Question

23. Assume the approprlate discount rate for each of the following prolects (1,2,3) Is 7.25% per perlod and the projects are mutually exclusive. Based on NPV, which of the following prolects In management most likely to pursuel Project 1 (100) $ 60 $ 50 $ Project 2 (100) S 50 $ 61 $ Project 3 1=0 $ (100) 1=1 210 (110) 1=2 S a. 1 ь. " d. I& II e. None of the projects 24. A company estimates an NPV of a project under three different set of assumptions (Bear, Base, Bull) to evaluate forecasting risk; management agrees to undertake the project if the weighted average NPV for the three different scenarios (Bear, Base, Bull) Is positive. Based on the scenario analysis performed, the company will pursue the project. Evaluate the underlined words in italics. True or False? Scenerio NPV Probability (100) 35 65 Bear 30.00% 50.00% 20.00% Base Bull a. True b. False 25. Assume management has found profitable investment opportunities, but lacks the funds to undertake one or more of these opportunities. This situation is most closely related to the concept of: a. Managerial options b. Sensitivity analysis C. Forecasting risk d. Capital rationing e. Opportunity costs

Answer 1

PV of Cash Flows (discounting factor*cash flow) Discounting F Cash Flows actor Period [1/(1.0725^ye ar)] 2 3 -100 -100 -100 -100 -100 -100 55.94405594 46.62004662 195.8041958 43.46857494 53.03166142 0.932400932 60 50 210 -95.6308649 2. 0.869371499 50 61 -110 NPV= -0.58736912 -0.34829196 0.173330943 Sum of PVs NPV* Scenario Probability NPV Probability Bear -100 -30 35 Base 0.5 17.5 Bull 65 0.2 13 Expected NPV= Sum of Above 0.5

23.

As NPV of Project 3 is positive, Management is most likely to pursue Project 3.

24.

As the Expected NPV is positive, the company will pursue the peoject. Therefore, the statement is True.

25.

Managerial Options is to choose an option for a project, after it is implented, keeping in mind its cashflows.

Sensitivity Analysis and Forecastng Risk are the risk management tools. So IRRELEVANT.

Opportunity Cost comes into picture when, there is an outfow or reduction in inflow in the EXISTING PROJECT, due to acceptance of new project.

Capital Rationing means imposing higher cost of capital in order to limit the number of new projects implemented.

Managerial Options, Sensitivity Analysis & Forecasting Risk are TOTALLY IRRELATED.

Opportunity Cost can be SOMEWHAT RELATED.

But, Capital Rationing is MOST RELATED.

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