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Chapter 10
Project Analysis
10-1
Chapter 10 - Project Analysis
5. You are given the following data for year-1. Revenue = $43; Total costs = $30;
Depreciation = $3; Tax rate = 30%. Calculate the operating cash flow for the project for year-
1.
A. $7
B. $10
C. $13
D. None of the above
6. A project has an initial investment of 100. You have come up with the following estimates
of the projects with cash flows.
If the cash flows are perpetuities and the cost of capital is 10%. What does a sensitivity
analysis of NPV (no taxes) show?
A. -50, 20, +100
B. -100, -50, +80
C. -50, +50, +70
D. None of the above
7. You are given the following data for year-1: Revenues = 100, Fixed costs = 30; Total
variable costs = 50; Depreciation = $10; Tax rate = 30%. Calculate the after tax cash flow for
the project for year-1.
A. $17
B. $7
C. $10
D. None of the above
10-2
Chapter 10 - Project Analysis
9. You have come up with the following estimates of project cash flows:
The cash flows are perpetuities and the cost of capital is 8%. What does a sensitivity analysis
of NPV (without taxes) show?
A. 25, +232.50, +440
B. -100, +500, +800
C. -90, -55, -20
D. None of the above
10. A project has an initial investment of $150. You have come up with the following
estimates of revenues and costs. Calculate the NPV assuming that cash flow and perpetuities.
(No taxes.) (Cost of capital = 10%)
10-3
Chapter 10 - Project Analysis
11. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. Cash flows from the project are:
A. CF0: -90,000; CF1: 12,600; CF2: 12,600; CF3: 29,600
B. CF0: -100,000; CF1: 42,600; CF2: 42,600; CF3: 59,600
C. CF0: -100,000; CF1: 42,600; CF2: 42,600; CF3: 42,600
D. none of the above
12. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. Calculate the NPV of the project:
A. 3840
B. 8443
C. -2735
D. None of the above
13. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 12%. Calculate the NPV of the project:
A. 14,418
B. 8443
C. -2735
D. None of the above
10-4
Chapter 10 - Project Analysis
14. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. What would the NPV of the project be if the revenues were higher by
10% and the costs were 65% of the revenues?
A. $8443
B. $964
C. $5566
D. None of the above
15. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. What would the NPV if the discount rate were higher by 10%?
A. $5648
B. $3840
C. -$2735
D. None of the above
17. Which of the following statements most appropriately describes "Scenario Analysis".
A. it looks at the project by changing one variable at a time
B. it provides the break-even level of sales for the project
C. it looks at different but consistent combination of variables
D. each of the above statements describes "Scenario Analysis" correctly
10-5
Chapter 10 - Project Analysis
18. Financial Calculator Company proposes to invest $12 million in a new calculator making
plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to
manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of
capital is 20%, what is the break-even level (i.e. NPV = 0) of annual rates?
(Approximately)(Assume no taxes.)
A. 150,000 units
B. 342,290 units
C. 381,777 units
D. None of the above
19. Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed
costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for
$20/unit. If the plant lasts for 3 years and the cost of capital is12%, what is the approximate
break-even level (i.e. NPV = 0) of annual sales? (Assume no taxes.)(approximately)
A. $133,333 units
B. $272,117 units
C. $227,533 units
D. None of the above
20. Firms often calculate a project's break-even sales using book earnings. Generally, break-
even sales based on NPV is:
A. Higher than the one calculated using book earnings
B. Lower than the one calculated using book earnings
C. Equal to the one calculated using book earnings
D. None of the above
10-6
Chapter 10 - Project Analysis
23. Financial Calculator Company proposes to invest $12 million in a new calculator making
plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to
manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of
capital is 20%, what is the accounting break-even level? (Approximately)(Assume no taxes.)
