10 Finance - Risk Project Analysis

The simulation approach provides us with

• a single value for the risk-adjusted net present value.
• an approximation of the systematic risk level.
• a probability distribution of the project's net present value or internal rate of return.
• a graphic exposition of the year-by-year sequence of possible outcomes.

________ is a method of quantifying uncertainty without having to estimate probabilities.

• Standard deviation
• Sensitivity analysis
• Coefficient of variation
• Decision tree analysis

Sensitivity analysis is the form of risk analysis

• that examines the relationship between total firm cash flows and the NPV of a particular project.
• that examines the volatility of NPV.
• that examines the impact of key variables such as sales or costs in various combinations.
• that examines the impact of key variables such as sales or costs one at a time.

Scenario analysis is the form of risk analysis

• that examines the relationship between total firm cash flows and the NPV of a particular project.
• that examines the volatility of NPV.
• that examines the impact of key variables such as sales or costs in various combinations.
• that examines the impact of key variables such as sales or costs one at a time.

________ is a risk analysis technique in which the best- and worst-case net present values are compared with the project's expected net present value.

• Project standing alone risk
• Decision tree analysis
• Scenario analysis
• Pure play method

Mork Pharmaceuticals believes that changes in health insurance may increase demand by as much as 10%, but also lower prices by as much as 10%. It is also concerned that the cost of materials may increase as much as 10% and the company may or may not be able to pass these higher costs on to its customers. To estimate expected, best case and worst case results, Mork should use

• sensitivity analysis.
• scenario analysis.
• political risk analysis.
• probability analysis.

The end result of a simulation analysis is

• a probability distribution of project cash flows.
• a clear decision on whether or not a project should be accepted.
• a probability distribution of possible NPV's.
• a list of value drivers and their probabilities.

Natick Nurseries has used scenario analysis to evaluate the purchase of a former dairy to use for nursery stock. The best case scenario produced a very favorable NPV of $4,000,000; the NPV of the most likely case was $2,000,000, but the worst case scenario resulted in an NPV of $(3,000,000) which would bring the company close to bankruptcy. Natick could improve its decision by

• using sensitivity analysis.
• using simulation analysis.
• simply accepting the best case scenario and rejecting the other outcomes.
• weighting the favorable scenarios more heavily to increase the expected NPV.

Which of the following costs is NOT covered in an accounting break-even analysis?

• Shareholders expected rate of return
• Variable production costs
• Interest expense
• Depreciation expense

Accounting break-even analysis solves for the level of sales that will result in

• IRR=Cost of Capital.
• net income = $0.00.
• free cash flow = $0.00.
• NPV = $0.00.