Question 1

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

Accepted Answer

A) It measures unsystematic risk. 
B) It is a guaranteed measure of the success of the project. 
C) The beta concept can be used to determine RADR. 
D) It evaluates the efficiency of the management team. 
A) It measures unsystematic risk. 
B) It is a guaranteed measure of the success of the project. 
C) The beta concept can be used to determine RADR. 
D) It evaluates the efficiency of the management team. C

Question 2

With the risk adjusted discount rate approach, in the context of total risk, the discount rates used in evaluating cash flows are determined .

Accepted Answer

A) objectively 
B) subjectively 
C) using regression analysis 
D) objectively and by using regression analysis 
A) objectively 
B) subjectively 
C) using regression analysis 
D) objectively and by using regression analysis B

Question 3

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

Accepted Answer

Just as beta of a portfolio of securities can be computed as the weighted average of the individual security betas, a firm may be considered as a portfolio of assets, each having its own beta.From this perspective, the systematic risk of the firm is simply the weighted average of the systematic risk of the individual assets.

Question 4

The risk of an investment project is defined in terms of the potential of its returns.

Accepted Answer

A) certainty 
B) size 
C) variability 
D) timing 
A) certainty 
B) size 
C) variability 
D) timing

Question 5

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

Accepted Answer

A) plot a required rate of return value profile 
B) compute a mean and a standard deviation of returns 
C) provide the decision maker with a measure of beta risk 
D) plot the coefficient of variation of the annual net cash flows 
A) plot a required rate of return value profile 
B) compute a mean and a standard deviation of returns 
C) provide the decision maker with a measure of beta risk 
D) plot the coefficient of variation of the annual net cash flows

Question 6

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?

Accepted Answer

A) 8.58% 
B) 14.83% 
C) 17.65% 
D) 12.81% 
A) 8.58% 
B) 14.83% 
C) 17.65% 
D) 12.81%

Question 7

Which of the following is/are a risk associated with projects that must be considered when determining the net present value?

Accepted Answer

A) Only statement I is correct 
B) Only statement II is correct 
C) Both statements I and II are correct 
D) Neither statement I nor II is correct 
A) Only statement I is correct 
B) Only statement II is correct 
C) Both statements I and II are correct 
D) Neither statement I nor II is correct

Question 8

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

Accepted Answer

A)  99.38% 
B) 0.62% 
C) 34.5% 
D) 49.38% 
A)  99.38% 
B) 0.62% 
C) 34.5% 
D) 49.38%

Question 9

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?

Accepted Answer

A) 89.44% 
B) 10.56% 
C) 39.44% 
D) 21.19% 
A) 89.44% 
B) 10.56% 
C) 39.44% 
D) 21.19%

Question 10

Quick Flick is considering two investments.Both require a net investment of $120,000 and have the following net cash flows:
 
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?

Accepted Answer

A) only Project X 
B) only Project Y 
C) both projects X and Y 
D) reject both projects 
A) only Project X 
B) only Project Y 
C) both projects X and Y 
D) reject both projects

Question 11

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:
 
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?

Accepted Answer

A) $20,083,000 
B) $6,628,400 
C) $13,905,000 
D) $3,019,400 
A) $20,083,000 
B) $6,628,400 
C) $13,905,000 
D) $3,019,400

Question 12

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

Accepted Answer

A) net cash flows, numerator 
B) risk-free rate, numerator 
C) required return, numerator 
D) net cash flows, denominator 
A) net cash flows, numerator 
B) risk-free rate, numerator 
C) required return, numerator 
D) net cash flows, denominator

Question 13

The hurdle rate approach in determining the acceptability of projects:

Accepted Answer

A) is an improvement over the risk-adjusted discount rate approach because it provides for an objective basis to determine risk premiums for individual projects. 
B) is a modification of the internal rate of return approach. 
C) is inconsistent with the principle of project risk balancing. 
D) is a method used with the certainty equivalent approach. 
A) is an improvement over the risk-adjusted discount rate approach because it provides for an objective basis to determine risk premiums for individual projects. 
B) is a modification of the internal rate of return approach. 
C) is inconsistent with the principle of project risk balancing. 
D) is a method used with the certainty equivalent approach.

