Principles of Corporate Finance Concise 2Nd Edition Brealey Test Bank Full Chapter PDF

Principles of Corporate Finance
Concise 2nd Edition Brealey Test Bank

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Chapter 10 - Project Analysis
Chapter 10
Project Analysis
Multiple Choice Questions
1. Discounted cash flow (DCF) analysis generally:

I) assumes that firms hold assets passively when it invests in a project
II) considers opportunities to expand a project if the project is successful
III) considers opportunities to abandon a project if the project is a failure
A. I only
B. II only
C. II and III only
D. I, II, and III
2. A firm's capital investment proposals should reflect:

I) Capital budgeting process
II) Strategic planning process
III) Middle managers' ideas and views
A. I only
B. I and II only
C. I, II, and III
D. III only
3. Generally, postaudits are conducted for large projects:

A. shortly after the completion of the project
B. after several years after the completion of the project
C. shortly after the project has begun to operate
D. well before the start of the project
10-1
4. Generally, postaudits for projects are conducted:

I) to identify problems that need fixing
II) to check the accuracy of forecasts
III) to come up with questions that should have been asked before the project was undertaken
A. I only
B. II only
C. I and II only
D. I, II, and III
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
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
10-2
8. A project has the following cash flows: C0 = -100,000; C1 = 50,000; C2 = 150,000; C3 =

100,000. If the discount rate changes from 12% to 15%, what is the change in the NPV of the
project (approximately)?
A. 12,750 increase
B. 12,750 decrease
C. 122,650 increase
D. 135,400 decrease
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
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%)
A. 50, -100, +400

B. -50, +300, +500
C. -100, +150, +350
10-3
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
cost of capital is 15%. Calculate the NPV of the project:
A. 3840
B. 8443
C. -2735
A. 14,418
B. 8443
C. -2735
10-4
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
cost of capital is 15%. What would the NPV if the discount rate were higher by 10%?
A. $5648
B. $3840
C. -$2735
16. The following are drawbacks of sensitivity analysis except:

A. it provides ambiguous results.
B. underlying variables are likely to be interrelated.
C. it provides additional information about the project that is useful.
D. all of the above statements are drawbacks of sensitivity analysis.
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
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
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
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
21. The accounting break-even point occurs when:

A. the total revenue line cuts the fixed cost line
B. the present value of inflows line cuts the present value of outflows line
C. the total revenue line cuts the total cost line
10-6
22. The NPV break-even point occurs when:

A. the present value of inflows line cuts the present value of outflows line
B. the total revenue line cuts the fixed cost line
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
$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
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
10-7
26. Hammer Company proposes to invest $6 million in a new type of hammer-making

equipment. The fixed costs are $0.5 million per year. The equipment is expected to last for
five years. The manufacturing cost per hammer is $1and the selling price per hammer is $6.
Calculate the break-even (i.e. NPV = 0) volume per year. (Ignore taxes.)
A. 500,000 units
B. 600,000 units
C. 100,000 units

five years. The manufacturing cost per hammer is $1 and the selling price per hammer is $6.
A. 500,000 units
B. 600,000 units
C. 100,000 units
28. Everything else remaining the same, an increase in fixed costs:

I) increases the break-even point based on NPV
II) increases the accounting break-even point
III) decreases the break-even point based on NPV
IV) decreases the accounting break-even point
A. I and III only
B. III and IV only
C. II and III only
D. I and II only
10-8
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
30. Simulation models are useful:

I) To understand the project better
II) To forecast expected cash flows
III) To assess the project risk
A. I only
B. II only
C. III only
D. I, II and III
31. Monte Carlo simulation involves the following steps:

I) Step 1: Modeling the project
II) Step 2: Specifying probabilities
III) Step 3: Simulate the cash flows
IV) Step 4: Calculate present value
A. I and II only
B. I, II, and III only
C. II, III, and IV only
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
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
35. Monte Carlo simulation is likely to be most useful:

A. For very complex problems
B. For problems of moderate complexity
C. For very simple problems
D. Regardless of the problem's complexity
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
10-10
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
38. The following are real options except:

A. Stock options
B. Timing options
C. Option to expand
D. Option to abandon
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
40. Option to expand a project is a:

A. Call option
B. Put option
C. Stock option
D. Swap
10-11
41. Option to abandon a project is a:

A. Call option
B. Put option
C. Stock option
D. Swap
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
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
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
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):
If the cost of capital is 15%, calculate the optimal year to harvest:

A. Year 1
B. Year 2
C. Year 3
D. Year 4
10-13
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
What is the accounting break even number of books that must be sold?
A. 582
B. 667
C. 805
D. 953
True / False Questions
10-14
50. Postaudits are conducted before the start of the projects.

