Chapter 09 Project Analysis

True / False Questions 1. A capital budget shows a proposed list of investments. TRUE 2. he strategic planning portion of the capital budgeting process is essentially a !bottom"up! process. FALSE #. Competitive advantage is an important element of many successful capital budgeting proposals. TRUE $. %hile sensitivity analysis is forward"loo&ing' scenario analysis attempts to reconstruct and analy(e the past. FALSE

). he level of sales at which project *P+ is (ero is referred to as the accounting brea&"even point. FALSE ,. he economic brea&"even level of sales will be higher than the accounting brea&"even level. TRUE -. he degree of operating leverage shows the relationship between sales and pre"ta. profits. TRUE /. 0perating leverage increases with fi.ed cost. TRUE

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Chapter 09 Project Analysis

9. 1f a large proportion of costs is fi.ed' a shortfall in sales has a magnified effect on profits. 2rom the above statement we &now that the ris& of a project is affected by the degree of operating leverage. TRUE 10. he greater the 304' the greater the protection against operating losses during economic downturns. FALSE 11. Clothing industry is considered to have high degree of operating leverage. FALSE 12. he option to abandon a project becomes more valuable as the possible outcomes become more varied. TRUE

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Chapter 09 Project Analysis

1#. Conflicts of interest between shareholders and managers may result in the sacrifice of attractive capital budgeting proposals. TRUE 1$. 5ensitivity analysis ta&es into consideration the interrelationship of variables. FALSE 1). 5cenario analysis allows managers to loo& at different and sometimes inconsistent combinations of variables. FALSE 1,. !%hat"if! 6uestions as& what will happen to a project in various circumstances. TRUE 1-. %hat"if analysis is not crucial to capital budgeting. FALSE 1/. %hat"if analysis can help identify the inputs that are most worth refining before you commit to a project. TRUE 19. he inputs that are most worth refining before you commit to a project are the ones that have the greatest potential to alter project *P+. TRUE 20. 5cenario analysis allows managers to loo& at different but consistent combinations of interrelated variables. TRUE 21. A project that brea&s even in accounting terms will surely have a negative *P+. TRUE 22. A project that simply brea&s even on an accounting basis gives you your money bac& but does not cover the opportunity cost of the capital tied up in the project. TRUE 2#. 7anagers that accept projects that only brea& even on an accounting basis are helping their shareholders. FALSE Multiple Choice Questions

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Chapter 09 Project Analysis

2$. %hat level of management is responsible for originating capital budgeting proposals8 A. 5enior management 9. 3ivisional management C. 4ower management D. All levels of management 2). he capital budget should be consistent with the firm:s; A. growth in sales. B. strategic plans. C. current level of funds. 3. dividend policy. 2,. %hich of the following would not be judged a traditional category of capital budgeting project8 A. 7achine replacement proposals B. 5alary adjustment proposals C. *ew product proposals 3. Plant e.pansion proposals 2-. %hich of the following industry has low operating leverage8 A. 5teel. 9. <ailroads. C. =lectric utilities. 3. Autos. 2/. %hich of the following capital budgeting proposals is most li&ely to display a conflict of interests8 A. he proposal with highest *P+. 9. he proposal with the longest paybac& period. C. he proposal with highest 1<< and 6uic&est paybac&. 3. he proposal to solve pollution problems. 29. %hich of the following is least li&ely to be responsible for a regional manager:s conflict of interest in promoting a capital budgeting proposal8 A. 3esire for professional advancement B. horough &nowledge of the region C. 0verly optimistic economic forecasts 3. he need for 6uic& profitability #0. 5oft capital rationing may be beneficial to a firm if it; A. reduces a firm:s interest e.pense. B. weeds out proposals with wea&er or biased *P+s. C. allows managers to select their favorite projects. 3. increases funds to be used for other purposes.

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Chapter 09 Project Analysis

#1. he purpose of sensitivity analysis is to show; A. the optimal level of the capital budget. 9. how price changes affect brea&"even volume. C. seasonal variation in product demand. D. how variables in a project affect profitability. #2. 5ensitivity analysis evaluates projects by; A. forecasting changes in interest rates that would increase financing costs. B. recording profitability changes while changing one variable at a time. C. insuring that the project sponsor has proper incentives. 3. testing for interrelated variables. ##. %hat happens to the *P+ of a one"year project if fi.ed costs are increased from >$00 to >,00' the firm is profitable' has a 1)? ta. rate and employs a 12? cost of capital8 A. *P+ decreases by >200.00. 9. *P+ decreases by >1-#.91. C. *P+ decreases by >1#0.00. D. *P+ decreases by >11#.0$.

change in cash flow @ A200B C -0 @ A1#0B' which discounts to >11#.0$ #$. %hat happens to the *P+ of a one"year project if fi.ed costs are increased from >$00 to >,00' the firm is not profitable' has a 1)? ta. rate and employs a 12? cost of capital8 A. *P+ decreases by >200.00. B. *P+ decreases by >1-/.)-. C. *P+ decreases by >1#0.00. 3. *P+ decreases by >11#.0$.

change in cash flow @ A200B' which discounts to >1-/.)#). %hich of the following appears to be a more li&ely result from using sensitivity analysis8 A. Agreement on the appropriate discount rate 9. 3etermine whether to finance with debt or e6uity. C. 1solation of pivotal factor in project profitability 3. 5elect the best capital budgeting project.

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Chapter 09 Project Analysis

#,. 1f a 20? reduction in forecast sales would not e.tinguish a project:s profitability' then sensitivity analysis would suggest; A. deemphasi(ing that variable as a critical factor. 9. re6uiring a more detailed sales forecast. C. the initial sales forecasts were inflated. 3. a reallocation of fi.ed costs to this product. #-. 1f sensitivity analysis concludes that the largest impact on profits would come from changes in the sales level' then; A. fi.ed costs should be traded for variable costs. 9. variable costs should be traded for fi.ed costs. C. the project should not be underta&en. D. additional mar&eting analysis may be beneficial before proceeding. #/. %hich of the following statements is correct concerning sensitivity analysis8 A. 1t ignores interrelationships between variables. 9. 5everal variables are allowed to change concurrently. C. 1t considers all feasible variable combinations. 3. 1ts results are free from ambiguity. #9. 1f sensitivity analysis indicates none of the individual variables will cause a negative *P+ under pessimistic conditions' then the; A. project is assured to be successful. 9. project:s discount rate should be reduced. C. economic forecasts are possibly overly optimistic. D. interaction of the variables should be considered.

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