Cma-P3-Su20

Front 1

An investor uses risk analysis to measure the probability of the variability of future returns from a proposed investment. What is the approach that
is based upon utility theory and compels the decision maker to choose at what point he or she is indifferent to the choice between a certain
amount of money and the expected value of a risky amount?


A- Capital Asset Pricing Model
B- Certainty equivalent adjustments
C- Risk-adjusted discount rates
D- Sensitivity analysis

Back 1

Strategic pon utility theory and compels the decision maker to choose at what point he or she is indifferent to the choice between a certain Certainty equivalent adjustments is a risk analysis technique that is based upon utility theory. The utility is how much a certain sum of money is worth to the investor. It makes the decision maker stipulate at what point he or she is indifferent to the choice between a certain amount of money and the expected value of a risky amount.

The amount of payoff (e.g., money or utility) that an investor would have to receive between that payoff and a given risk or gamble is called that gamble's certainty equivalent. For a risk averse investor the certainty equivalent is less than the expected value of the gamble because the investor prefers to reduce uncertainty.

A certainty equivalent represents the maximum amount we are willing to pay for some gamble. It is also the minimum premium we are willing to pay to insure against some risk.

Front 2

In linear programming, the shadow price refers to the:


A- measurement of the value of relaxing a constraint in a problem with dual variables.

B- marginal change in profit associated with a change in the contribution margin of one of the variables.

C- unused capacity available once the optimal solution is obtained.

D- variables that are included in the final solution of the linear programming model.

Back 2

The use of shadow prices is simply a kind of sensitivity analysis, which is any kind of analysis that determines what degree of change occurs on a result by changing any one of the variables. A shadow price is the amount by which the optimal solution of an objective function in a linear programming problem changes if a single-unit change is made in a constraint.

Front 3

Andrew Corporation is evaluating a capital investment that would result in a $30,000 higher contribution margin benefit and increased annual
personnel costs of $20,000. The effects of income taxes on the net present value computation on these benefits and costs for the project are to:


A- decrease both benefits and costs.
B- have no net effect on either benefits or costs.
C- decrease benefits but increase costs.
D- increase benefits but decrease costs.

Back 3

Cash flows are relevant in capital investment decision situations. The generation of $30,000 additional contribution margin considered here will result in Andrew's having to pay income tax on this amount, thereby the net benefit and its present value. Going the other way, an increase of $20,000 in personnel costs will be partially offset by its tax deductibility its net present value. In short, income taxes reduce the net amount of both inflows and outflows!

Front 4

A measure of project risk is provided by the capital budgeting technique of:


A- net present value.
B- internal rate of return.
C- accounting rate of return.
D- payback.

Back 4

D is correct

The payback capital budgeting technique indicates how soon a project will recover its cost. The sooner the cost is recovered, the less risky the project returns are less knowable the further in the future they are.

Front 5

Using a real options approach in capital investments planning helps managers in dealing with which of the following?


A- Competitors
B- Prolonged strikes
C- Tax issues
D- Uncertainty

Back 5

D is correct.

The major benefit of using a real options approach is its effectiveness in dealing with uncertainty.

An investment is considered similar to acquisition of stock using options. The option is purchased but will be exercised only if investment in the
related shares of stock appears profitable. If not, the option is not exercised and the potential loss minimized. Capital investment projects can be dealt with similarly.

Front 6

Which of the following methods is commonly used as a method for valuing real options?

A- Monte Carlo simulation
B- Input-output tables
C- Decision tree analysis
D- Black-Scholes equation

Back 6

B is correct.

The four methods that are commonly used for valuing real options are the:

1. Black-Scholes formula,
2. binomial lattice,
3. decision tree, and
4. Monte Carlo simulation.

Front 7

Which of the following is a type of real option?


A- An entry or growth option
B- A timing option
C- An exit or abandonment option
D- A momentum option

Back 7

D is correct.

An is the equivalent of a call option on the right to undertake new investments in new or uncertain businesses. Examples
would include R&D spending or the purchase of drilling rights on oil and gas in some geographic area.


A creates the right to delay or accelerate a particular activity. For example, assume that your demand has been growing and
thereby putting pressure on capacity. You are concerned that future demand is uncertain and you might wish to consider negotiating an outsourcing contract for manufacturing which would give you the right to defer the decision to expand capacity until you are more certain that the demand increase is permanent.

An is like a put option that would provide the firm with the right to sell an asset. An example would be a termination clause in a business contract. This option is designed to help a firm avoid becoming stuck in an unattractive business without a viable exit. An example of a firm in such a situation might be a gasoline station which cannot be sold because doing so would trigger environmental cleanup obligations for the buyer.