SMChap010 - Chapter 10 Project Analysis CHAPTER 10 Project...

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Chapter 10 - Project Analysis CHAPTER 10 Project Analysis Answers to Problem Sets 1. a. False. The capital budget is not the final sign-off for specific projects. Most companies require for each project appropriation requests, which include more detailed analysis. b. True. Strategic planning requires consideration of alternatives. c. True. Cash flow forecasts are regularly overstated. Est. Time: 01 - 05 2. a. Cash flow forecasts are overstated. b. One project proposal may be ranked below another simply because cash flows are based on different forecasts. c. Project proposals may not consider strategic alternatives. Est. Time: 01 - 05 3. a. Analysis of how project profitability and NPV change if different assumptions are made about sales, cost, and other key variables b. Project NPV is recalculated by changing several inputs to new, but consistent, values. c. Determines the level of future sales at which project profitability or NPV equals zero. d. An extension of sensitivity analysis that explores all possible outcomes and weights each by its probability e. A graphical technique for displaying possible future events and decisions taken in response to those events f. Option to modify a project at a future date g. The additional present value created by the option to bail out of a project and recover part of the initial investment if the project performs poorly. 10-1
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Chapter 10 - Project Analysis h. The additional present value created by the option to invest more and expand output if a project performs well Est. Time: 06 - 10 4. a. False. Sensitivity analysis may show where additional information would be most useful. b. True c. True d. True e. False. A business with high fixed costs has high operating leverage. f. True Est. Time: 01 - 05 5. a. Describe how project cash flow depends on the underlying variables. b. Specify probability distributions for forecast errors for these cash flows. c. Draw from the probability distributions to simulate the cash flows. Est. Time: 01 - 05 6. a. True b. True c. False. Just as the option to expand has value, the option to terminate also raises the present value of the project. d. False. The optimal date to undertake an investment is the one that maximizes its contribution to the firm today. Est. Time: 01 - 05 7. Adding a fudge factor to the discount rate pushes project analysts to submit more optimistic forecasts. Est. Time: 01 - 05 10-2
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Chapter 10 - Project Analysis 8. We assume that the idea for a new obfuscator machine originates with a plant manager in the Deconstruction Division. (Keep in mind, however, that in addition to bottom-up proposals, such as the obfuscator machine proposal, top-down proposals also originate with divisional managers and senior management.) Other steps in the capital budgeting process include the following: Many large firms begin the process with forecasts of economic variables, such as inflation and GDP growth, as well as variables of particular interest to the industry, such as prices of raw materials and industry sales projections.
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