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    Risk and Refinements in Capital Budgeting: Learning Goals

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    Kristel Sumabat
    This chapter discusses approaches for incorporating risk into capital budgeting analysis. It covers breakeven cash flows, sensitivity and scenario analysis, and simulation as tools for dealing with risk. It also addresses risk-adjusted discount rates and selecting projects under capital rationing. Additionally, it discusses unique risks that multinational companies face, such as transfer pricing and exchange rate fluctuations.

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    Risk and Refinements in Capital Budgeting: Learning Goals

    Uploaded by

    Kristel Sumabat
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    This chapter discusses approaches for incorporating risk into capital budgeting analysis. It covers breakeven cash flows, sensitivity and scenario analysis, and simulation as tools for dealing with risk. It also addresses risk-adjusted discount rates and selecting projects under capital rationing. Additionally, it discusses unique risks that multinational companies face, such as transfer pricing and exchange rate fluctuations.

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    This chapter discusses approaches for incorporating risk into capital budgeting analysis. It covers breakeven cash flows, sensitivity and scenario analysis, and simulation as tools for dealing with risk. It also addresses risk-adjusted discount rates and selecting projects under capital rationing. Additionally, it discusses unique risks that multinational companies face, such as transfer pricing and exchange rate fluctuations.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    14 views2 pages

    Risk and Refinements in Capital Budgeting: Learning Goals

    Uploaded by

    Kristel Sumabat
    This chapter discusses approaches for incorporating risk into capital budgeting analysis. It covers breakeven cash flows, sensitivity and scenario analysis, and simulation as tools for dealing with risk. It also addresses risk-adjusted discount rates and selecting projects under capital rationing. Additionally, it discusses unique risks that multinational companies face, such as transfer pricing and exchange rate fluctuations.

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    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
    Learning Goal: 2
    Topic: Recognizing Risk in Capital Budgeting
    414 Gitman • Principles of Finance, Eleventh Edition

    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.
    Answer: FALSE
    Level of Difficulty: 3
    Learning Goal: 2
    Topic: Simulation Analysis

    8. The output of simulation provides an excellent basis for decision making since it allows the decision
    maker to view a continuum of risk-return trade-offs rather than a single-point estimate.
    Answer: TRUE
    Level of Difficulty: 3
    Learning Goal: 2
    Topic: Simulation Analysis

    9. In international trade, transfer prices are prices that subsidiaries charge each other for the goods and
    services traded between them.
    Answer: TRUE
    Level of Difficulty: 2
    Learning Goal: 3
    Topic: International Risk Analysis

    10. The danger that an unexpected change in the exchange rate between the dollar and the currency in
    which a project’s cash flows are denominated can increase the market value of that project’s cash
    flow.
    Answer: FALSE
    Level of Difficulty: 3
    Learning Goal: 3
    Topic: International Risk Analysis

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