Multiple-Choice Quiz

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Chapter 14: Risk and Managerial Options in Capital Budgeting

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1. The investment proposal with the greatest relative risk would have

the highest standard deviation of net present value.

the highest coefficient of variation of net present value.

the highest expected value of net present value.

the lowest opportunity loss likelihood.

2. Probability-tree analysis is best used when cash flows are expected to be

independent over time.

risk-free.

related to the cash flows in previous periods.

known with certainty.

3. You are considering two mutually exclusive investment proposals, project A and project B. B's expected value of net present value is $1,000 less than that for A and A has less dispersion. On the basis of risk and return, you would say that

Project A dominates project B.

Project B dominates project A.

Project A is more risky and should offer greater expected value.

Each project is high on one variable, so the two are basically equal.

4. If two projects are completely independent (or unrelated), the measure of correlation between them is:

-1

5. Managerial options can be viewed as

methods for reducing agency risk through the use of incentives.

methods for reducing total firm risk through diversification.

strategies for increasing management compensation.

opportunities for altering management decisions in the future.

6. A managerial option, in effect,

limits the flexibility of management's decision-making.

limits the downside risk of an investment project.

limits the profit potential of a proposed project.

applies only to new projects.

7. When using a probability tree approach, we discount the various cash flows to their present value at

the firm's weighted-average cost of capital.

the project's required rate of return.

the risk-free rate.

the after-tax cost of the firm's long-term debt.

8. The presence of managerial, or real, options the worth of an investment project.

increases

decreases

does not affect

increase or decreases

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