risk projects by XT42872H

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									4.         Which of the following statements is CORRECT?
a. The discounted cash flow method of estimating the cost of equity cannot be used
   unless the growth rate, g, is expected to be constant forever.
b. If the calculated beta underestimates the firm's true investment risk i.e., if the
   forward-looking beta that investors think exists exceeds the historical beta then
   the CAPM method based on the historical beta will produce an estimate of rs and
   thus WACC that is too high.
c. Beta measures market risk, which is, theoretically, the most relevant risk measure
   for a publicly-owned firm that seeks to maximize its intrinsic value. This is true
   even if not all of the firm's stockholders are well diversified.
d. An advantage shared by both the DCF and CAPM methods when they are used
   to estimate the cost of equity is that they are both "objective" as opposed to
   "subjective," hence little or no judgment is required.
e. The specific risk premium used in the CAPM is the same as the risk premium
   used in the bond-yield-plus-risk-premium approach.

           13. Which of the following statements is CORRECT?
a. One defect of the IRR method versus the NPV is that the IRR does not take
   account of cash flows over a project's full life.
b. One defect of the IRR method versus the NPV is that the IRR does not take
   account of the time value of money.
c. One defect of the IRR method versus the NPV is that the IRR does not take
   account of the cost of capital.
d. One defect of the IRR method versus the NPV is that the IRR values a dollar
   received today the same as a dollar that will not be received until sometime in the
   future.
e. One defect of the IRR method versus the NPV is that the IRR does not take
   proper account of differences in the sizes of projects

19.            Assume that the economy is enjoying a strong boom, and as a result interest
               rates and money costs generally are relatively high. The WACC for two
               mutually exclusive projects that are being considered is 12%. Project S has
               an IRR of 20% while Project L's IRR is 15%. The projects have the same
               NPV at the 12% current WACC. However, you believe that the economy will
               soon fall into a mild recession, and money costs and thus your WACC will
               soon decline. You also think that the projects will not be funded until the
               WACC has decreased, and their cash flows will not be affected by the
               change in economic conditions. Under these conditions, which of the
               following statements is CORRECT?
a.    You should reject both projects because they will both have negative NPVs under
      the new conditions.
b.    You should delay a decision until you have more information on the projects, even
      if this means that a competitor might come in and capture this market.
c.    You should recommend Project L, because at the new WACC it will have the
      higher NPV.
d.    You should recommend Project S, because at the new WACC it will have the
      higher NPV.
e.    You should recommend Project L because it will have both a higher IRR and a
      higher NPV under the new conditions.
              21. You are considering two mutually exclusive, equally risky, projects. Both
              have IRRs that exceed the WACC. Which of the following statements is
              CORRECT? Assume that the projects have normal cash flows, with one
              outflow followed by a series of inflows.
a.   If the two projects' NPV profiles do not cross, then there will be a sharp conflict as
     to which one should be selected.
b.   If the cost of capital is greater than the crossover rate, then the IRR and the NPV
     criteria will not result in a conflict between the projects. The same project will rank
     higher by both criteria.
c.   If the cost of capital is less than the crossover rate, then the IRR and the NPV
     criteria will not result in a conflict between the projects. The same project will rank
     higher by both criteria.
d.   For a conflict to exist between NPV and IRR, the initial investment cost of one
     project must exceed the cost of the other.
e.   For a conflict to exist between NPV and IRR, one project must have an increasing
     stream of cash flows over time while the other has a decreasing stream. If both
     sets of cash flows are increasing or decreasing, then it would be impossible for a
     conflict to exist, even if one project is larger than the other.


____          22. Which of the following statements is CORRECT? Assume that the project
              being considered has normal cash flows, with one outflow followed by a
              series of inflows.
a.   A project's MIRR is always greater than its regular IRR.
b.   A project's MIRR is always less than its regular IRR.
c.   If a project's IRR is greater than its WACC, then the MIRR will be less than the
     IRR.
d.   If a project's IRR is greater than its WACC, then the MIRR will be greater than the
     IRR.
e.   To find a project's MIRR, we compound cash inflows at the IRR and then discount
     the terminal value back to t = 0 at the WACC.