A. 300,000 units
B. 150,000 units
C. 381,777 units
D. None of the above
24. Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed
costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for
$20/unit. If the plant lasts for 3 years and the cost of capital is 12%, what is the approximate
break-even level (accounting) of annual sales? (Assume no taxes.)(approximately)
A. $133,334 units
B. $272,117 units
C. $244,444 units
D. None of the above
25. Taj Mahal Tour Company proposes to invest $3 million in a new tour package project.
Fixed costs are $1 million per year. The tour package costs $500 and can be sold at $1500 per
package to tourists. This tour package is expected to be attractive for the next five years. If the
cost of capital is 20%, what is the NPV break-even number of tourists per year? (Ignore taxes,
give an approximate answer)
A. 1000
B. 2000
C. 15000
D. None of the above
10-7
Chapter 10 - Project Analysis
10-8
Chapter 10 - Project Analysis
29. Project analysis, in addition to NPV analysis, includes the following procedures:
I) Sensitivity analysis
II) Break-even analysis
III) Monte Carlo simulation
IV) Scenario Analysis
A. I only
B. I and II only
C. I, II, and III only
D. I, II, III, and IV
32. After the completion of project analysis, the final decision on the project would be from:
A. Sensitivity analysis
B. Break-even analysis
C. Decision trees
D. NPV
10-9
Chapter 10 - Project Analysis
33. Which of the following simulation outputs is likely to be most useful and easy to
interpret? The output shows the distribution(s) of the project:
A. Earnings
B. Internal rate of return
C. Cash flows
D. Profits
34. Generally, the simulation models for projects are developed using a:
A. Pair of dice
B. Roulette wheel
C. Computer
D. Pack of cards
36. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction
of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price
of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per
year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore
taxes). Calculate the NPV to invest today.
A. +10,000,000
B. +6,000,000
C. +4,000,000
D. none of the above
10-10
Chapter 10 - Project Analysis
37. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction
of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price
of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per
year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore
taxes). Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year and then
expected NPV of the project if postponed by one year is:
A. +10,000,000
B. +25,000,000
C. +5,000,000
D. none of the above
39. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction
of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price
of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per
year forever. The risk-free rate is 10% per year which is also the cost of capital (Ignore taxes).
Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year. If the project if
postponed by one year, calculate the value of the option to wait for one year: (approximately)
A. +15,000,000
B. +40,000,000
C. +10,000,000
D. none of the above
10-11
Chapter 10 - Project Analysis
42. You are planning to produce a new action figure called "Hillary". However, you are very
uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50
million per year for 3 years (starting next year). If it fails, you will only have net cash flows of
$10 million per year for 2 years (starting next year). There is an equal chance that it will be a
hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the
first year's cash flows are in. You have to spend $80 million immediately for equipment and
the rights to produce the figure. If the discount rate is 10%, calculate the NPV without the
abandonment option.
A. -9.15
B. +13.99
C. +9.15
D. -14.4
43. You are planning to produce a new action figure called "Hillary". However, you are very
uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50
million per year for 3 years (starting next year). If it fails, you will only have net cash flows of
$10 million per year for 2 years (starting next year). There is an equal chance that it will be a
hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the
first year's cash flows are in. You have to spend $80 million immediately for equipment and
the rights to produce the figure. If you can sell your equipment for $60 million once the first
year's cash flows are received, calculate the NPV with the abandonment option. (The discount
rate is 10%)
A. -9.1
B. +9.1
C. +13.99
D. -14.4
10-12
Chapter 10 - Project Analysis
44. You are planning to produce a new action figure called "Hillary". However, you are very
uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50
million per year for 3 years (starting next year). If it fails, you will only have net cash flows of
$10 million per year for 2 years (starting next year). There is an equal chance that it will be a
hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the
first year's cash flows are in. You have to spend $80 million immediately for equipment and
the rights to produce the figure. If you can sell your equipment for $60 million once the first
year's cash flows are received, calculate the value of the abandonment option. (The discount
rate is 10%)
A. -9.15
B. +13.99
C. +23.14
D. None of the above
45. The following options associated with a project increases managerial flexibility:
I) Option to expand
II) Option to abandon
III) Production options
IV) Timing options
A. I only
B. II only
C. I, II, III, and IV
D. IV only
46. Given the following net future values for harvesting trees (one time harvest):
10-13
Chapter 10 - Project Analysis
47. The Consumer- Mart Company is going to introduce a new consumer product. If brought
to market without research about consumer tastes the firm believes that there is a 60% chance
that the product will be successful. If successful, the project has a NPV = $500,000. If the
product is a failure (40%) and withdrawn from the market, then NPV = -$100,000. A
consumer survey will cost $60,000 and delay the introduction by one year. If the survey is
successful, then there is an 80% chance of consumer acceptance, in which case the NPV =
$500,000. If, on the other hand the survey is a failure, then NPV = -$100,000. The discount
rate is 10%. By how much does the marketing survey change the expected net present value
of the project? (approximately)
A. Increase the NPV by $25,455
B. decrease the NPV by $5950
C. decrease the NPV by $8955
D. decrease the NPV by $25,455
48. KMW Inc. sells a finance textbook for $150 each. The variable cost per book is $30 and
the fixed cost per year is $30,000. The process of creating a textbook costs $150,000 and the
average book has a life span of 3 years. Using straight line depreciation and a tax rate of 25%,
what is the economic or present value break even number of books that must be sold given a
discount rate of 12%?
A. 582
B. 667
C. 805
D. 953
49. KMW Inc. sells a finance textbook for $150 each. The variable cost per book is $30 and
the fixed cost per year is $30,000. The process of creating a textbook costs $150,000 and the
average book has a life span of 3 years. Using straight line depreciation and a tax rate of 25%,
What is the accounting break even number of books that must be sold?
A. 582
B. 667
C. 805
D. 953
10-14
Chapter 10 - Project Analysis
51. Most firms keep track of the progress of projects by conducting postaudits shortly after
the projects have begun to operate.
True False
52. Projects with high fixed costs have lower break-even points.
True False
53. The break-even point in terms of NPV is usually lower than the break-even point on an
accounting basis.
True False
54. Firms that use break-even on an accounting basis are really losing the opportunity cost of
capital on their investments.
True False
55. Monte Carlo simulation is a tool for considering all possible combinations of variables.
True False
56. In constructing a simulation model of an investment project, one can ignore possible
interdependencies between variables.
True False
57. Monte Carlo simulation should be used to get the distribution of NPV values for a
project.
True False
10-15
Chapter 10 - Project Analysis
58. Tangible assets usually have higher abandonment value than intangible ones.
True False
59. Abandonment option is a call option, while the option to expand is a put option.
True False
60. In drawing a decision tree, a square represents a decision point, and a triangle represents a
decision point for fate.
True False
62. In almost al cases the present value break even quantity is higher than the accounting
break even quantity.
True False
64. Indicate some of the problems associated with capital investment process.
10-16
Chapter 10 - Project Analysis
67. How do managers supplement the NPV analysis of a project to gain better understanding
of a project?
10-17
Chapter 10 - Project Analysis
69. Briefly discuss the usefulness of Monte Carlo simulation in project analysis.
71. Briefly discuss various real options associated with capital budgeting projects.
10-18
Chapter 10 - Project Analysis
75. Why is sensitivity analysis less realistic than Monte Carlo Simulation?
10-19
Chapter 10 - Project Analysis
Type: Medium
Type: Difficult
Type: Medium
10-20
Chapter 10 - Project Analysis
Type: Difficult
5. You are given the following data for year-1. Revenue = $43; Total costs = $30;
Depreciation = $3; Tax rate = 30%. Calculate the operating cash flow for the project for year-
1.
A. $7
B. $10
C. $13
D. None of the above
Type: Difficult
10-21
Chapter 10 - Project Analysis
6. A project has an initial investment of 100. You have come up with the following estimates
of the projects with cash flows.
If the cash flows are perpetuities and the cost of capital is 10%. What does a sensitivity
analysis of NPV (no taxes) show?
