Chapter 10, Problem 1PS

Terminology* Match each of the following terms to one of the definitions or descriptions listed below: sensitivity analysis, scenario analysis, break-even analysis, operating leverage, Monte Carlo simulation, decision tree, real option, tornado diagram.

1. a. Recalculation of project NPV by changing several inputs to new but consistent values.
2. b. Opportunity to modify a project at a future date.
3. c. Analysis of how project NPV changes if different assumptions are made about sales, costs, and other key variables.
4. d. The degree to which fixed costs magnify the effect on profits of a shortfall in sales.
5. e. A graphical technique for displaying possible future events and decisions taken in response to those events.
6. f. A graphical technique that is often used to display the results of a sensitivity analysis.
7. g. Determination of the level of future sales at which project profitability or NPV equals zero.
8. h. Method for calculating the probability distribution of possible outcomes.

Summary Introduction

To match: The terms with its appropriate definitions.

Explanation of Solution

a) The computation of the NPV of the project by changing various inputs to a consistent and a new values.

Hence, the correct answer is scenario analysis.

b) The chance to change the project on a future date.

Hence, the correct answer is real option.

c) The evaluation of how the NPV of the project changes if varied assumptions are made for costs, sales and any other fundamental variables.

Hence, the correct answer is sensitivity analysis.

d) The extent to which the fixed costs expands the outcome on profits for a shortfall in the sales.

Hence, the correct answer is operating leverage.

e) The graphical method for viewing a possible upcoming decisions and events taken in response for those activities.

Hence, the correct answer is decision tree.

f) A graphical method, which is usually utilized to view the outcome of sensitivity analysis.

Hence, the correct answer is tornado diagram.

g) Identification of the future sales level at which the profitability or NPV of the project is equivalent to zero.

Hence, the correct answer is break-even analysis.

h) The technique of computing the probability distribution of possible results.

Hence, the correct answer is Monte Carlo simulation.