Chapter 9
True or false: While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time. a. True b. False
A
What is the basic output of a Monte Carlo simulation? a. A distribution of cash flows for each future year b. A probability of success for each future year c. A single net present value estimate d. A single cash flow for each future year
A
What is the difference between scenario analysis and sensitivity analysis? a. Scenario analysis considers only one scenario while sensitivity analysis focuses on interaction among a group of variables. b. Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time. c. There is no difference between scenario analysis and sensitivity analysis. d. Both scenario and sensitivity analysis focus on examining the impact on NPV if one of the underlying variables changes.
B
Which of the following is an example of a timing option? a. Disposing of a piece of property in an area where development prospects have failed to materialize. b. Building a gas station and waiting to see if that gas station is successful before building additional stations. c. Waiting to build a convenience store in an area where several housing developments have been proposed.
C
Which of the following is not true of NPV? a. It uses all cash flows. b. It uses cash flows rather than profits. c. It ignores time value of money. d. It is a superior capital budgeting technique.
C
Which of the following is the most complex technique for capital budgeting analysis? a. Scenario analysis b. Break-even analysis c. Monte Carlo simulation d. Sensitivity analysis
C
Which of the following represents the accounting profit break-even point? a. Fixed costs/Contribution margin b. Total taxes/Contribution margin c. (Fixed costs + Depreciation)/Contribution margin d. Depreciation/Contribution margin
C
Which costs are included in the numerator of the accounting profit break-even point equation? a. Variable costs b. Sunk costs c. Depreciation d. Fixed costs
C & D
Consider a project that will payoff $2 million if it is successful and nothing if it is not successful. If the probability of success is 20 percent, what is the project's expected payoff? a. $2,000,000 b. $0 c. $400,000 d. $1,000,000
C [(.20x2)+(.80x0)]
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. a. $25,000 b. $13,000 c. $3,000 d. $5,000
D (15,000-10,000)
Calculate the accounting break-even point for a firm that reports the following information: Sales per unit = $40,000; Variable cost per unit = $25,000; Fixed costs (excluding depreciation) = $960,000; Depreciation = $25,000. a. 64 units b. 63.33 units c. 68.31 units d. 65.67 units
D [(960,000+25,000)/(40,000-25,000)]
Which of the following defines the contribution margin? Ignore taxes. a. Contribution Margin = Sales + Interest income b. Contribution Margin = Sales - Fixed costs c. Contribution Margin = Sales - Variable costs d. Contribution Margin = Sales + Capital gains
C
Which of the following is the final step in the Monte Carlo method? a. The Computer Draws One Outcome b. Specify the Basic Model c. Calculate NPV d. Specify a Distribution for Each Variable in the Model
C
Contribution margin refers to the contribution made by each additional unit sold to a. taxes. b. pretax sales. c. dividends. d. aftertax profits.
D
A firm will start generating positive accounting profits a. at the point at which revenues exceed total fixed costs. b. beyond the break-even sales point. c. at the break-even sales point. d. below the break-even sales point.
B
A decision tree involves a. depicting the decision-making process in a firm using an organizational chart. b. mapping a strategy for dealing with the competition. c. mapping the sequential outcomes of various decisions and corresponding probabilities. d. determining the number of decisions that need to be made before a product can be approved.
C
Survey results indicate that the Monte Carlo simulation technique is a. used by about 15 percent of firms. b. not used by any firm. c. used by all firms. d. used by approximately 50 percent of firms.
A
True or false: Many capital budgeting approaches, including NPV, ignores real options. a. True b. False
A
Your manager has developed the following pricing equation: Price = Base price + $2 × Industry sales (in thousands) +/- $5 If the base price is $30 and industry sales are $2,000, the higher price, according to the model, would be a. $20. b. $39 c. $29 d. $69
B [30+(2x2)+5]
Which of the following are true of NPV analysis? Select all that apply a. Opportunity costs are excluded. b. Opportunity costs are included. c. Sunk costs are excluded. d. Side effects are excluded. e. Sunk costs are included. f. Side effects are included.
B, C, & F
An accounting break-even point of 2,000 means the firm a. has total costs (including depreciation) of $2,000. b. will start generating losses if it sells more than 2,000 units. c. will start generating profits if it sells more than 2,000 units. d. will start generating profits if its costs reach $2,000.
C
What is a sunk cost? a. A significant cost that will be incurred at the end of a project's life. b. A cost that created a significant business loss. c. A cost incurred in the past that is irrelevant to the capital investment decision process.
C
The contribution margin per unit will increase if a. the sales price per unit increases while the variable cost per unit decreases. b. fixed costs decrease. c. both the sales price per unit and the variable cost per unit increase. d. the sales price per unit decreases while the variable cost per unit increases.