A. -50, 20, +100
B. -100, -50, +80
C. -50, +50, +70
D. None of the above
Pessimistic NPV = [(15 - 10)/0.1] - 100 = -50 Most Likely NPV = [(20 - 8)/0.1] 100 = +20
Optimistic NPV = [(25 - 5)/0.1] 100 = +100
Type: Medium
7. You are given the following data for year-1: Revenues = 100, Fixed costs = 30; Total
variable costs = 50; Depreciation = $10; Tax rate = 30%. Calculate the after tax cash flow for
the project for year-1.
A. $17
B. $7
C. $10
D. None of the above
Type: Difficult
10-22
Chapter 10 - Project Analysis
Type: Difficult
9. You have come up with the following estimates of project cash flows:
The cash flows are perpetuities and the cost of capital is 8%. What does a sensitivity analysis
of NPV (without taxes) show?
A. 25, +232.50, +440
B. -100, +500, +800
C. -90, -55, -20
D. None of the above
Type: Medium
10-23
Chapter 10 - Project Analysis
10. A project has an initial investment of $150. You have come up with the following
estimates of revenues and costs. Calculate the NPV assuming that cash flow and perpetuities.
(No taxes.) (Cost of capital = 10%)
Type: Difficult
11. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. Cash flows from the project are:
A. CF0: -90,000; CF1: 12,600; CF2: 12,600; CF3: 29,600
B. CF0: -100,000; CF1: 42,600; CF2: 42,600; CF3: 59,600
C. CF0: -100,000; CF1: 42,600; CF2: 42,600; CF3: 42,600
D. none of the above
Type: Difficult
10-24
Chapter 10 - Project Analysis
12. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. Calculate the NPV of the project:
A. 3840
B. 8443
C. -2735
D. None of the above
Type: Difficult
13. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 12%. Calculate the NPV of the project:
A. 14,418
B. 8443
C. -2735
D. None of the above
Type: Difficult
10-25
Chapter 10 - Project Analysis
14. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. What would the NPV of the project be if the revenues were higher by
10% and the costs were 65% of the revenues?
A. $8443
B. $964
C. $5566
D. None of the above
Type: Difficult
15. A project requires an initial investment in equipment of $90,000 and then requires an
investment in working capital of $10,000 at the beginning (t = 0). The project is expected to
produce sales revenues of $120,000 for three years. Manufacturing costs are estimated to be
60% of the revenues. The assets are depreciated using straight-line depreciation. At the end of
the project, the firm can sell the equipment for $10,000. The corporate tax rate is 30% and the
cost of capital is 15%. What would the NPV if the discount rate were higher by 10%?
A. $5648
B. $3840
C. -$2735
D. None of the above
Type: Difficult
10-26
Chapter 10 - Project Analysis
Type: Medium
17. Which of the following statements most appropriately describes "Scenario Analysis".
A. it looks at the project by changing one variable at a time
B. it provides the break-even level of sales for the project
C. it looks at different but consistent combination of variables
D. each of the above statements describes "Scenario Analysis" correctly
Type: Easy
18. Financial Calculator Company proposes to invest $12 million in a new calculator making
plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to
manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of
capital is 20%, what is the break-even level (i.e. NPV = 0) of annual rates?
(Approximately)(Assume no taxes.)
A. 150,000 units
B. 342,290 units
C. 381,777 units
D. None of the above
Type: Difficult
10-27
Chapter 10 - Project Analysis
19. Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed
costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for
$20/unit. If the plant lasts for 3 years and the cost of capital is12%, what is the approximate
break-even level (i.e. NPV = 0) of annual sales? (Assume no taxes.)(approximately)
A. $133,333 units
B. $272,117 units
C. $227,533 units
D. None of the above
Type: Difficult
20. Firms often calculate a project's break-even sales using book earnings. Generally, break-
even sales based on NPV is:
A. Higher than the one calculated using book earnings
B. Lower than the one calculated using book earnings
C. Equal to the one calculated using book earnings
D. None of the above
Type: Difficult
Type: Medium
10-28
Chapter 10 - Project Analysis
Type: Medium
23. Financial Calculator Company proposes to invest $12 million in a new calculator making
plant. Fixed costs are $3 million a year. A financial calculator costs $10 per unit to
manufacture and can be sold for $30 per unit. If the plant lasts for 4 years and the cost of
capital is 20%, what is the accounting break-even level? (Approximately)(Assume no taxes.)
