Managers are only prepared to invest in certainties
Companies will insure themselves against all possible losses
Investors will require extra returns if they are to take risks
The management of a company have estimated that the NPV they expect on an investment is as follows, Below average rainfall - 2m; Average rainfall - 6m; Above average rainfall - 9m. Probabilities of rainfall are: Below average .1; Average .7; Above average .2. The expected NPV is:
4.2m
5.8m
6.2m
13m
If two projects have the same ENPVs then:
Managers will be indifferent as to which one to select
Both projects will produce the same returns
Managers will take into account the relative return profiles in making their decisions
Nobody could choose between them
Sensitivity analysis is concerned with:
How sensitive managers are to the risk of losses
How sensitive shareholders are to the risk of losses
How sensitive the stock exchange is as regards the company's profits
The aspects of the forecast of project performance that are most significant
A risk premium is:
The amount a company is prepared to pay for insurance.
An additional return required to compensate for risk
An amount paid if a project fails
Compensation received if a project fails
Given the following information:
State
Prob
£NPV
I
.2
+ 200
II
.7
+ 100
III
.1
- 600
What would the maximum value of a survey that could tell you in advance which state of the world would occur?
50
60
70
110
A significant problem in the recognition of the abandonment decision is
It is not always possible to predict the costs of abandonment
It is not always possible to predict the benefits of abandonment
The mathematical approaches used are unreliable
Managers can be reluctant to accept advice based of very complex modelling
A certainty equivalent is:
A guaranteed outcome from gained from inside information.
A lower amount that would be accepted without risk in exchange for a higher, uncertain outcome
A decision technique used in financial services
A guarantee that a project will not fail
A particular advantage of sensitivity analysis is:
It guarantees a positive outcome
It helps managers cope better with uncertain positions
It allows for managers to concentrate on the aspects of a decision that are most likely to cause problems
It is a very straightforward activity
A difference between risk and uncertainty is:
Risk is measureable whilst uncertainty is not
Risk is likely to result in financial loss
Uncertainty only applies to situations that will produce positive results but we don’t know how positive
We can always avoid risk but we cannot always avoid uncertainty