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For any investment decision, it is important for financial managers to evaluate risk. There are several tools and techniques available to help financial decision makers
For any investment decision, it is important for financial managers to evaluate risk. There are several tools and techniques available to help financial decision makers evaluate project risk. Some managers use the combined net present value/payback (NPV/PB) approach. In this approach, the managers might decide to ___ a project unless it has a positive net present value and a payback of ___ than a certain stated number of years. Since a cutoff point in the payback period is used as a criterion in the NPV/PB approach, managers consider the approach to be extremely useful in: Projects in the high-tech sector Projects in politically stable countries Since there are limitations to the NPV/PB approach, managers use different techniques to evaluate project risk. For larger projects, managers use simulation analysis. Although very expensive, simulation analysis helps financial managers evaluate project risk-that is, the probability of project success or failure based on company benchmarks. Suppose you are evaluating the risk of two major investment projects for your firm. After ail preliminary calculations and simulation iterations, you create a probability distribution and collect the mean values for the two projects. You also have some data on the number of standard deviations (z), which tells you how far away a particular value of return or cash flow is from the expected value. Suppose you were using the coefficient of variation criterion to make a decision. Which project seems riskier based on this criterion? Project Y Project X Suppose you were using the standard deviation criterion to make a decision. Which project seems riskier based on this criterion? Project X Project Y Based on your simulation results, what is the probability that project Y will have a net present value of greater than $36, 800? 30.50% 2.28% 29.12% 7.49%
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