True False
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
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
61. In drawing a decision tree, it is important to include all possible eventualities.

True False
62. In almost al cases the present value break even quantity is higher than the accounting
break even quantity.
True False
63. Monte Carlo simulation is merely an advanced version of scenario analysis.

True False
Short Answer Questions
64. Indicate some of the problems associated with capital investment process.
10-16
65. Discuss the importance of conducting post audits.
66. Briefly describe sensitivity analysis used for project analysis.
67. How do managers supplement the NPV analysis of a project to gain better understanding
of a project?
68. Briefly discuss break-even analysis.
10-17
69. Briefly discuss the usefulness of Monte Carlo simulation in project analysis.
70. Briefly explain the term "real options."
71. Briefly discuss various real options associated with capital budgeting projects.
72. Define the term "abandonment value."
10-18
73. Briefly explain timing options.
74. Explain the usefulness of decision trees in project analysis.
75. Why is sensitivity analysis less realistic than Monte Carlo Simulation?
10-19
Chapter 10 Project Analysis Answer Key
Multiple Choice Questions
1. Discounted cash flow (DCF) analysis generally:

I) assumes that firms hold assets passively when it invests in a project
II) considers opportunities to expand a project if the project is successful
III) considers opportunities to abandon a project if the project is a failure
A. I only
B. II only
C. II and III only
D. I, II, and III
Type: Medium
2. A firm's capital investment proposals should reflect:

I) Capital budgeting process
II) Strategic planning process
III) Middle managers' ideas and views
A. I only
B. I and II only
C. I, II, and III
D. III only
Type: Difficult
3. Generally, postaudits are conducted for large projects:

A. shortly after the completion of the project
B. after several years after the completion of the project
C. shortly after the project has begun to operate
D. well before the start of the project
Type: Medium
10-20
4. Generally, postaudits for projects are conducted:

I) to identify problems that need fixing
II) to check the accuracy of forecasts
III) to come up with questions that should have been asked before the project was undertaken
A. I only
B. II only
C. I and II only
D. I, II, and III
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
(43 - 30 - 3) = 10; Tax = 10(0.3) = 3; Net Profit = 10 - 3 = 7; Operating cash flow 7 + 3 = 10
Type: Difficult
10-21
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
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
EBT = (100 - 30 - 50 - 10) = 10; T = 10(0.3) = 3; CF1 = 10 - 3 + 10 = 17
Type: Difficult
10-22
8. A project has the following cash flows: C0 = -100,000; C1 = 50,000; C2 = 150,000; C3 =

100,000. If the discount rate changes from 12% to 15%, what is the change in the NPV of the
project (approximately)?
A. 12,750 increase
B. 12,750 decrease
C. 122,650 increase
D. 135,400 decrease
NPV at 12% = 135,400, NPV at 15% = 122,650.

Change = 135, 410 - 122,650 = 12,750
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
Pessimistic NPV = [(30 - 20)/0.08] - 100 = +25

Most likely NPV = [(40 - 15)/0.08] - 80 = +232.50
Optimistic NPV = [(50 - 10)/0.08] - 60 = +440
Type: Medium
10-23
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%)
A. 50, -100, +400

B. -50, +300, +500
C. -100, +150, +350
Pessimistic NPV = [(30 - 25)/0.1] - 150 = -100

Expected NPV = [(50 - 20)/0.1] - 150 = +150
Optimistic NPV = [(65 - 15)/0.1] - 150 = +350
Type: Difficult
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
Initial Investment = 90,000 + 10,000 = 100,000; CF0 = -100,000

CF1&CF2: (120,000 - 72,000 - 30,000)(1 - 0.3) + 30,000 = 42,600
CF3: (120,000 - 72,000 - 30,000)(1 - 0.3) + 30,000 + (10,000)(1 - 0.3) + 10,000 = 59,600
Type: Difficult
10-24
A. 3840
B. 8443
C. -2735
NPV = -100,000 + 42,600/(1.15) + 42,600/(1.15^2) + 59,600/(1.15^3) = 8,443
Type: Difficult
A. 14,418
B. 8443
C. -2735