A. 300,000 units
B. 150,000 units
C. 381,777 units
D. None of the above
Type: Difficult
24. Calculator Company proposes to invest $5 million in a new calculator making plant. Fixed
costs are $2 million a year. A calculator costs $5/unit to manufacture and can be sold for
$20/unit. If the plant lasts for 3 years and the cost of capital is 12%, what is the approximate
break-even level (accounting) of annual sales? (Assume no taxes.)(approximately)
A. $133,334 units
B. $272,117 units
C. $244,444 units
D. None of the above
Type: Difficult
10-29
Chapter 10 - Project Analysis
25. Taj Mahal Tour Company proposes to invest $3 million in a new tour package project.
Fixed costs are $1 million per year. The tour package costs $500 and can be sold at $1500 per
package to tourists. This tour package is expected to be attractive for the next five years. If the
cost of capital is 20%, what is the NPV break-even number of tourists per year? (Ignore taxes,
give an approximate answer)
A. 1000
B. 2000
C. 15000
D. None of the above
Type: Difficult
Type: Difficult
10-30
Chapter 10 - Project Analysis
Type: Difficult
Type: Medium
29. Project analysis, in addition to NPV analysis, includes the following procedures:
I) Sensitivity analysis
II) Break-even analysis
III) Monte Carlo simulation
IV) Scenario Analysis
A. I only
B. I and II only
C. I, II, and III only
D. I, II, III, and IV
Type: Easy
10-31
Chapter 10 - Project Analysis
Type: Easy
Type: Medium
32. After the completion of project analysis, the final decision on the project would be from:
A. Sensitivity analysis
B. Break-even analysis
C. Decision trees
D. NPV
Type: Difficult
10-32
Chapter 10 - Project Analysis
33. Which of the following simulation outputs is likely to be most useful and easy to
interpret? The output shows the distribution(s) of the project:
A. Earnings
B. Internal rate of return
C. Cash flows
D. Profits
Type: Medium
34. Generally, the simulation models for projects are developed using a:
A. Pair of dice
B. Roulette wheel
C. Computer
D. Pack of cards
Type: Easy
Type: Easy
10-33
Chapter 10 - Project Analysis
36. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction
of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price
of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per
year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore
taxes). Calculate the NPV to invest today.
A. +10,000,000
B. +6,000,000
C. +4,000,000
D. none of the above
Type: Difficult
37. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction
of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price
of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per
year forever. The risk-free rate is 10% per year, which is also the cost of capital (Ignore
taxes). Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year and then
expected NPV of the project if postponed by one year is:
A. +10,000,000
B. +25,000,000
C. +5,000,000
D. none of the above
Type: Difficult
10-34
Chapter 10 - Project Analysis
Type: Medium
39. Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction
of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price
of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per
year forever. The risk-free rate is 10% per year which is also the cost of capital (Ignore taxes).
Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year. If the project if
postponed by one year, calculate the value of the option to wait for one year: (approximately)
A. +15,000,000
B. +40,000,000
C. +10,000,000
D. none of the above
Type: Difficult
Type: Medium
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Chapter 10 - Project Analysis
Type: Medium
42. You are planning to produce a new action figure called "Hillary". However, you are very
uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50
million per year for 3 years (starting next year). If it fails, you will only have net cash flows of
$10 million per year for 2 years (starting next year). There is an equal chance that it will be a
hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the
first year's cash flows are in. You have to spend $80 million immediately for equipment and
the rights to produce the figure. If the discount rate is 10%, calculate the NPV without the
abandonment option.
