Exam 13: Capital Budgeting and Risk

The use of sensitivity analysis requires that _____.

How can beta, a measure of systematic risk of a portfolio of securities, be used to judge the risk of a firm?

Rolling in Dough Cookie Corporation is trying to determine its certainty equivalent NPV. What is the CNPV if the risk free rate is 2% and the initial investment is $19,000 (rounded)? ? Year Cash Flows Certainty Equival ents 1 \ 15,000 90\% 2 \ 15,000 60\% 3 \ 8,000 50\%

Determine the coefficient of variation for the following annual cash inflows from an investment project: Cash Flow (\ 000) Probability \ 2,000 0.10 \ 2,500 0.20 \ 3,000 0.30 \ 3,500 0.20 \ 4,000 0.20

What item has made sensitivity analysis simple and inexpensive?

Given the following cash flows and certainty equivalent factors for an investment project, determine the certainty equivalent net present value. The firm's cost of capital is 14% and the risk-free rate is 6%. Cash Certainty-Equivalent Year Flow Factor 0 -\ 100,000 1.00 1 \ 60,000 0.90 2 \ 60,000 0.75 3 \ 60,000 0.55

Determine the pure project beta of a project that has 45% debt and 55% equity. The beta for the company is 1.6, and it has a tax rate of 40%.

MedChem has a capital structure of 60% equity and 40% debt and a current beta of 1.2. MedChem is considering an investment project in a new line of business that has an expected internal rate of return of 16%. The typical firm already in the line of business that MedChem is considering expanding into has a beta of 1.5 and a capital structure that has 55% debt and 45% equity. The marginal tax rate for all these firms, including MedChem, is 40%. If the current risk-free rate is 7% and the expected market risk premium is 8%, should MedChem expand into the new line? Assume that MedChem will retain its current capital structure.

The ____ the amount of debt in a firm's capital structure, the ____ will be the firm's beta.

The risk-adjusted discount rate approach is used in the analysis of projects for which ____ is the applicable risk measure.

A major disadvantage of the risk-adjusted discount rate approach is that it _____.

The certainty equivalent approach adjusts the ____ for risk in the ____ of the net present value equation.

American Biodyne (AB) is considering expanding into a new line of business. The expansion will require an investment of $500,000 in new equipment. This equipment, which will cost another $300,000 to install, will be depreciated on a straight-line basis over an 8-year period to an estimated salvage value of zero. If the expansion project is accepted, working capital will increase by $100,000 immediately. Revenues for the first 3 years are forecasted at $650,000 per year and at $800,000 in years 4-8. Operating costs exclusive of depreciation are expected to be $310,000 per year for 3 years and increase to $400,000 per year for the following 5 years. AB has a marginal tax rate of 40%, and its required rate of return for the project under consideration is 16%. If AB assumes that the new equipment will have an actual market value of $50,000 at the end of the 8th year, should the expansion be undertaken?

Quick Flick is considering two investments. Both require a net investment of $120,000 and have the following net cash flows: Year Project Project Y 1 \ 50,000 \ 25,000 2 \ 40,000 \ 45,000 3 \ 30,000 \ 50,000 4 \ 25,000 \ 60,000 5 \ 20,000 \ 70,000 ? Quick uses a combination of the net present value approach and the payback approach to evaluate investment alternatives. The firm uses a discount rate of 14 percent and requires that all projects have a payback period no longer than 3 years. Which investment or investments should Quick accept?

Faris currently has a capital structure of 40 percent debt and 60 percent equity, but is considering a new product that will be produced and marketed by a separate division. The new division will have a capital structure of 70 percent debt and 30 percent equity. Faris has a current beta of 1.1 but is not sure what the beta for the new division will be. AMX is a firm that produces a product similar to the product under consideration by Faris. AMX has a beta of 1.6, a capital structure of 40 percent debt and 60 percent equity, and a marginal tax rate of 40 percent. Assuming Faris's tax rate is 40 percent, estimate the levered beta for the new product division.

Project C has been classified into risk class II by the analyst of a major firm. The risk premium required for projects in this risk class is 8%. The current risk-free rate measured by the analyst is 10%. If the project has an estimated return of 20%, the analyst would recommend _____.

A simulation analysis for a new acquisition has indicated that the expected NPV is $50 million with a standard deviation of $40 million. Assume that NPV is normally distributed. What is the probability that the project will be unacceptable?

The ____ risk of a firm is a weighted average of the ____ risk of the individual assets in the firm.

How and when should firms consider employing additional risk analysis techniques in judging the suitability of large projects prior to implementation?

In a simulation analysis, a model is simulated on a computer program and run through several iterations. The results of these iterations are used to _____.