____         23. Projects S and L both have normal cash flows, and the projects have the
             same risk, hence both are evaluated with the same WACC, 10%. However, S
             has a higher IRR than L. Which of the following statements is CORRECT?
a.   Project S must have a higher NPV than Project L.
b.   If Project S has a positive NPV, Project L must also have a positive NPV.
c.   If the WACC falls, each project's IRR will increase.
d.   If the WACC increases, each project's IRR will decrease.
e.   If Projects S and L have the same NPV at the current WACC, 10%, then Project L,
     the one with the lower IRR, would have a higher NPV if the WACC used to
     evaluate the projects declined.
____           24. Which of the following statements is CORRECT? Assume that all projects
               being considered have normal cash flows and are equally risky.
a.    If a project's IRR is equal to its WACC, then, under all reasonable conditions, the
      project's NPV must be negative.
b.    If a project's IRR is equal to its WACC, then under all reasonable conditions, the
      project's IRR must be negative.
c.    If a project's IRR is equal to its WACC, then under all reasonable conditions the
      project's NPV must be zero.
d.    There is no necessary relationship between a project's IRR, its WACC, and its
      NPV.
e.    When evaluating mutually exclusive projects, those projects with relatively long
      lives will tend to have relatively high NPVs when the cost of capital is relatively
      high.


____
               35. Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects,
               10% for average-risk projects, and 12% for above-average risk projects.
               Which of the following independent projects should Tapley accept, assuming
               that the company uses the NPV method when choosing projects?
a.    Project A, which has average risk and an IRR = 9%.
b.    Project B, which has below-average risk and an IRR = 8.5%.
c.    Project C, which has above-average risk and an IRR = 11%.
d.    Without information about the projects' NPVs we cannot determine which
      project(s) should be accepted.
e.    All of these projects should be accepted.

37.            Rowell Company spent $3 million two years ago to build a plant for a new
               product. It then decided not to go forward with the project, so the building is
               available for sale or for a new product. Rowell owns the building free and
               clear there is no mortgage on it. Which of the following statements is
               CORRECT?
a.    Since the building has been paid for, it can be used by another project with no
      additional cost. Therefore, it should not be reflected in the cash flows for any new
      project.
b.    If the building could be sold, then the after-tax proceeds that would be generated
      by any such sale should be charged as a cost to any new project that would use
      it.
c.    This is an example of an externality, because the very existence of the building
      affects the cash flows for any new project that Rowell might consider.
d.    Since the building was built in the past, its cost is a sunk cost and thus need not
      be considered when new projects are being evaluated, even if it would be used by
      those new projects.
e.    If there is a mortgage loan on the building, then the interest on that loan would
      have to be charged to any new project that used the building.


____
38.         Which of the following statements is CORRECT?
a. Sensitivity analysis as it is generally employed is incomplete in that it fails to
    consider the probability of occurrence of the key input variables.
b. In comparing two projects using sensitivity analysis, the one with the steeper lines
    would be considered less risky, because a small error in estimating a variable
    such as unit sales would produce only a small error in the project's NPV.
c. The primary advantage of simulation analysis over scenario analysis is that
    scenario analysis requires a relatively powerful computer, coupled with an efficient
    financial planning software package, whereas simulation analysis can be done
    efficiently using a PC with a spreadsheet program or even with just a calculator.
d. Sensitivity analysis is a type of risk analysis that considers both the sensitivity of
    NPV to changes in key input variables and the probability of occurrence of these
    variables' values.
e. As computer technology advances, simulation analysis becomes increasingly
    obsolete and thus less likely to be used as compared to sensitivity analysis.

								
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