10 - Chapter 10 Risk and Refinements In Capital Budgeting...

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Chapter 10 Risk and Refinements In Capital Budgeting 157 Chapter 10 Risk and Refinements In Capital Budgeting Learning Goals 1. Understand the importance of recognizing risk in the analysis of capital budgeting projects. 2. Discuss breakeven cash flows, sensitivity and scenario analysis, and simulation as behavioral  approaches for dealing with risk. 3. Discuss the unique risks that multinational companies face. 4. Describe the determination and use of risk-adjusted discount rates (RADRs), portfolio effects, and  the practical aspects of RADRs. 5. Select the best of a group of unequal-lived mutually exclusive projects using annualized net present  values (ANPVs). 6. Explain the role of real options and the objective and procedures for selecting projects under capital  rationing. True/False 1. The breakeven cash inflow is the minimum level of cash inflow necessary for a project to be  acceptable. Answer: TRUE Level of Difficulty: 1 Learning Goal: 2 Topic: Breakeven Cash Inflow 2. Projects with a small chance of being acceptable and a broad range of expected cash flows are more  risky than projects having a high chance of being acceptable and a narrow range of expected cash  flows. Answer: TRUE Level of Difficulty: 2 Learning Goal: 2 Topic: Sensitivity Analysis 3. In capital budgeting, risk refers to the chance that a project has a high degree of variability of the  initial investment. Answer: FALSE Level of Difficulty: 2
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158 Gitman • Principles of Finance,  Eleventh Edition Learning Goal: 2 Topic: Recognizing Risk in Capital Budgeting
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Chapter 10 Risk and Refinements In Capital Budgeting 159 4. Sensitivity analysis is a behavioral approach that uses a number of possible values for a given  variable to assess its impact on a firm’s return. Answer: TRUE Level of Difficulty: 2 Learning Goal: 2 Topic: Sensitivity Analysis 5. Sensitivity analysis is a statistically based approach used in capital budgeting to get a feel for risk by applying predetermined probability distributions and random numbers to estimate risky outcomes. Answer: FALSE Level of Difficulty: 3 Learning Goal: 2 Topic: Sensitivity Analysis 6. Scenario analysis is an approach that uses a number of possible values for a given variable in order  to assess its impact on a firm’s return. Answer: FALSE Level of Difficulty: 3 Learning Goal: 2 Topic: Scenario Analysis 7. Simulation is an approach that evaluates the impact on return of simultaneous changes in a number  of variables.
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