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Finance Quiz: Ultimate Exam Questions!

Question 1 of 3

Q1 . Sensitivity analysis can be used to identify the variables most crucial to a project's success.

Q2 . Most companies require appropriation requests for each proposal, including detailed forecasts, discounted-cash-flow analyses, and back-up information.

Q3 . If only one variable is uncertain, sensitivity analysis gives "optimistic" and "pessimistic" values for a project cash flow and NPV.

Q4 . The break-even sales level of a project is higher when breakeven is defined in terms of NPV rather than accounting income.

Q5 . Monte Carlo simulation can be used to help forecast cash flows.

Q6 . Decisions trees can help identify and describe real options.

Q7 . A decision tree is a diagram of sequential decisions and their possible outcomes, including competitors' possible responses to those decisions.

Q8 . The company's cost of capital is the cost of debt of the firm.

Q9 . Project sponsors are likely to be overoptimistic.

Q10 . Fudge factors in discount rates are dangerous because they displace clear thinking about future cash flows.

Q11 . Operating leverage refers to the proportion of fixed and variable operating costs in a project's operation. Operating leverage increases the variability of outcomes.

Q12 . A business with high fixed costs is said to have high operating leverage. Operating leverage is usually defined in terms of accounting profits rather than cash flows and is measured by the percentage change in profit for each 1% change in sales. The Degree of Operating Leverage (DOL) = % change in profits / % change in sales.

Q13 . The Monte Carlo simulation is a tool for considering all possible combinations, thus inspecting the entire distribution of project outcomes.

Q14 . The cost of capital is estimated as a blend of the cost of debt (the interest rate) and the cost of equity (the expected rate of return demanded by investors in the firm's common stock).

Q15 . The main categories of real options include expansion options, abandonment options, timing options, and options providing flexibility in production.

Q16 . It is generally more accurate to estimate an "industry beta" for a portfolio of companies in the same industry than to estimate beta for a single company in that industry.

Q17 . Postaudits identify problems that need fixing, check the accuracy of forecasts, and suggest questions that should have been asked before the project was undertaken.

Q18 . Real options are options on real assets. Real options benefit from managerial flexibility in anticipating and responding to uncertainty. Opportunities to modify projects as the future unfolds are known as real options.

Q19 . Each project should be evaluated at its own opportunity cost of capital. The true cost of capital depends on the use to which the capital is put.

Q20 . The model's results are only as good as the model. Focus on the model's assumptions.

Q21 . Capital budgets and project authorizations are mostly developed "bottom-up." Strategic planning is a "top-down" process.

Q22 . Empirical tests confirm that companies with high operating leverage actually do have high betas.

Q23 . The company cost of capital is defined as the expected return on a portfolio of all the company's existing securities.

Q24 . Managers sometimes prefer to ask how bad sales can get before the project begins to lose money. This exercise is known as a break-even analysis.

Q25 . A diversifiable risk has no effect on the risk of a well-diversified portfolio and therefore no effect on the project's beta. If a risk is diversifiable it does not change the cost of capital for the project. However, any possibility of bad outcomes does need to be factored in when calculating expected cash flows.

Q26 . In negative abandonment, you have to pay to get rid of the project.

Q27 . The blended measure of the company cost of capital is called the weighted-average cost of capital or WAACC.

Q28 . The appropriate hurdle rate for capital budgeting decisions is ______

Q29 . The company cost of capital is not the correct discount rate if the new projects are more or less risky than the firm's existing business.

Q30 . The noise in returns can obscure the true beta.

Q31 . Projects with higher operating leverage (higher ratio of fixed costs to project value) tend to have higher betas.

Q32 . Cash Flow = revenue - fixed costs - variable costs.

Q33 . The capital budget is a list of investment projects planned for the coming year.

Q34 . You should compare your company to an industry portfolio rather than a competitor.

Q35 . The option to expand increases PV.

Q36 . Adding fudge factors to discount rates undervalues long-lived projects compared with quick payoff projects.

Q37 . Cyclicality: Firms that vary positively with the business cycle tend to have higher betas.

Q38 . Although scenarios allow you to strategically think about how you might structure operations and adapt to changing circumstances, they cannot depict the true range of possible outcomes.

Q39 . PV(asset) = PV(revenue) - PV(fixed costs) - PV(variable costs)

Q40 . Portfolio betas are more precise than individual asset betas.

Q41 . Brealey, Myers, and Allen's second law state that the proportion of proposed projects having positive NPVs at the corporate hurdle rate is independent of the hurdle rate.

Q42 . The company cost of capital is the correct discount rate for all projects because the high risks of some projects are offset by the low risk of other projects.

Q43 . Only non-diversifiable risks affect the cost of capital.

Q44 . NPV should represent your best guess, so do not add fudge factors to cash flows or the cost of capital.

Q45 . The company cost of capital is the appropriate discount rate for a firm's ______