A
Which of the following addresses real-world uncertainty to the greatest extent? a. Monte Carlo simulation b. Scenario analysis c. Accounting break-even d. Sensitivity analysis
A
Compute the depreciation tax shield based on the following information: Depreciation expense = $40,000; Net profit before depreciation expense = $60,000; Tax rate = 20 percent. a. $8,000 b. $5,000 c. $4,000 d. $12,000
A (.20x40,000)
Compute the depreciation tax shield based on the following information: EAC = $740,000; Fixed costs = $950,000; Depreciation expense = $475,000; Tax rate = 24 percent. a. $114,000 b. $63,600 c. $361,000 d. $291,600
A (.24x475,000)
Which of the following pieces of information are required in order to compute NPV? Select all that apply a. The time horizon of the project. b. The discount rate. c. Projected future cash flows. d. Projected future debt costs.
A, B, & C
A Monte Carlo simulation analyzes a. the impact on NPV under specific scenarios. b. the expected NPV by determining a probability distribution for each variable. c. the sensitivity of NPV to external factors. d. the impact on NPV when one of the underlying variable changes.
B
A firm will start generating positive profits when a. total revenue exceeds the initial investment required to generate that revenue. b. the total number of units sold exceeds the accounting break-even point. c. total revenue exceeds the total fixed costs. d. total variable costs exceed total fixed costs.
B
A probability distribution a. shows the expected range of values associated with any variable, such as labor or materials cost. b. shows the range of distribution for any variable and assigns probabilities to each value identified within that range. c. shows the range of values that lie between the average value and the most optimistic value. d. is based on real outcomes.
B
What are real options? a. The NPV of a capital budgeting project stated in real dollars. b. Adjustments that a firm can make after a project is accepted. c. The NPV of a project under conditions of absolute certainty using the risk-free rate as the discount rate. d. The value of stock options awarded to project managers.
B
What is the purpose of accounting profit break-even analysis? a. To determine the level of sales at which variable costs are fully recovered. b. To determine the level of sales at which profits are equal to zero. c. To determine the level of sales at which profits generate the minimum rate of return expected by shareholders. d. To determine the maximum number of units that can be produced in a plant.
B
Which of the following is true of the Monte Carlo model? Select all that apply a. The basic output for the model is a distribution of cash flow for each past year. b. The basic output for the model is a distribution of cash flow for each future year. c. The basic property of the model is a single outcome. d. The basic property of the model is repeated outcomes.
B & D
A firm has a 40 percent probability of obtaining approval to enter a new regional market. If it enters that market, there is a 30 percent probability of successfully gaining significant market share. What is the probability of successfully entering the regional market? a. 30% b. 12% c. 10% d. 1.2%
B (.40x.30)
Compute the expected total revenues based on the following projections: Market size = 200,000 units; Market share = 7.5 percent; Price per unit = $75. a. $15,000,000 b. $1,125,000 c. $875,000 d. $11,250,000
B (200,000x.075x75)
Which of the following does the accounting break-even point ignore compared to the financial break-even point? a. Depreciation b. Fixed costs c. Sales price less variable costs d. Opportunity cost of initial investment
D
Which of the following can be used to calculate annual costs needed for the first step of the Monte Carlo model? a. Fixed manufacturing costs + Variable manufacturing costs b. Fixed manufacturing costs + Variable manufacturing costs - Marketing and selling costs c. Fixed manufacturing costs + Variable manufacturing costs + Marketing and selling costs + Initial investment d. Fixed manufacturing costs + Variable manufacturing costs + Marketing and selling costs
D
Which of the following is an opportunity cost in the context of a vacant building that a firm currently owns? a. The loss of reputation the firm incurs because it owns a vacant building. b. The cost of maintaining the empty building c. The original cost of the building. d. The rental income lost from owning a vacant building
D
When is a firm most apt to select the option to expand a project? a. When the project is a success. b. When the project outcome is initially unknown. c. When the project is a failure.
A
Which of the following could make purchasing vacant land with no source of revenue a positive business decision? a. A timing option b. A sentimental attachment to the land by the CEO c. Federal regulations will make the land less valuable in the future.
A
Which of the following formulas can be used to determine total revenue for a firm using Monte Carlo simulation? a. Market size × Market share × Price per unit b. Market size × Market share c. Market size × Price per unit d. Market share × Price per unit
A
Which of the following are true of decision trees? Select all that apply a. Decisions are made in reverse order. b. They are a device for identifying sequential decisions in NPV analysis. c. They use non-discounted cash flows to make decisions. d. They ignore preliminary cash outflows.