A. -9.15
B. +13.99
C. +9.15
D. -14.4
Type: Difficult
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Chapter 10 - Project Analysis
43. You are planning to produce a new action figure called "Hillary". However, you are very
uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50
million per year for 3 years (starting next year). If it fails, you will only have net cash flows of
$10 million per year for 2 years (starting next year). There is an equal chance that it will be a
hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the
first year's cash flows are in. You have to spend $80 million immediately for equipment and
the rights to produce the figure. If you can sell your equipment for $60 million once the first
year's cash flows are received, calculate the NPV with the abandonment option. (The discount
rate is 10%)
A. -9.1
B. +9.1
C. +13.99
D. -14.4
Type: Difficult
44. You are planning to produce a new action figure called "Hillary". However, you are very
uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50
million per year for 3 years (starting next year). If it fails, you will only have net cash flows of
$10 million per year for 2 years (starting next year). There is an equal chance that it will be a
hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the
first year's cash flows are in. You have to spend $80 million immediately for equipment and
the rights to produce the figure. If you can sell your equipment for $60 million once the first
year's cash flows are received, calculate the value of the abandonment option. (The discount
rate is 10%)
A. -9.15
B. +13.99
C. +23.14
D. None of the above
Value of the abandonment option = NPV (with the option) - NPV (without the option) =
13.99 - (-9.15) = 23.14
Type: Difficult
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Chapter 10 - Project Analysis
45. The following options associated with a project increases managerial flexibility:
I) Option to expand
II) Option to abandon
III) Production options
IV) Timing options
A. I only
B. II only
C. I, II, III, and IV
D. IV only
Type: Medium
46. (p. 300) Given the following net future values for harvesting trees (one time harvest):
Type: Difficult
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Chapter 10 - Project Analysis
47. The Consumer- Mart Company is going to introduce a new consumer product. If brought
to market without research about consumer tastes the firm believes that there is a 60% chance
that the product will be successful. If successful, the project has a NPV = $500,000. If the
product is a failure (40%) and withdrawn from the market, then NPV = -$100,000. A
consumer survey will cost $60,000 and delay the introduction by one year. If the survey is
successful, then there is an 80% chance of consumer acceptance, in which case the NPV =
$500,000. If, on the other hand the survey is a failure, then NPV = -$100,000. The discount
rate is 10%. By how much does the marketing survey change the expected net present value
of the project? (approximately)
A. Increase the NPV by $25,455
B. decrease the NPV by $5950
C. decrease the NPV by $8955
D. decrease the NPV by $25,455
Type: Difficult
48. KMW Inc. sells a finance textbook for $150 each. The variable cost per book is $30 and
the fixed cost per year is $30,000. The process of creating a textbook costs $150,000 and the
average book has a life span of 3 years. Using straight line depreciation and a tax rate of 25%,
what is the economic or present value break even number of books that must be sold given a
discount rate of 12%?
A. 582
B. 667
C. 805
D. 953
Type: Difficult
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Chapter 10 - Project Analysis
49. KMW Inc. sells a finance textbook for $150 each. The variable cost per book is $30 and
the fixed cost per year is $30,000. The process of creating a textbook costs $150,000 and the
average book has a life span of 3 years. Using straight line depreciation and a tax rate of 25%,
What is the accounting break even number of books that must be sold?
A. 582
B. 667
C. 805
D. 953
Type: Difficult
Type: Easy
51. Most firms keep track of the progress of projects by conducting postaudits shortly after
the projects have begun to operate.
TRUE
Type: Easy
52. Projects with high fixed costs have lower break-even points.
FALSE
Type: Medium
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Chapter 10 - Project Analysis
53. The break-even point in terms of NPV is usually lower than the break-even point on an
accounting basis.
FALSE
Type: Medium
54. Firms that use break-even on an accounting basis are really losing the opportunity cost of
capital on their investments.
TRUE
Type: Medium
55. Monte Carlo simulation is a tool for considering all possible combinations of variables.
TRUE
Type: Medium
56. In constructing a simulation model of an investment project, one can ignore possible
interdependencies between variables.
