Chapter 21 - Answer

Solutions Manual CHAPTER 21

FI NANCI AL RI SK MANAGEME MENT

SUGGESTED ANSWERS TO THE R EVIEW EVIEW QUESTIONS AND PROBLEMS I.

Questions

1. Refe Referr to to page page 520. 520. 2. Refer Refer to pages pages 520 throug through h 521 521.. 3. Refe Referr to to page page 521. 521. 4. Refer Refer to pages pages 522 throug through h 523 523.. 5. Refer Refer to pages pages 524 throug through h 527 527.. 6. Refe Referr to to page page 532. 532. 7. Refer Refer to pages pages 527 though though 528. 528. 8. Refer Refer to pages pages 537 throug through h 538 538.. 9. Refer Refer to to page pagess 538 538 thro through ugh 539. 539. 10. A decision tree is tree  is an analytical tool used in a prole! in "hich a series of decision has to e !ade at #arious ti!e inter#als$ "ith each decision influenced y the infor!ation that is a#ailale at the ti!e it is !ade. %he decision ranches "ill e dra"n as ro&en lines e!erging fro! s'uare nodes and the outco!es of a trail as solid lines e!erging fro! round nodes. %he s'uare nodes$ fro! "hich the decision ranches are dra"n$ represent the points at "hich decision !a&er selects his decision. %he round nodes nodes repres represent ent the point pointss at "hich "hich the outco! outco!ee of the decision arises. %he decision !a&er has no control o#er the outco!e and can only only esti! esti!ate ate the proa proaili ility ty of the #ariou #ariouss outco outco!es !es actua actually lly occurring. (hen all of the decisions and outco!es ha#e een represented on the tree$ each of the possile routes through tree is considered and the !onetary payoff is sho"n at the end of each route. Any costs incurred y the decisions are indicated along the appropriate ranches. II.  Multiple Choice Questions Questions

21-1

Chat!" #$

1.

Financial Risk Management

)

2.

)

3.

*

III. Problems P"o%l!& $

 Expected Profit: +roduct , -

0.20 / +8$000  0.10 / +5$000  0.30 +11$000  0.20 +14$000  0.20 +17$000 - +7$400

+roduct 

0.15 / +12$000  0.15 / +10$000  0.40 +14$000  0.20 +16$000  0.10 +18$000 - +7$300

-

 Analysis: *ased on the ao#e data$ the choice "ill e !ade for +roduct ,. P"o%l!& #

a

%o rea&/e#en$ the co!pany !ust earn enough total contriution to co#er  its fied costs. %he contriution to fied costs and profits is +2.50 per  unit +6  3.5 per unit. %o rea&/e#en$ sales !ust e as follo"s ontriution re'uired ontriution per unit

-

+34$000 +2.50

-

13$600 units

%he proaility that sales "ill e'ual or eceed 13$600 units is the  proaility that sales "ill e 14$000$ 16$000 or 18$000 units$ "hich is 0.25  0.30  0.20 - 0.75 or 75. 

%o earn profit of +10$000$ the co!pany !ust earn enough contriution to co#er its fied costs +34$000 and then !a&e the profit$ so total contriution !ust e +44$000. %o earn this contriution$ sales !ust e as follo"s +44$000 +2.50

-

17$600 units

%he proaility that sales "ill e'ual or eceed 17$600 units is the  proaility of sales eing 18$000 units$ "hich is 0.20 or 20.

21-2

Financial Risk Management 

Chat!" #$

P"o%l!& '  Sales Volume (units)

 Probability

0.10 0.30 0.30 0.20  0.10 1.00

 Expecte Sales Volume (units)

2$000 6$000 8$000 10$000 14$000

 of contriution ero. %herefore$ the sensiti#ity for proBect cost is +1$112 +12$000



100

-

9.27

(b) !ensitivity for Annual Cas "nflo# Cf the present #alue of annual cash inflo" is lo"er y +1$112$ the =+ of the  proBect "ill eco!e >ero. %herefore$ the sensiti#ity for annual cash flo" is +1$112 +13$112



100

-

8.48

(c) !ensitivity for Cost of Capital