CF1&CF2: (120,000 - 72,000 - 30,000)(1 - 0.3) + 30,000 = 42,600
CF3: (120,000 - 72,000 - 30,000)(1 - 0.3) + 30,000 + (10,000)(1 - 0.3) + 10,000 = 59,600
NPV = -100,000 + 42,600/(1.12) + 42,600/(1.12^2) + 59,600/(1.12^3) = 14,418
Type: Difficult
10-25
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

CF1&CF2: (132,000 - 85,800 - 30,000)(1 - 0.3) + 30,000 = 41,340
CF3: (132,000 - 85,800 - 30,000)(1 - 0.3) + 30,000 + (10,000)(1 - 0.3) + 10,000 = 58,340
NPV = -100,000 + 41,340/(1.15) + 41,340/(1.15^2) + 58,340/(1.15^3) = 5,566
Type: Difficult
cost of capital is 15%. What would the NPV if the discount rate were higher by 10%?
A. $5648
B. $3840
C. -$2735

CF1&CF2: (120,000 - 72,000 - 30,000)(1 - 0.3) + 30,000 = 42,600
CF3: (120,000 - 72,000 - 30,000)(1 - 0.3) + 30,000 + (10,000)(1 - 0.3) + 10,000 = 59,600
NPV at 16.5% = -100000 + (42,600/1.165) + (42600/(1.165^2)) + (59600/(1.165^3)) = $5648
Type: Difficult
10-26
16. The following are drawbacks of sensitivity analysis except:

A. it provides ambiguous results.
B. underlying variables are likely to be interrelated.
C. it provides additional information about the project that is useful.
D. all of the above statements are drawbacks of sensitivity 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
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
EAC = 12/2.5887 = $4,635,531 million; X (30 - 10) -3,000,000 = 4,635,531; X =

7,635,531/20 = 381,777 units
Type: Difficult
10-27
$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
EAC = 5,000,000/2.40183 = 2,081,745 million; (X) (20 - 5) - 2,000,000 = 2,081745;

X = (4,081,745/15) = 272,117 units
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
Type: Difficult
21. The accounting break-even point occurs when:

A. the total revenue line cuts the fixed cost line
B. the present value of inflows line cuts the present value of outflows line
Type: Medium
10-28
22. The NPV break-even point occurs when:

A. the present value of inflows line cuts the present value of outflows line
B. the total revenue line cuts the fixed cost line
Type: Medium
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
X = (FC + D)/(p-v) = (3,000,000 + 3,000,000)/(30 - 10) = 300,000
Type: Difficult
$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
X = (2,000,000 + 1,666,667)/(20 - 5) = 244,444 units
Type: Difficult
10-29
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
EAC = $3 million/2.9906 = $1.00 million; (X) * (1500 - 500) - 1,000,000 = 1,000,000 X

(1000) = 2,000,000
X = 2,000,000/1000 = 2000
Type: Difficult

five years. The manufacturing cost per hammer is $1and the selling price per hammer is $6.
A. 500,000 units
B. 600,000 units
C. 100,000 units
EAC = 6/2.9906 = 2 million

X (6 - 1) - 500,000 = 2,000,000
X = 2,500,000/5 = 500,000 units
Type: Difficult
10-30

five years. The manufacturing cost per hammer is $1 and the selling price per hammer is $6.
A. 500,000 units
B. 600,000 units
C. 100,000 units
EAC = 6/2.9906 = 2 million

X (6 - 1) - 1,000,000 = 2,000,000
X = 3,000,000/5 = 600,000 units
Type: Difficult
28. Everything else remaining the same, an increase in fixed costs:

I) increases the break-even point based on NPV
II) increases the accounting break-even point
III) decreases the break-even point based on NPV
IV) decreases the accounting break-even point
A. I and III only
B. III and IV only
C. II and III only
D. I and II only
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
Type: Easy
10-31
30. Simulation models are useful:

I) To understand the project better
II) To forecast expected cash flows
III) To assess the project risk
A. I only
B. II only
C. III only
D. I, II and III
Type: Easy
31. Monte Carlo simulation involves the following steps:

I) Step 1: Modeling the project
II) Step 2: Specifying probabilities
III) Step 3: Simulate the cash flows
IV) Step 4: Calculate present value
A. I and II only
B. I, II, and III only
C. II, III, and IV only
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
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
35. Monte Carlo simulation is likely to be most useful:

