PRACTICE

QUESTION 1

A ____ is a course of action that can be made available, usually at a cost, which improves financial results under certain conditions.

	a.	risk-adjusted option
	b.	probability distribution
	c.	real option
	d.	decision tree

5 points

QUESTION 2

A company's cost of capital is the most appropriate discount rate to use when analyzing which type of project(s)?

	a.	Expansion and new venture projects
	b.	Replacement and expansion projects
	c.	Expansion projects
	d.	Replacement projects
	e.	New venture projects

5 points

QUESTION 3

Decision tree analysis:

	a.	provides a relatively quick and easy way to get a rough idea of the probability distribution of NPV outcomes in a capital budgeting project.
	b.	may prompt management to reject a project with a positive NPV (point estimate).
	c.	does not apply to IRR analysis.
	d.	a and b are both correct.

5 points

QUESTION 4

In theory, the risk-free rate is more appropriate for the NPV calculation in the certainty equivalent approach since:

	a.	certainty equivalent factors cannot take negative values.
	b.	certainty equivalents imply zero risk.
	c.	it is assumed that there is no business-specific risk associated with the projects.
	d.	certainty equivalents consider unsystematic risk only.

5 points

QUESTION 5

Scenario/sensitivity analysis is a procedure that can be used in the capital budgeting process to indicate how sensitive the ____ is to changes in a particular variable.

	a.	probability
	b.	return distribution
	c.	net present value
	d.	standard deviation

5 points

QUESTION 6

The ____ makes risky projects less acceptable by simply lowering the cash flow estimates themselves.

	a.	overlay approach
	b.	accounting beta method
	c.	pure play method
	d.	certainty equivalent approach

5 points

QUESTION 7

The NPV and IRR of any capital budgeting project are random variables with means that represent their most likely values and variances that reflect:

	a.	variations in profit.
	b.	value inconsistencies.
	c.	risk.
	d.	unstable expectancies.

5 points

QUESTION 8

The Monte Carlo simulation:

	a.	is a computer simulation which calculates NPV based on random observations for each of a project's cash flows.
	b.	Is an approach that involves the use of numbers drawn randomly from probability distributions.
	c.	All of the above
	d.	Involves making assumptions that specify the shapes of the probability distributions for each future cash flow in a capital budgeting project.

5 points

QUESTION 9

A _____________________ is a graphic representation of a business project in which multiple events can have multiple outcomes.

	a.	Decision Tree
	b.	Probability distribution
	c.	Simulation
	d.	Timeline

5 points

QUESTION 10

In capital budgeting:

	a.	Projects are thought to be incremental to the normal business of the firm.
	b.	All of the above.
	c.	Risk is important and should be included in the analysis but often isn't.
	d.	If a firm accepts projects without regard for risk, then the company can change its overall risk profile firm as perceived by investors.