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Chapter 14:   Risk and Managerial Options in Capital Budgeting

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1. An investment project whose expected returns have a standard deviation of zero would be considered very risky.

2. There is approximately a 95% probability that the actual value (outcome) will be within two standard deviation of the expected value of a normal distribution.

3. The greater the variability of a project's cash flows, the riskier the project -- considered by itself -- is said to be.

4. "Independent cash flows" means that the outcome in time period t is not dependent upon the outcome of the t-1 flow.

5. When using a probability-tree approach to calculate "expected NPV," we typically use the risk-free rate to discount the cash flows.

6. By accepting projects with relatively high degrees of positive correlation with other company projects, a firm may be able to lower its risk.

7. The variance of the portfolio's probability distribution of possible net present values is just the sum of the variances of the individual projects.

8. Even though a project is profitable, it may make sense to abandone it if its abandonment value is sufficiently high.

9. A managerial option is simply the flexibility of management to change a previously made decision.

10. If the calculated net present value of a project is less than zero, this is a clear signal to reject the project, regardless of whether or not managerial options are present.

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