1. Project A generates $5,000.00 in revenue two years from today and costs $4,000.00. Project B generates $4,000.00 (50% probability) or $6,000.00 (50% probability) one year from today and costs $4,500.00. Assuming a discount rate of 12% for both projects, which project does a risk averse manager prefer?
Project B
Project A
Neither project
Cannot be determined.
2. Why should a risk averse manager select one project over another when both projects generate the same NPV?
Because the manager prefers the project which has more variance in its cash flows.
Because the manager prefers the project with the higher IRR.
Because the manager prefers the project which has higher standard deviation in its cash flows.
Because the manager prefers the project with less risky cash flows.
3. If a low cash flow this year makes a low cash flow next year more likely to occur, this means the project cash flows tend to be ____.
less predictable
more volatile
correlated
independent of each other
4. Suppose a firm builds a plant with more space than the firm currently needs. What type of real option best describes the firm's behavior?
An abandonment option
A contraction option
A land option contract
An expansion option