Fabozzi Frank, Peterson Pamela. Financial Management and Analysis Workbook
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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 ______________ equiva-
lent ______________ 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 dif-
ficult to apply as the ______________ value of the cer-
tainty 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 var-
ious ______________ 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
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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 Manage-
ment and Analysis.
1. Define and explain how the range, standard deviation,
and coefficient of variation are used to describe the dis-
persion 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?
PROBLEMS
Refer to Chapter 14, pages 451–481 in Financial Manage-
ment and Analysis.
1. ABC Company’s cost of capital is 15% and uses equity
financing. It is investigating the possibility of investing in
a project that is different from its line of business. ABC
has identified a pure play firm, DEF, Inc., for that particu-
lar project that has an equity beta of 1.36. DEF has a
45% debt to equity ratio and has a 35% marginal tax
rate. What rate of return should ABC use to evaluate tak-
ing on the project if the relevant risk-free rate is 5.5% and
the market risk premium is 12%?
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134 QUESTIONS AND PROBLEMS
2. Consider the following cash flows for Projects A and B.
a. What are the cash flows range for each project?
b. What is the expected cash flow for each project?
Project A Project B
Probability Cash Flow Probability Cash Flow
0.25 $1,300 0.30 $3,000
0.40 $1,500 0.25 –$1,000
0.35 $800 0.45 $1,500
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Capital Budgeting and Risk 135
c. What is the standard deviation of the possible cash flows
for each project?
d. What is the coefficient of variation for each project?
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136 QUESTIONS AND PROBLEMS
e. Assume a firm is trying to decide between these two
projects and uses a 13% required rate of return to evalu-
ate all the projects having a coefficient of variation of less
than 0.5 and an 18% required rate for those projects
with coefficients greater than 0.5. Project A requires an
initial outlay of $2,000, whereas Project B costs $1,000.
Each project is expected to have a five-year life. Which
project should be undertaken if the projects are mutually
exclusive?
f. Conduct a sensitivity analysis on Project B making each
of the following changes:
■
Change the discount rate to 19%.
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Capital Budgeting and Risk 137
■
Change the initial outlay to $ 1,800.
■
Change the expected cash flows to $1,000.
■
Assume all these changes occur at the same time.
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CHAPTER
15
139
Intermediate and Long-Term Debt
FILL IN THE BLANKS
Refer to Chapter 15, pages 487–527 in Financial Manage-
ment and Analysis.
1. The amount borrowed in a(n) ______________ is called the
______________ and is repaid either at the ______________
of the period or at regular ______________ during this
period. The ______________ or note holder or
______________ receives ______________ as compensation.
For some types of debt the ______________ is paid periodi-
cally, and for other types is paid at the ______________ of
the debt period. The interest rate can be a(n)
______________ rate or a(n) ______________ rate which is
popularly referred to as a(n) ______________ rate.
2. Debt backed by ______________ is called ______________
debt and the property is ______________ or
______________. If there is no security, the creditor relies
entirely on the ______________ of the borrower to make
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