FI480 EXAM 3 REVIEW QUESTIONS AND
ANSWERS A+ GRADED
Sunk Cost
Outlay related to the project that was incurred in the past and that cannot be recovered
in the future regardless of whether or not the project is accepted
Sunk costs are not
incremental cash flows and thus are not relevant in a capital budgeting analysis
Sensitivity Analysis
measures the change in NPV that results from a given percentage change in one input
variable when other inputs are held at their expected values
Sensitivity Analysis is the
most commonly used type of risk analysis
The __________ the range, the ___________ the variable's slope, and the more
sensitive the NPV is to this variable
larger, steeper
Scenario Analysis
Assumes several possible scenarios, including the inputs and the probability of
occurrence for each scenario. Uses the scenario's inputs to calculate key results (such
as NPV), and then uses the probabilities to estimate the expected value and standard
deviation of each key result.
Standalone principle
Risk an investor would take by holding only one asset
What measures stand alone risk
standard deviation
Stand alone risk reflects the
uncertainty of a projects cash flows
Residual distribution (dividend) model
firms should pay dividends only when more earnings are available than needed to
support the optimal capital budget
4 steps when establishing its target distribution ratio (Residual distribution
(dividend) model)
1. It determines the optimal capital budget
2. It determines the amount of equity needed to finance that budget, given its target
capital structure
3. It uses reinvested earnings to meet equity requirements to the extent possible
4. It pays dividends or repurchases stock only if more earnings are available than are
needed to support the optimal capital budget
Financial risk
the additional risk placed on the common stockholders as a result of the decision to
finance with debt
ANSWERS A+ GRADED
Sunk Cost
Outlay related to the project that was incurred in the past and that cannot be recovered
in the future regardless of whether or not the project is accepted
Sunk costs are not
incremental cash flows and thus are not relevant in a capital budgeting analysis
Sensitivity Analysis
measures the change in NPV that results from a given percentage change in one input
variable when other inputs are held at their expected values
Sensitivity Analysis is the
most commonly used type of risk analysis
The __________ the range, the ___________ the variable's slope, and the more
sensitive the NPV is to this variable
larger, steeper
Scenario Analysis
Assumes several possible scenarios, including the inputs and the probability of
occurrence for each scenario. Uses the scenario's inputs to calculate key results (such
as NPV), and then uses the probabilities to estimate the expected value and standard
deviation of each key result.
Standalone principle
Risk an investor would take by holding only one asset
What measures stand alone risk
standard deviation
Stand alone risk reflects the
uncertainty of a projects cash flows
Residual distribution (dividend) model
firms should pay dividends only when more earnings are available than needed to
support the optimal capital budget
4 steps when establishing its target distribution ratio (Residual distribution
(dividend) model)
1. It determines the optimal capital budget
2. It determines the amount of equity needed to finance that budget, given its target
capital structure
3. It uses reinvested earnings to meet equity requirements to the extent possible
4. It pays dividends or repurchases stock only if more earnings are available than are
needed to support the optimal capital budget
Financial risk
the additional risk placed on the common stockholders as a result of the decision to
finance with debt
