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5. Methods of analyzing risk for capital budgeting decisions Aa Aa E Several types of analyses are available for evaluating a project's risk. In the
5. Methods of analyzing risk for capital budgeting decisions Aa Aa E Several types of analyses are available for evaluating a project's risk. In the following table, correctly identify the analysis being described. Scenario Sensitivity Simulation Analysis Analysis Analysis Requires changes in one assumption at a time to observe the impact on NPV Estimates the NPV after a given period of time, assuming specific changes in the values of multiple key factors that could affect a project's NPV Uses an algorithmic method to pick values randomly from probability distributions to calculate a project's NPV Consider the following case: Coppinger Corp. is evaluating a new project. Coppinger used the expected values of unit sales, price per unit, and variable cost per unit to calculate an expected NPV of $13,500. Coppinger has developed a few different possible cases of what demand and costs might look like for the new project, which are summarized in this table: Base case Worst case Best case Unit Sales 120,000 70,000 150,000 Price per Variable Cost Unit per Unit $6.00 $4.25 $5.50 $5.25 $6.50 $3.80 NPV $13,500 -$22,600 $31,200 What kind of risk analysis is Coppinger using? Scenario analysis Sensitivity analysis Simulation analysis Suppose Coppinger Corp. is evaluating a new capital budgeting project and conducting some basic risk analysis. First, it calculates the project's NPV at various levels for the project's key input variables. Coppinger next calculates the project's NPV at various prices per unit, plots the results on the accompanying graph, and then repeats this process separately for variable cost per unit and required return. This process is a , whose results are shown on the graph. NPV (Millions of $1 200 Price per Unit Required Return Variable Cost per Unit -200 -20 -12 -4 12 20 DEVIATION (%) According to this analysis, which variable is the key value At the current input-value estimates, does this project driver for the project? have a positive or negative NPV? O Price per unit Negative NPV Variable cost per unit Positive NPV Required return Decision trees are a visual representation of the sequential choices that financial decision makers face when making capital budgeting and investment decisions. True or False: In decision tree analysis, risk varies as you move through the decision tree
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