV to take into account the option to wait. 
B) In practice,correctly modeling the sources of uncertainty and the appropriate dynamic decisions usually requires an extensive amount of time and financial expertise. 
C) Some firms use the following rule of thumb: Invest whenever the profitability index is below a specified level. 
D) Instead of raising the bar on the NPV,the hurdle rate rule raises the discount rate. 
A) The profitability index rule of thumb raises the bar on the NPV to take into account the option to wait. 
B) In practice,correctly modeling the sources of uncertainty and the appropriate dynamic decisions usually requires an extensive amount of time and financial expertise. 
C) Some firms use the following rule of thumb: Invest whenever the profitability index is below a specified level. 
D) Instead of raising the bar on the NPV,the hurdle rate rule raises the discount rate.

Question 17

Which of the following statements is FALSE?

Accepted Answer

A) One way to see why you sometimes choose not to invest in a positive-NPV project is to think about the decision of when to invest as a choice between two mutually exclusive projects: (1)invest today or (2)wait. 
B) You invest today only when the NPV of investing today exceeds the value of the option of waiting,which from option pricing theory we know to be always positive. 
C) When you do not have the option to wait,it is optimal to invest in any positive-NPV project. 
D) When you have the option of deciding when to invest,it is usually optimal to invest only when the NPV is positive but close to zero. 
A) One way to see why you sometimes choose not to invest in a positive-NPV project is to think about the decision of when to invest as a choice between two mutually exclusive projects: (1)invest today or (2)wait. 
B) You invest today only when the NPV of investing today exceeds the value of the option of waiting,which from option pricing theory we know to be always positive. 
C) When you do not have the option to wait,it is optimal to invest in any positive-NPV project. 
D) When you have the option of deciding when to invest,it is usually optimal to invest only when the NPV is positive but close to zero.

Question 18

Which of the following statements is FALSE?

Accepted Answer

A) The hurdle rate rule for projects with the option to delay uses a lower discount rate than the cost of capital to compute the NPV,but then applies the regular NPV rule: Invest whenever the NPV calculated using this lower discount rate is positive. 
B) While using a hurdle rate rule for deciding when to invest might be a cost-effective way to make investment decisions,it is important to remember that this rule does not provide an accurate measure of value. 
C) When the cash flows are constant and perpetual,and the reason to wait derives solely from interest rate uncertainty,the hurdle rate rule of thumb is always exact.However,when these conditions are not satisfied,the rule of thumb merely approximates the correct decision. 
D) When a firm faces the same uncertainty for most of its investment decisions,using a single profitability index criterion for all projects can provide a useful rule of thumb to account for cash flow uncertainty. 
A) The hurdle rate rule for projects with the option to delay uses a lower discount rate than the cost of capital to compute the NPV,but then applies the regular NPV rule: Invest whenever the NPV calculated using this lower discount rate is positive. 
B) While using a hurdle rate rule for deciding when to invest might be a cost-effective way to make investment decisions,it is important to remember that this rule does not provide an accurate measure of value. 
C) When the cash flows are constant and perpetual,and the reason to wait derives solely from interest rate uncertainty,the hurdle rate rule of thumb is always exact.However,when these conditions are not satisfied,the rule of thumb merely approximates the correct decision. 
D) When a firm faces the same uncertainty for most of its investment decisions,using a single profitability index criterion for all projects can provide a useful rule of thumb to account for cash flow uncertainty.

Question 19

Use the information for the question(s)below.
Kinston Industries has come up with a new mountain bike prototype and is ready to go ahead with pilot production and test marketing.The pilot production and test marketing phase will last for one year and cost $500,000.Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new mountain bike.If the test-marketing phase is successful,then Kinston Industries will invest $3 million in year one to build a plant that will generate expected annual after-tax cash flows of $400,000 in perpetuity beginning in year two.If the test marketing is not successful,Kinston can still go ahead and build the new plant,but the expected annual after-tax cash flows would be only $200,000 in perpetuity beginning in year two.Kinston has the option to stop the project at any time and sell the prototype mountain bike to an overseas competitor for $300,000.Kinston's cost of capital is 10%.
-Assume that Kinston has the ability to ignore the pilot production and test marketing and to go ahead and build their manufacturing plant immediately.Assuming that the probability of high or low demand is still 50%,the NPV of the Kinston Industries Mountain Bike Project is closest to:

Accepted Answer

A) $0. 
B) $90,000. 
C) -$45,000. 
D) $1,000,000. 
A) $0. 
B) $90,000. 
C) -$45,000. 
D) $1,000,000.

Question 20

Which of the following statements is FALSE?

Accepted Answer

A) Abandonment options can add value to a project because a firm can drop a project if it turns out to be unsuccessful. 
B) Corporate bonds often contain embedded abandonment options: The issuing firm sometimes has the option to convert the bond-that is,to repay it. 
C) An abandonment option is the option to walk away. 
D) An important abandonment option that many people encounter at some point in their lives is the option to abandon their mortgage. 
A) Abandonment options can add value to a project because a firm can drop a project if it turns out to be unsuccessful. 
B) Corporate bonds often contain embedded abandonment options: The issuing firm sometimes has the option to convert the bond-that is,to repay it. 
C) An abandonment option is the option to walk away. 
D) An important abandonment option that many people encounter at some point in their lives is the option to abandon their mortgage.

Exam 22: Real Options

Which of the following statements is FALSE?

Can value can be created by waiting for uncertainty to resolve?

Describe the two factors that affect the value of an investment timing option?

When the value of one project depends on the outcome of one or more other projects,this is known as:

Use the table for the question(s)below. Consider the following mutually exclusive projects: -The equivalent annual benefit of project A is closest to:

Use the table for the question(s)below. Consider the following mutually exclusive projects: -The NPV of project B is closest to:

Which of the following statements is FALSE?

The callable annuity rate can be calculated as:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Financial Distress,managerial Incentives,and Information

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

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