A & B
Which of the following costs relating to a doctor's office are variable costs? Select all that apply a. Medical supplies b. Lab reports for patients c. Secretary's salary d. Rent for the medical office
A & B
Sensitivity analysis is also known as: Select all that apply a. bop (best, optimistic and pessimistic) analysis. b. profit and loss analysis. c. simulation analysis. d. what-if analysis. e. break-even analysis
A & D
Compute net accounting profit based on the following information: Revenues = $4,000; Variable costs = $1,600; Fixed costs = $700; Depreciation = $300; Tax rate = 20 percent. a. $1,120 b. $1,400 c. $1,360 d. $1,372
A [(4,000-1,600-700-300)x(1-.20)]
Compute the accounting break-even point for a firm reporting the following information: Fixed costs = $50,000; Depreciation = $10,000; Sale price per unit = $50; Variable cost per unit = $30. a. 3,000 units b. 2,000 units c. 1,200 units d. 2,500 units
A [(50,000+10,000)/(50-30)]
Which of the following are steps involved in performing a Monte Carlo simulation? Select all that apply a. Generating outcomes b. Specifying a distribution for each variable in the model c. Calculating NPV d. Drawing the decision tree e. Specifying a model
A, B, C, & E
What is the total number of inputs that change while doing sensitivity analysis? a. 0 b. 1 c. All inputs change
B
Which of the following is an example of an option to abandon? a. Withdrawing an offer to take over a firm b. Stopping production of a product if sales fall below a certain level c. Retaining a project for its planned duration d. Ignoring sunk costs when determining the cash flows of a potential project
B
Which of the following are benefits of performing sensitivity analysis? Select all that apply a. It eliminates all errors in the estimates. b. It can indicate whether NPV analysis should be trusted. c. It shows where more information is needed. d. It prevents making the wrong decision.
B & C
Which of the following are reasons why NPV is considered a superior capital budgeting technique? Select all that apply a. NPV results in only one rate of return. b. NPV considers time value of money. c. NPV considers all the cash flows. d. NPV properly discounts earnings.
B & C
Which of the following are true of the option to abandon? Select all that apply a. It decreases the value of any potential project. b. It increases the value of any potential project. c. Choosing to abandon can often save companies a large amount of money. d. Choosing to abandon is cowardly and should be avoided.
B & C
Which of the following statements are true regarding fixed and variable costs? Select all that apply a. Both the fixed costs per unit and the variable costs per unit will decrease as the level of output increases. b. Total fixed costs remain constant while total variable costs increase if the level of output increases. c. Fixed costs per unit will decrease while variable costs per unit will stay constant if the level of output increases. d. Fixed costs per unit and variable costs per unit will increase if the level of output increases.
B & C
The present value break-even point differs from accounting profit break-even point for the following reasons: Select all that apply a. The present value break-even point ignores taxes. b. The present value break-even point considers the opportunity cost of the initial investment. c. The present value break-even point does not differ from the accounting profit break-even point. d. The present value break-even point adjusts for the depreciation tax shield benefit.
B & D
What are the two main benefits of performing sensitivity analysis? Select all that apply a. It makes it possible to make a correct decision every time. b. It identifies the variable that has the most effect on NPV. c. It is easier to perform than conventional NPV analysis. d. It reduces a false sense of security by giving a range of values instead of a single value.
B & D
A project requires an initial investment of $250,000. There is a 30 percent probability of success with a $1.2 million 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 15 percent? a. -$250,000 b. $63,043 c. $950,000 d. $186,957
B [-250,000+(.30x1,200,000)/1.15]
A project requires an initial investment of $500,000. There is a 20 percent probability of success with a $2 million 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 percent? a. $1.5 million b. -$136,364 c. $363,636 d. -$100,000
B [-500,000+(.20x2,000,000)/1.1]
What is scenario analysis? a. Scenario analysis determines the probability of occurrence of various future events that could affect the project. b. Scenario analysis maps out the various steps involved in the manufacturing process. c. Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario. d. Scenario analysis determines the impact on NPV of a change in a single variable.
C
Which of the following defines the contribution margin? Ignore taxes. a. Contribution Margin = Sales + Capital gains b. Contribution Margin = Sales - Fixed costs c. Contribution Margin = Sales - Variable costs d. Contribution Margin = Sales + Interest income
C
Which one of the following is an example of a situation in which sensitivity analysis increases the false sense of security among managers? a. All optimistic estimates of NPV are negative. b. All pessimistic estimates of NPV are negative. c. All pessimistic estimates of NPV are positive. d. All optimistic estimates of NPV are positive.
C
What are the two main drawbacks of sensitivity analysis? a. It considers the effects of interactions among variables. b. It is easy to compute. c. It does not consider interaction among variables. d. It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive.
C & D
You are in the business of manufacturing watches. The estimated variable costs for each of these watches costs is $25. Fixed costs for the month are $8,000. What will be the total monthly costs if you manufacture 400 watches? a. $10,000 b. $2,000 c. $18,000 d. $8,000
C [(25x400)+8,000]
A contribution margin of $35 means that a. each additional sale will add $35 to the total revenues. b. the firm has to generate $35 in sales to reach the accounting break-even point. c. the firm generates a net profit of $35 on each unit sold. d. each sale of an additional unit will contribute $35 to the profit.
D
In the context of capital budgeting, what does sensitivity analysis do? a. It examines the increase in the cost of a project when the cost of capital increases. b. It examines the sensitivity of profits to changes in market share. c. It examines the sensitivity of management to the possibility that a project will be rejected. d. It examines how sensitive a particular NPV calculation is to changes in underlying assumptions.
D
Which of the following statements is true in the context of comparing accounting profit and present value break-even points? a. Accounting profit is superior because the financial statements report profits and not present value. b. The superiority of a particular technique will vary from firm to firm depending on the unique circumstances of the firm. c. Both techniques are equally good. d. Present value is superior to accounting profit because it considers the opportunity cost of the initial investment.
D