Exam 13: Capital Budgeting and Risk

A weakness of the net present value/payback method is that _____.

Which of the following is (are) a risk associated with projects that must be considered when determining the net present value? I. Financial risk II. Pure project risk

The net present value of a project is normally distributed with an expected value of $52,000 and a standard deviation of $31,515. Determine the probability that the project will have a net present value of less than zero.

Billy Bob is considering building a water slide park that will require a net investment of $200,000 and yield the following net cash flows: Year Net Cash Flows Cert. Equiv. Factor 1 \ 120,000 0.90 2 \ 90,000 0.80 3 \ 60,000 0.65 4 \ 30,000 0.50 5 \ 10,000 0.30 ? If the risk-free rate is 8 percent and the market risk premium is 6 percent, what is the certainty equivalent NPV for this project?

M-tel is financed entirely with equity, and the firm's stock has a beta of 0.85. M-tel is considering investing in a project that is expected to have a beta of 1.3. The project requires an initial outlay of $6 million and is expected to generate after-tax net cash flows of $1.3 million each year for 8 years. Calculate the NPV of the project. Assume the risk-free rate is 7% and the expected market return is 14%. (Note: Problem requires either calculator use or interpolation from the tables. The suggested solutions use calculator accuracy.)

A project has an expected NPV of $50,000 with a standard deviation of the NPV of $20,000. Assume that NPV is normally distributed. What is the probability that the project will have a net present value greater than $60,000?

____ are needed for sensitivity analysis and have made the application simple and inexpensive.

The Bull Company, a lawn mower manufacturer, is considering the introduction of a new model. The initial outlay required is $22 million. Net cash flows over the 4-year life cycle and the corresponding certainty-equivalents of the new model are as follows: Year Net Cash Flow Certainty-equival ent 1 \ 15 million 0.90 2 13 million 0.75 3 11 million 0.55 4 9 million 0.30 ? The firm's cost of capital is 14%, and the risk-free rate is 6%. Bull uses the certainty-equivalent approach in evaluating above-average risk investments such as this one. What is the project's certainty-equivalent NPV?

IKON is financed entirely with equity, and its beta is 1.31. If the current risk-free rate is 6.25% and the expected market return is 12.8%, what is IKON's required rate of return on a project of average risk?

The discount rate used in calculating the certainty equivalent net present value is the ______.

Simulation techniques are _____.

Which of the following statements is correct about adjusting for beta risk in capital budgeting?

The Chris-Kraft Co. is financed entirely with equity, and the firm has a beta of 1.25. The current risk-free rate is 7 percent, and the expected market return is 15 percent. Chris-Kraft is considering an investment project with a risk that matches the firm's average risk, requires a net investment of $70,000, and has net cash flows of $18,000 per year for 8 years. Should Chris-Kraft invest in the project?

The certainty equivalent factors used to adjust the cash flows for risk can range from _____.

A firm's leveraged beta will always be ____ its unleveraged beta.

A major problem with using the risk-adjusted discount rate approach is the determination of _____.

Calco is a multi-divisional firm with a weighted cost of capital of 14 percent and a risk-adjusted discount rate for its can division of 17 percent. A planned expansion in the can division requires a net investment of $170,000 and results in expected cash inflows of $42,000 a year for seven years. Should Calco invest in this expansion?

SCAN is a multi-divisional utility company. SCAN has four divisions with the following betas and proportions of the firm's total assets: ? Division Beta \% of Assets Electric \& Gas 0.85 60 Bus transportation 0.95 10 Real estate 1.40 25 Recreation 1.15 5 ? What is the firm's weighted average beta?

The certainty equivalent approach is a risk evaluation technique. Which of the following statements is (are) correct? I. Certainty equivalents adjust the cash flows in the numerator of the NPV equation. II. Using the RADR involves adjustments to the denominator of the NPV equation.

With the ____ approach, the decision maker adjusts separately each period's cash flows to account for the specific risk of those cash flows.