Financial Policies MIDTERM Ch 7

True or False: While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time.

True

The project requires an initial investment of $500,000. There is a 20% probability of success with a two million-dollar cash flow next year. If the project fails, the project will not generate any cash flows. What is the npv if the discount rate is 10%?

$-136,363.64

Compute net acct profit based on the following info: Revenues = 4,000; VC = 1,600; FC = 700; Dep = 300; Tax rate = 20%

$1,120

A real estate agent has leased 10 rooms in a resort area for $100,000 for the summer season. She hopes to rent these rooms and generate profit for her business. What will the fixed costs be for the real estate agent if only 6 rooms are occupied because of excessive rains?

$100,000

You are in the business of manufacturing watches. The parts for each of these watches costs an average of $25. Your costs for the month are $3,000. What will be the monthly total variable costs if you manufacture 100 watches?

$2500 --> ($25 per watch x 100 watches)

What is next year's expected cash flow if there is a 50/50 probability that it will be either $10 million or $60 million?

$35 mil

Consider a project that will pay off 2 million dollars if it is successful and nothing if it is not successful. If the probability of success is 20% what is the Project's expected payoff?

$400,000

What is the contribution margin if the sales price per unit is $15,000, variable cost per unit is $10,000 and fixed costs are $2,000? Ignore taxes.

$5,000

What are the two main benefits of performing a sensitivity analysis?

- It identifies the variable that has the most effect on NPV - It reduces a false sense of security by giving a range of values for NPV instead of a single value

What are the two main drawbacks of sensitivity analysis?

- It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive - It does not consider interactions among variables

In a monte carlo simulation, specifying a distribution for annual revenue will generally involve which of the following?

- Modeling industry sales - determining a distribution of sales prices - forecasting probabilities of various market shares

Which of the following are examples of fixed costs for a car repair shop performing oil changes and other repairs?

- Monthly rent for the shop - Insurance - Salary

What is a sunk cost?

A cost incurred in the past that is irrelevant to the capital investment decision process.

What is the basic output of a Monte Carlo simulation?

A distribution of CF for each future year

In general, what is the decision rule for evaluating two mutually exclusive projects using NPV?

Accept the project that has the higher positive NPV

What is the relationship between variable costs and output?

Total variable costs are directly related to the level of output.

Which of the following defines the contribution margin? Ignore taxes.

Contribution margin = sales - VC

What costs are included in the numerator of the accounting profit break-even point equation?

Depreciation and fixed costs

What is scenario analysis?

Determines the impact on NPV of a set of events relating to a specific scenario

True pr False: Opportunity costs are irrelevant costs when doing capital budgeting analysis.

False; they are relevant costs

Which of the following is the most complex technique for capital budgeting analysis?

Monte carlo simulation

Which of the following statements is true in the context of comparing accounting profit and present value break even point?

PV is superior to acct profit because it adjusts for time value and considers the depreciation tax shield effect

Which of the following is an example of a sunk cost?

R&D expense incurred in the past

A Monte Carlo simulation analyzes __________.

The expected NPV by determining a probability distribution for each variable

Which of the following is an opportunity cost in the context of a vacant building that a firm currently owns?

The rental income lost from owning a vacant building.

Timing option:

Waiting to build a store in an area where housing developments have been proposed

An accounting break-even point of 2,000 means the firm ____________.

Will start generating profits if it sells more than 2,000 units

Synergy will cause the cash flows from the sale of existing products to __________.

increase

A decision tree involves ____________.

mapping the sequential outcomes of various decisions and corresponding probabilities

Which of the following formulas can be used to determine total revenue for a firm using Monte Carlo simulation?

market size x market share x price per unit

Contribution margin refers to the contribution made by each additional unit sold to ___________.

pretax profits

A fixed cost is a cost that ________.

remains constant as the level of business activity changes

In a Monte Carlo simulation, a distribution of CFs for each future year of a given project is generated from ___________.

repeated drawings

Corporate managers care about the break-even point because it indicates:

the level to which sales can fall before a project will start losing money

The contribution margin per unit will increase if _________

the sales price per unit increases while the variable cost per unit decreases

A firm will start generating positive profits when _______.

the total number of units sold exceeds the accounting break-even point

Survey results indicate that the Monte Carlo simulation technique is ________.

used by 15% of firms

Which of the following pieces of info are required in order to compute NPV?

- The discount rate - The time horizon of the project - Projected future cash flows

Under which of the following scenarios will an option to abandon be a valuable option?

- When a project's assets can be quickly liquidated at fair values - When there is the possibility of a negative future outcome - When future market conditions are unpredictable

The present value break-even point differs from accounting profit break-even point for the following reasons:

- adjusts for time value of money - adjusts for depreciation tax shield benefit

Which of the following is an example of a situation in which sensitivity analysis increases the false sense of security among managers?

- all pessimistic estimates of NPV are positive

Sensitivity analysis is also known as __________.

- bop (best, optimistic, and pessimistic) analysis - what-if analysis

Which of the following statements are true regarding fixed and variable costs?

- fixed cost per unit will decrease while variable cost per unit will stay constant if the level of output increases - total fixed costs remain constant while total variable cost increase if the level of output increases

What is the total number of inputs that is changed at one point while doing sensitivity analysis?

1

Which of the following are reasons why NPV is considered a superior capital budgeting technique?

- NPV considers time value of money - NPV considers all the cash flows *** Earnings do not represent real money*** NPV does not give a rate of return***

True or False: The value of real options, if they exist, must be included in capital budgeting analysis.

True

Which of the following are steps involved in performing a Monte Carlo simulation?

- Specifying a distribution for each variable in the model - Specifying a model - Generating outcomes -Calculating NPV

Compute the NPV of a project that has the following end-of-year cash flow projections: Year 1 = $40,000; Year 2 = $50,000; Year 3 =-$22,000. the project requires an initial investment of $75,000 and has a discount rate of 10%.

-$13,843