True or False?

1. Scenario analysis determines the degree to which the NPV value reacts to a change in a single variable

2. In most cases the net present value break-even quantity is higher than the accounting profit break-even quantity.

3. The real option to abandon a project adds value.

4. According to Modigliani and Miller Proposition II, since the expected rate of return on debt is less than the expected rate of return on equity, the weighted average cost of capital declines as more debt is issued.

5. Financial leverage increases the expected return and risk of the shareholder due to increased business risk.

6. When the costs of financial distress are included, the value of a levered firm is given by Value of levered firm = Value of unlevered firm + PV (tax shield) PV (costs of financial distress).

7. The right to default is valuable to shareholders.

8. According to the trade-off theory, more profitable firms should have more debt and thus higher debt ratios on average.

9. One can estimate the value of a firm by calculating the present value of free cash flows using the WACC (weighted average cost of capital) for the discount rate.

10. The total value of a firm is the present value of its free cash flows minus the present value of its horizon value.

11. If expected long-term growth is constant, the firm's horizon value at period H is given by PVH = (FCFH _{+ 1})/(WACC g).

Multiple Choice:

1. When you assign the lowest anticipated sales price and the highest anticipated costs to a project, you are analyzing the project under the condition known as:

a. best-case sensitivity analysis.

b. best-case scenario analysis.

c. base-case scenario analysis.

d. worst-case scenario analysis.

e. worst-case sensitivity analysis.

2. What are some of the possible consequences of financial distress?

I) Bondholders, who face the prospect of getting only part of their money back, will likely want the company to take additional risks.

II) Equity investors would like the company to cut its dividend payments to conserve cash.

III) Stockholders would like the firm to shift toward riskier lines of business.

IV) Stockholders may turn down low-risk, low-return but positive NPV projects.

I only

II only

III only

I and II only

III and IV only