A. For very complex problems
B. For problems of moderate complexity
C. For very simple problems
D. Regardless of the problem's complexity
Type: Easy
10-33
taxes). Calculate the NPV to invest today.
A. +10,000,000
B. +6,000,000
C. +4,000,000
NPV today = -50,000,000 + (200,000)(50 - 20)/0.1 = +10,000,000
Type: Difficult
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
NPV(oil price = $70/bbl) = +50,000,000

NPV(oil price = $40 \/bbl) = -10,000,000/1.1 = -9,090,909 (reject)
NPV(oil price = $10/bbl) = 0
Expected NPV = (0.5)(0) + (0.5)(50,000,000) = 25,000,000
Type: Difficult
10-34
38. The following are real options except:

A. Stock options
B. Timing options
C. Option to expand
D. Option to abandon
Type: Medium
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
NPV today = -50,000,000 + (200,000)(50 - 20)/0.1 = +10,000,000

NPV(oil price = $70/bbl) = +50,000,000
NPV(oil price = $40/bbl) = -10,000,000/1.1 = -9,090,909 (reject)
NPV(oil price = $10/bbl) = 0
Expected NPV = (0.5)(0) + (0.5)(50,000,000) = 25,000,000
Value of the Option to Wait = 25,000,000 - 10,000,000 = 15,000,000
Type: Difficult
40. Option to expand a project is a:

A. Call option
B. Put option
C. Stock option
D. Swap
Type: Medium
10-35
41. Option to abandon a project is a:

A. Call option
B. Put option
C. Stock option
D. Swap
Type: Medium
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
PV(Success) = 50 (2.48685) = 124.3426

PV(Failure) = 10 (1.73554) = 17.3554
NPV = -80 + (124.3426)(0.5) + (17.3554)(0.5) = -9.15
Type: Difficult
10-36
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
NPV with abandonment option:

PV(success) = 50(2.48685) = 124.3426
PV(Failure) = 10/1.1 + 60/1.1 = 63.6364
(assuming that the equipment will be sold if the action figure is a failure)
NPV = -80 + (124.3426)(0.5) + (63.6364)(0.5) = +13.99
Type: Difficult
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
Value of the abandonment option = NPV (with the option) - NPV (without the option) =
13.99 - (-9.15) = 23.14
Type: Difficult
10-37
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):
If the cost of capital is 15%, calculate the optimal year to harvest:

A. Year 1
B. Year 2
C. Year 3
D. Year 4
Type: Difficult
10-38
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
No survey: Expected NPV = 500,000 (0.6) - 100,000 (0.4) = +260,000

With the survey: Expected NPV = -60,000 + [(500,000)(0.8) - (100,000)(0.2)]/(1.1)
= +285455
Increase in NPV by the survey = 285455 - 260,000 = 25,455
Type: Difficult
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
PVAF of 12% over 3 years = 2.4018

Solve for P if NPV = 0; NPV = -150,000 + 2.4018(90P - 10,000)
Type: Difficult
10-39
What is the accounting break even number of books that must be sold?
A. 582
B. 667
C. 805
D. 953
Solve for P if Net Income = 0; Net Income = 90P - 60,000
Type: Difficult
True / False Questions
50. Postaudits are conducted before the start of the projects.

FALSE
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
10-40
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
10-41
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
61. In drawing a decision tree, it is important to include all possible eventualities.

FALSE
Type: Medium
62. In almost al cases the present value break even quantity is higher than the accounting
break even quantity.
TRUE
Type: Medium
63. Monte Carlo simulation is merely an advanced version of scenario analysis.

TRUE
Type: Medium
10-42
Short Answer Questions
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
65. Discuss the importance of conducting post audits.
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
66. Briefly describe sensitivity analysis used for project analysis.
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
10-43
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
68. Briefly discuss break-even analysis.
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
70. Briefly explain the term "real options."
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
10-44
71. Briefly discuss various real options associated with capital budgeting projects.
There are four types of real options. They are:

