Capital Budgeting And Risk

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Question 1
Free
Multiple Choice

The discount rate used in calculating the certainty equivalent net present value is the

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A

risk-adjusted discount rate

B

cost of capital

C

risk-free rate

D

cost of equity capital

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Question 2
Free
Multiple Choice

The certainty equivalent factors used to adjust the cash flows for risk can range from

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A

-1 to + 1

B

0 to infinity

C

+.01 to + .99

D

0 to + 1.0

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Question 3
Free
Multiple Choice

The basic capital budgeting decision models, that is, NPV and IRR, handle risk by

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A

ignoring it

B

assuming all cash flows are known with certainty

C

assuming all projects are of average risk and evaluating them based on expected values

D

using risk-adjusted discount rates to evaluate projects

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Question 4
Free
Multiple Choice

All of the following are advantages of the NPV-payback approach to risk analysis except

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A

it is easy and inexpensive to apply

B

it considers a project's liquidity

C

it explicitly considers the variability of a project's return

D

it is consistent with the notion that risk increases with futurity

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Question 5
Free
Multiple Choice

The subjective approach to determining risk-adjusted discount rates

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A

uses the risk-free rate for average-risk projects

B

explicitly considers the probability distribution of a project's cash flows

C

always leads to the correct investment decisions

D

groups projects into risk classes and evaluates all projects in a particular risk class at the same risk- adjusted discount rate

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Question 6
Multiple Choice

Simulation techniques are

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A
cheap to apply
B
widely used
C
mostly beneficial for large projects
D
identical to sensitivity analysis
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Question 7
Multiple Choice

The use of sensitivity analysis requires that

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A
a model of a project's cash flows be developed
B
probability distributions of the determinants of a project's cash flows be estimated
C
the firms have access to a very large computer
D
the firm is greatly interested in the portfolio risk reduction characteristics of a project
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Question 8
Multiple Choice

Project C has been classified into risk class II by the analyst of a major firm. The risk premium required for projects in this risk class is 8%. The current risk-free rate measured by the analyst is 10%. If the project has an estimated return of 20%, the analyst would recommend

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A
accepting project C
B
rejecting project C
C
reestimating the risk premiums for class II projects
D
none of the above
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Question 9
Multiple Choice

Total project risk is

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A
the contribution a project makes to the risk of the firm
B
measured by the correlation coefficient
C
the chance that a project will perform different from expectations
D
measured by the project's beta
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Question 10
Multiple Choice

A firm's leveraged beta will always be ____ its unleveraged beta.

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A
less than
B
greater than
C
the same as
D
could be all of the above
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Question 11
Multiple Choice

The ____ the amount of debt in a firm's capital structure, the ____ will be the firm's beta.

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A
larger, larger
B
smaller, larger
C
larger, smaller
D
smaller, smaller
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Question 12
Multiple Choice

The risk-adjusted discount rate approach is preferable to the weighted cost of capital approach when

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A
all projects have the same risk characteristics
B
the risk-free rate is known with certainty
C
the projects under consideration have different risk characteristics
D
the firm is unlevered
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Question 13
Multiple Choice

A major problem with using the risk-adjusted discount rate approach is the determination of

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A
the beta value for the firm
B
the firm's weighted cost of capital
C
the firm's required rate of return
D
beta values for individual projects
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Question 14
Multiple Choice

Which of the following techniques can be used to analyze total project risk?

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A
net present value/payback approach
B
risk-adjusted discount rate approach
C
simulation analysis
D
all of the above
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Question 15
Multiple Choice

The net present value/payback approach is a useful approach when

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A
screening projects characterized by rapid technological advances
B
cash flow estimates are known with certainty
C
the more risky cash flows occur during the startup period
D
None of the above
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Question 16
Multiple Choice

In a simulation analysis, a model is simulated on a computer program and run through several iterations. The results of these iterations are used to

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A
plot a required rate of return value profile
B
compute a mean and a standard deviation of returns
C
provide the decision maker with a measure of beta risk
D
plot the coefficient of variation of the annual net cash flows
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Question 17
Multiple Choice

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.

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A
probability
B
return distribution
C
net present value
D
standard deviation
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Question 18
Multiple Choice

When analyzing a sensitivity curve, the ____ the slope, the more sensitive the net present value is to a change in the computed variable.

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A
more negative
B
steeper
C
more general
D
smaller
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Question 19
Multiple Choice

A major disadvantage of the risk-adjusted discount rate approach is that it

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A
can lead to selecting only above-average risk projects
B
provides the decision maker with a range of numbers
C
can lead to selecting only below-average risk projects
D
is difficult to estimate the appropriate risk premium for a project
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Question 20
Multiple Choice

The certainty equivalent approach adjusts the ____ for risk in the ____ of the net present value equation.

Choose correct answer/s
A
net cash flows, numerator
B
risk-free rate, numerator
C
required return, numerator
D
net cash flows, denominator
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