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Exam 10: Project Analysis

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Question 21

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A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0) .You expect the project to produce sales revenue of $120,000 per year for three years.You estimate manufacturing costs at 60% of revenues.(Assume all revenues and costs occur at year-end,i.e.,t = 1,t = 2,and t = 3.) The equipment depreciates using straight-line depreciation over three years.At the end of the project,the firm can sell the equipment for $10,000 and also recover the investment in net working capital.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) CF₀: -100,000; CF₁: 42,600; CF₂: 42,600; CF₃: 49,600.Initial Investment = 90,000 + 10,000 = 100,000; CF₀ = -100,000;CF₁ and 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.

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Question 22

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Briefly discuss various real options associated with capital budgeting projects.

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There are four types of real options.The...

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Question 23

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Projects with higher fixed costs have lower break-even points.

The Solar Calculator Company proposes to invest $5 million in a new calculator-making plant.Fixed costs are $2 million per year.A solar calculator costs $5 per unit to manufacture and sells for $20 per unit.If the plant lasts for three years and the cost of capital is 12%,what is the break-even level of annual sales? (Assume that revenues and costs occur at the end of each year.Assume no taxes.) Round to the nearest 1,000 units.

Why is sensitivity analysis less realistic than Monte Carlo simulation?

Firms with higher fixed costs tend to have higher degrees of operating leverage.

In most cases the present value break-even quantity is higher than the accounting break-even quantity.

Firms often calculate a project's break-even sales using book earnings.However,break-even sales based on NPV is generally:

Briefly discuss the usefulness of Monte Carlo simulation in project analysis.

Monte Carlo simulation should be used to get the distribution of NPV values for a project.

The break-even point in terms of NPV is usually lower than the break-even point on an accounting basis.

Petroleum Inc.(PI) controls offshore oil leases.It is considering the construction of a deep-sea oil rig at a cost of $500 million.The price of oil is $100/bbl.and extraction costs are $50/bbl.PI expects prices and costs to remain constant.The rig will produce an estimated 1,200,000 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.

In constructing a Monte Carlo simulation model of an investment project,one typically ignores possible interdependencies between variables.

Explain the usefulness of decision trees in project analysis.

The NPV break-even point occurs when:

Monte Carlo simulation is a tool intended to consider all possible combinations of variables.

The option to wait is a type of abandonment option.

Monte Carlo simulation involves the following steps: I.Step 1: Modeling the project; II.Step 2: Specifying probabilities; III.Step 3: Simulating cash flows; IV.Step 4: Calculating present value

Project analysis,beyond simply calculating NPV,includes the following procedures: I.sensitivity analysis; II.break-even analysis; III.Monte Carlo simulation; IV.scenario analysis

The following options associated with a project increase managerial flexibility: i.option to expand; II) option to abandon; III) production options; IV) timing options