Question 14

The net present value/payback approach is a useful approach when

Accepted Answer

A) screening projects characterized by rapid technological advances 
B) cash flow estimates are known with certainty 
C) the more risky cash flows occur during the startup period 
D) None of these 
A) screening projects characterized by rapid technological advances 
B) cash flow estimates are known with certainty 
C) the more risky cash flows occur during the startup period 
D) None of these

Question 15

Simulation techniques are

Accepted Answer

A) cheap to apply 
B) widely used 
C) mostly beneficial for large projects 
D) identical to sensitivity analysis 
A) cheap to apply 
B) widely used 
C) mostly beneficial for large projects 
D) identical to sensitivity analysis

Question 16

Which of the following techniques can be used to analyze total project risk?

Accepted Answer

A) net present value/payback approach 
B) risk-adjusted discount rate approach 
C) simulation analysis 
D) all of these 
A) net present value/payback approach 
B) risk-adjusted discount rate approach 
C) simulation analysis 
D) all of these

Question 17

The approach is widely used by firms that attempt to consider differential project risk in their capital budgeting procedures.

Accepted Answer

A) net present value 
B) internal rate of return 
C) risk-adjusted discount rate 
D) certainty equivalent 
A) net present value 
B) internal rate of return 
C) risk-adjusted discount rate 
D) certainty equivalent

Question 18

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

Accepted Answer

A) accepting project C 
B) rejecting project C 
C) re-estimating the risk premiums for class II projects 
D) none of these 
A) accepting project C 
B) rejecting project C 
C) re-estimating the risk premiums for class II projects 
D) none of these

Question 19

What are the primary advantages and disadvantages of applying simulation to capital budgeting risk analysis?

Accepted Answer

The simulation approach explicitly recog

Question 20

Haulin' It Towing Company is considering adding more tow trucks to its fleet.The cost of the new trucks is $150,000.The project will utilize the risk adjusted discount, the firm has a beta of 1.3, the risk free rate is 7% and the return in the market is 15%.Should Haulin' It add the additional trucks if the expected increased revenues will be as follows?
$$\begin{array} { | c | c | } 
\hline \text { Years } & \text { Cash Flaws } \
\hline 1 & \text { \$od,00] } \
\hline 2 & 195,000 \
\hline 3 & 110,000 \
\hline
\end{array}$$

Accepted Answer

A) No, the NPV of the project is -$15,175.19 
B) Yes, the NPV of the project is $75,275.16 
C) No, the NPV of the project is -$9,765.12 
D) Yes, the NPV of the project is $55,050.92 
A) No, the NPV of the project is -$15,175.19 
B) Yes, the NPV of the project is $75,275.16 
C) No, the NPV of the project is -$9,765.12 
D) Yes, the NPV of the project is $55,050.92

Exam 11: Capital Budgeting and Risk

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

With the risk adjusted discount rate approach, in the context of total risk, the discount rates used in evaluating cash flows are determined .

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

The risk of an investment project is defined in terms of the potential of its returns.

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

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?

Which of the following is/are a risk associated with projects that must be considered when determining the net present value?

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

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

The hurdle rate approach in determining the acceptability of projects:

The net present value/payback approach is a useful approach when

Simulation techniques are

Which of the following techniques can be used to analyze total project risk?

The approach is widely used by firms that attempt to consider differential project risk in their capital budgeting procedures.

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

What are the primary advantages and disadvantages of applying simulation to capital budgeting risk analysis?

The Role and Objective of Financial Management

The Domestic and International Financial Marketplace

Evaluation of Financial Performance

Financial Planning and Forecasting

The Time Value of Money

A: The Time Value of Money

Fixed-Income Securities: Characteristics and Valuation

Common Stock: Characteristics, Valuation, and Issuance

Analysis of Risk and Return

Capital Budgeting and Cash Flow Analysis

Capital Budgeting: Decision Criteria and Real Option Considerations

A: Capital Budgeting: Decision Criteria and Real Option Considerations

The Cost of Capital, Capital Structure, and Dividend Policy

Capital Structure Concepts

Capital Structure Management in Practice

A: Capital Structure Management in Practice

Dividend Policy

Working Capital Management

The Management of Cash and Marketable Securities

The Management of Accounts Receivable and Inventories

Lease and Intermediate-Term Financing

Financing with Derivatives

A: Financing with Derivatives

Risk Management

International Financial Management

Corporate Restructuring

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