• option to expand
• option to abandon
• production options
• timing options
Option to expand provides a firm with flexibility to expand but not commit them to expand.
Therefore they add value to the project. These are call options. In many cases, ability to
terminate a project or abandon a project adds flexibility to the project. This is useful when the
project fails to be profitable and needs to be terminated. Abandonment options are put
options. Production options provide a firm with additional flexibility to alter inputs or
processes. These have value when an input becomes scarce and needs to be replaced with an
alternative. These production options add value to the project. In many cases a positive NPV
project need not be undertaken right away. It might be even more valuable if undertaken in
the future. The ability to postpone a project also provides a firm with additional flexibility.
These options add value to the project. A project may have many options associated with
them. Many projects might become positive NPV projects if options associated with them are
recognized and evaluated.
Type: Difficult
72. Define the term "abandonment value."
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
10-45
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Principles of Corporate Finance

Concise 2nd Edition Brealey Test Bank

Multiple Choice Questions

1. Discounted cash flow (DCF) analysis generally:

2. A firm's capital investment proposals should reflect:

3. Generally, postaudits are conducted for large projects:

4. Generally, postaudits for projects are conducted:

8. A project has the following cash flows: C0 = -100,000; C1 = 50,000; C2 = 150,000; C3 =

A. 50, -100, +400

16. The following are drawbacks of sensitivity analysis except:

21. The accounting break-even point occurs when:

22. The NPV break-even point occurs when:

26. Hammer Company proposes to invest $6 million in a new type of hammer-making

27. Hammer Company proposes to invest $6 million in a new type of hammer-making

28. Everything else remaining the same, an increase in fixed costs:

30. Simulation models are useful:

31. Monte Carlo simulation involves the following steps:

35. Monte Carlo simulation is likely to be most useful:

38. The following are real options except:

40. Option to expand a project is a:

41. Option to abandon a project is a:

If the cost of capital is 15%, calculate the optimal year to harvest:

True / False Questions

50. Postaudits are conducted before the start of the projects.

61. In drawing a decision tree, it is important to include all possible eventualities.

63. Monte Carlo simulation is merely an advanced version of scenario analysis.

Short Answer Questions

65. Discuss the importance of conducting post audits.

66. Briefly describe sensitivity analysis used for project analysis.

68. Briefly discuss break-even analysis.

70. Briefly explain the term "real options."

72. Define the term "abandonment value."

73. Briefly explain timing options.

74. Explain the usefulness of decision trees in project analysis.

Chapter 10 Project Analysis Answer Key

Multiple Choice Questions

1. Discounted cash flow (DCF) analysis generally:

2. A firm's capital investment proposals should reflect:

3. Generally, postaudits are conducted for large projects:

4. Generally, postaudits for projects are conducted:

(43 - 30 - 3) = 10; Tax = 10(0.3) = 3; Net Profit = 10 - 3 = 7; Operating cash flow 7 + 3 = 10

EBT = (100 - 30 - 50 - 10) = 10; T = 10(0.3) = 3; CF1 = 10 - 3 + 10 = 17

8. A project has the following cash flows: C0 = -100,000; C1 = 50,000; C2 = 150,000; C3 =

NPV at 12% = 135,400, NPV at 15% = 122,650.

Pessimistic NPV = [(30 - 20)/0.08] - 100 = +25

A. 50, -100, +400

Pessimistic NPV = [(30 - 25)/0.1] - 150 = -100

Initial Investment = 90,000 + 10,000 = 100,000; CF0 = -100,000

NPV = -100,000 + 42,600/(1.15) + 42,600/(1.15^2) + 59,600/(1.15^3) = 8,443

Initial Investment = 90,000 + 10,000 = 100,000; CF0 = -100,000

Initial Investment = 90,000 + 10,000 = 100,000; CF0 = -100,000

Initial Investment = 90,000 + 10,000 = 100,000; CF0 = -100,000

16. The following are drawbacks of sensitivity analysis except:

EAC = 12/2.5887 = $4,635,531 million; X (30 - 10) -3,000,000 = 4,635,531; X =

EAC = 5,000,000/2.40183 = 2,081,745 million; (X) (20 - 5) - 2,000,000 = 2,081745;

21. The accounting break-even point occurs when:

22. The NPV break-even point occurs when:

X = (FC + D)/(p-v) = (3,000,000 + 3,000,000)/(30 - 10) = 300,000

X = (2,000,000 + 1,666,667)/(20 - 5) = 244,444 units

EAC = $3 million/2.9906 = $1.00 million; (X) * (1500 - 500) - 1,000,000 = 1,000,000 X

26. Hammer Company proposes to invest $6 million in a new type of hammer-making

EAC = 6/2.9906 = 2 million

27. Hammer Company proposes to invest $6 million in a new type of hammer-making