Capital Budgeting and Risk Assignment

Capital Budgeting and Risk Assignment1. Uncertainty arises from different sources, depending on
the type of ______________ being considered, as well as
the circumstances and the ______________ in which it is
operating. Such circumstances include ______________
conditions, ______________ conditions, ______________,
______________ rates, and ______________ conditions.
2. The sources of ______________ influence ______________
cash flows when ______________ the risk of a capital
project. Therefore, there is a(n) ______________ cost to consider: what the suppliers of capital could ______________
elsewhere for the ______________ level of ______________.
This is the required ______________ or cost of
______________ and it contains the ______________ return
necessary to ______________ investors for the risk they
bear, called the ______________ premium.
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128 QUESTIONS AND PROBLEMS
3. A project’s ______________ in isolation from the firm’s
other ______________ is also referred to as the project’s
______________ risk or ______________ risk. Because
most firms have many ______________, the
______________ risk of a project under consideration may
not be the ______________ risk for analysis. A firm is a(n)
______________ of assets, and the ______________ of
these different assets are not perfectly, positively
______________ with one another. The real concern is
with the ______________ of the project to the firm’s
______________ of assets and how it changes the
______________ of the firm’s ______________.
4. Three ______________ measures are used to evaluate the
______________ associated with a(n) ______________ possible outcomes: the ______________, the ______________
______________, and the ______________ of ______________.
The more ______________ or spread out the possible outcomes, the ______________ the degree of ______________
or risk of what is expected in the future.
5. In attempting to asses risk, it is important to perform analyses of the ______________ of cash flows to
______________ in the assumptions by ______________ the
cash flows for different ______________. ______________
analysis, also called ______________ analysis or
______________ analysis, is a method of looking at the
possible ______________, given a change in only
______________ of the factors at a time.
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Capital Budgeting and Risk 129
6. ______________ analysis provides a manageable approach
to changing ______________ or ______________ factors at
the ______________ time. It is ______________ simulation
by developing a(n) ______________ distribution of possible
______________, given a(n) ______________ distribution for
each ______________ that may ______________. With the
help of a computer simulation program, ______________
can be performed calculating ______________ of return that
yield a(n) ______________ distribution of the ______________
on investments.
7. An alternative approach that applies ______________ methods to ______________ assets, known as ______________
valuation (______________), considers the value of a project
that extends ______________ its value as measured by the
______________, meaning the value of project is
______________ by the value of ______________ inherent in
an investment opportunity. These ______________ are to
______________ the project, though there may be constraints (e.g., legally binding contracts) that affect when this
option can be ______________, the option to
______________, and the option to ______________ investment to some ______________ date. Because the options are
______________ decisions, the ______________ net present
value is referred to as the ______________ NPV.
8. The ______________ of stock options is rather complex, but
with the assistance of models such as the ______________
model, option values can be estimated. The ______________
option pricing model contains ______________ factors that
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130 QUESTIONS AND PROBLEMS
are important in the ______________ of an option. The most
______________ and ______________ factor to measure, the
______________ of the value of the underlying asset, directly
affects ______________ key elements of the ______________
value in that the greater the ______________, the greater the
______________ of the option and the greater the
______________ of ______________, which lowers the
______________ NPV.
9. A(n) ______________ equivalent is the ______________
cash flow that is considered to be ______________ to the
______________ cash flow. The ______________ equivalent ______________ of incorporating ______________
into the net present value analysis is useful because it
______________ the time ______________ of money and
______________, allows each ______________ cash flows
to be adjusted separately for ______________, and
______________ for risk can be ______________. It is difficult to apply as the ______________ value of the certainty equivalent is not easily ______________ and there is
no ______________ way of determining the certainty
equivalent value for each ______________ cash flow.
10.Considering the use of a(n) ______________ cost of
______________ and/or similar ______________ for all
projects can be hazardous. When ______________ the various ______________ capital ______________ techniques,
it may result in the ______________ of profitable projects
that have risk below the risk of the average risk project
because of ______________ future cash flows, and
Ch14 Page 130 Tuesday, December 16, 2003 9:11 AM
Capital Budgeting and Risk 131
______________ of unprofitable projects whose risk is
above the risk of the average project, because future cash
flows were ______________.
SHORT ANSWER QUESTIONS
Refer to Chapter 14, pages 451–481 in Financial Management and Analysis.
1. Define and explain how the range, standard deviation,
and coefficient of variation are used to describe the dispersion of future outcomes.
2. What are sensitivity and simulation analyses and when are
they appropriate?
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132 QUESTIONS AND PROBLEMS
3. How does financial leverage affect the measurement of
market risk?
4. If a firm is considering engaging in a new project, how
does it measure the risk for this new project?
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Capital Budgeting and Risk 133
5. How is a firm’s cost of capital generally determined?

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