FALSE
Type: Medium
57. Monte Carlo simulation should be used to get the distribution of NPV values for a
project.
FALSE
Type: Medium
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Chapter 10 - Project Analysis
58. Tangible assets usually have higher abandonment value than intangible ones.
TRUE
Type: Medium
59. Abandonment option is a call option, while the option to expand is a put option.
FALSE
Type: Medium
60. In drawing a decision tree, a square represents a decision point, and a triangle represents a
decision point for fate.
FALSE
Type: Medium
Type: Medium
62. In almost al cases the present value break even quantity is higher than the accounting
break even quantity.
TRUE
Type: Medium
Type: Medium
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Chapter 10 - Project Analysis
64. Indicate some of the problems associated with capital investment process.
There are several problems associated with capital budgeting. They are establishing consistent
forecasts, forecast bias, getting senior management timely and relevant information, and
conflict of interest.
Type: Medium
Post audits are important for several reasons: They identify problems in the capital budgeting
process that needs fixing; they provide a check on the accuracy of the cash flow forecasts;
they raise questions that are relevant for future projects.
Type: Medium
Using sensitivity analysis one can analyze the factors, which might have a large impact on the
project cash flows. For some projects, say, labor costs might have a large impact on the cash
flows. That means that small changes in labor costs will cause a large change in the cash
flows of the project. This helps the financial manager and the project manager to focus on a
few key variables and take corrective actions wherever possible. One drawback of sensitivity
analysis is that it always gives ambiguous results.
Type: Medium
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Chapter 10 - Project Analysis
67. How do managers supplement the NPV analysis of a project to gain better understanding
of a project?
Generally managers supplement the NPV analysis of a project through project analysis to get
a better insight into the project. Project analysis includes sensitivity analysis, break-even
analysis, Monte Carlo simulation and decision trees. The final decision should always be
made from NPV analysis.
Type: Medium
Break-even analysis provides the minimum level of sales or output above which a project has
positive net present value. Managers frequently calculate break-even points in terms of
accounting profits rather than NPV. But, this does not consider the opportunity cost of capital
and hence provides a misleading lower number.
Type: Medium
69. Briefly discuss the usefulness of Monte Carlo simulation in project analysis.
Monte Carlo simulation provides an exhaustive analysis of project outcomes. The main
problem is that developing the model is time consuming, expensive and difficult to verify.
Monte Carlo simulation generally involves three steps: modeling the project, specifying
probabilities, and simulating cash flows. This is generally done with the use of the computer.
Type: Medium
Real options are options to modify projects in the future. These have value as they provide
flexibility to project decisions and therefore are valuable. There are several types of real
options. They are: option to expand, option to abandon, timing options and production option.
Type: Medium
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Chapter 10 - Project Analysis
71. Briefly discuss various real options associated with capital budgeting projects.
Type: Difficult
The value of the option to bail out of a project is called abandonment value. This is a simple
concept, which has broad practical implications. Generally, an abandonment option increases
the value of a project. Generally, tangible assets have higher abandonment value than
intangible assets and general-purpose machines have higher abandonment value than special
purpose machines.
Type: Medium
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Chapter 10 - Project Analysis
Companies with positive-NPV projects need not undertake them right away. If there are
uncertainties associated with the project, costly mistakes might be avoided by waiting to
resolve them. These types of options to postpone investment are called timing options.
Type: Medium
Financial mangers in order to analyze projects involving sequential decisions use Decision
trees. Firms generally build prototypes or pilot plants before embarking on a large project
with huge investments. These involve expansion and abandonment decisions. These types of
sequential decisions are analyzed using decision trees.
Type: Medium
75. Why is sensitivity analysis less realistic than Monte Carlo Simulation?
Sensitivity analysis only changes one variable to one outcome. Reality almost never involves
only one variable changing and then have it change to one predetermined outcome. Reality
involves many variables changing from the current state to an infinite number of possible
outcomes. Monte Carlo more closely approximates reality given its many outcomes with
many variables.
Type: Difficult
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