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Questions and Answers
What is the NPV in the worst-case scenario?
Which term is considered more accurate than 'best' and 'worst' case scenarios?
How many scenarios should be considered for a thorough analysis according to the provided content?
What does sensitivity analysis primarily investigate?
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What significant outcome was experienced by Eurotunnel that illustrates underestimated risks?
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What is a potential downside of increasing the number of scenarios in analysis?
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Which of the following was NOT a post-launch data point for the Segway?
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What is the return rate in the worst-case scenario?
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What does sensitivity analysis primarily highlight regarding projected unit sales?
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In the context of sensitivity analysis, what is indicated by a steeper line when plotting NPV against unit sales?
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What does simulation analysis primarily evaluate?
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What might be a challenge when performing simulation analysis?
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What is a limitation of sensitivity analysis?
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Why is sales volume challenging to forecast when launching new products?
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In the example given for Bard Ventures, how does NPV change when the price per ton increases from $19 to $30?
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What does the average NPV reflect in simulation analysis?
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What happens to the cash flow during a period when a project breaks even on an accounting basis?
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What is the relationship between a project's payback period and its life when the project breaks even every period?
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If a project sells 60 boats and only breaks even, what will the net income be?
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What is the internal rate of return when a project breaks even on an accounting basis?
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If the total cash flow over a 5-year project is $100,000, what is the annual cash flow if the project breaks even each year?
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What is true about a project that performs better than break-even?
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What will be the result of a project that breaks even on an accounting basis?
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In the given example, what is the annual depreciation expense for the project?
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What does a project's operating cash flow (OCF) consist of?
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At what point does the sales level result in zero operating cash flow?
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What is the significance of financial break-even in project evaluation?
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How is the cash break-even calculated?
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What happens if a project's operating cash flow goes negative?
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What is the purpose of using the annuity factor when calculating financial break-even?
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If the initial investment is $3,500,000 and the required return is 20% for the Wettway Project, what financial measure is being evaluated?
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What does a project that breaks even on a cash flow basis indicate?
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What is indicated by a positive NPV in project evaluation?
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Which of the following factors should not be considered when identifying relevant cash flows?
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What does GIGO risk refer to in DCF analysis?
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What does forecasting risk entail in project cash flow estimates?
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In scenario analysis for investment evaluation, what is typically assessed?
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What is the primary concern if a project is identified as having a true positive NPV?
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What are cash break-even points used to determine in project evaluation?
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How does capital rationing impact a company's project acceptance decisions?
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Study Notes
Evaluating NPV Estimates
- The challenge is to determine if the estimated NPV accurately represents the true market value of the project.
- False positives occur when an inaccurate estimate suggests a positive NPV, while false negatives occur when a positive NPV is missed due to errors in estimation.
- Projected cash flows should be viewed as an average of all possible future outcomes based on current information and not expected to be perfect for individual cases.
Scenario Analysis
- Scenario analysis considers various possible outcomes by examining best-case, worst-case, and intermediate scenarios.
- Focusing on reasonably likely outcomes is more informative than focusing on extreme, improbable events.
- This technique helps identify potential risks and opportunities by considering different economic conditions and project performance levels.
Sensitivity Analysis
- Sensitivity analysis investigates how changes in one specific input variable impact the project's NPV while keeping other variables constant.
- It helps identify areas of high forecasting risk by evaluating the NPV's sensitivity to changes in key components of project cash flow.
- High sensitivity to changes in difficult-to-forecast variables indicates a higher level of forecasting risk, highlighting areas where further market research may be warranted.
Simulation Analysis
- Simulation analysis combines scenario and sensitivity analysis to evaluate multiple variables simultaneously.
- It uses random values within specified ranges for relevant components, such as unit sales, price, and variable costs, to generate a range of NPV estimates.
- This approach helps determine the average NPV and distribution of NPVs, which can be used to assess the project's risk and potential return.
Break-Even Analysis
- Break-even analysis helps determine the sales volume needed to cover different types of costs, providing insights into the project's profitability.
- Accounting break-even point is the sales level where the project's net income is zero, but it still generates a positive cash flow.
- Cash break-even point is the sales level where the operating cash flow is equal to zero, meaning the project can cover its fixed operating costs but does not generate any return on the initial investment.
- Financial break-even point considers the opportunity cost of capital and represents the sales level needed to achieve a zero NPV, indicating the project covers all costs and meets the required return on investment.
- Payback period is equal to the project's life if the project breaks even every period, while a project performing better than break-even has a shorter payback period.
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Description
This quiz explores the evaluation of Net Present Value (NPV) estimates and the techniques of scenario and sensitivity analysis. Understand the implications of false positives and negatives in NPV estimation, and learn how different scenarios can project risks and opportunities in a project. Test your knowledge on how these methods contribute to accurate financial decision-making.
