Project analysis

Question 1

What do we calculate when we compute the net present value (NPV) of a project?

Answer 1

Free cash flows (FCF)

Question 2

What is a FCF?

Answer 2

Amount generated by the project itself (+ ou -)

Question 3

What is excluded from the FCF?

Answer 3

1. Non-cash accounting items (depreciation)
2. CF from financing used to support the project.
3. Loan and interest on the loan

Question 4

What is the cost of capital?

Answer 4

Interest rate used to calculate the NPV.

Return on the project that investors need to invest in the project.

Question 5

What is a formula for a perpetuity with a growth rate of g?

Answer 5

1/(i-g)

Question 6

What is break-even analysis?

Answer 6

Determining the value of each assumption parameter for which the NPV = 0 assuming that the other parameters are at their baseline value.

Question 7

What is the internal rate of return (IRR)?

Answer 7

Alternative risk measure to the the NPV

IRR is the highest interest rate for which the company breaks even (NVP at least 0)

Question 8

What is sensitivity analysis?

Answer 8

Calculating the change in the NPV resulting from a change in a parameter. This analysis shows which parameter has the greatest impact on the NPV

Question 9

How does sensitivity analysis works?

Answer 9

Calculate the NPV for the parameter set to its worst scenario and to its best scenario. Then find the range for the NPV.

Question 10

What is scenario analysis?

Answer 10

Calculating the NPV for various scenarios where MORE THAN ONE parameter is changed. Sometimes parameters are correlated and should not be analyzed separately.

Question 11

Name four risk measure.

Answer 11

1. Variance
2. Semi-variance
3. Value at risk (VaR)
4. Tail value at risk (TVaR)

Question 12

How do you calculate the volatility ?

Answer 12

Square root of the variance.

Question 13

What is the use of the downside semi-variance?

Answer 13

We are more concerned with underperformance. The DSSM considers the squared difference from the mean ONLY when that difference is negative.

Question 14

What is the VaR?

Answer 14

VaR at level alpha is the 100(alpha)th percentile.

Question 15

Is alpha high or low when calculating the VaR for profits or rates of return?

Answer 15

LOW. The risk for those parameters is when the values are low.

Question 16

Is alpha high or low when calculating the VaR for the aggregate insurance loss?

Answer 16

HIGH. The risk for that parameter is when the values are high.

Question 17

What does the TVaR measures?

Answer 17

The severity of the downside risk in the remaining alpha of the time. (VaR identifies the amount which returns or profits will exceeds (1-alpha) of the time.

Question 18

What are the 4 desirable properties for a risk measure to be coherent?

Answer 18

1. Translation invariance
2. Positive homogeneity
3. Subadditivity
4. Monotonicity

Question 19

Describe subadditivity.

Answer 19

The risk measure for X+Y should not be greater that the sum of the risk measure for X and Y separately.
G(X+Y) < G(x) + G(Y)

Question 20

Describe monotonicity.

Answer 20

If P(X > Y) = 1 then G(X) > G(Y)

Question 21

What is a coherent risk measure? Give an example.

Answer 21

A risk measure is coherent if it satisfies all 4 properties. TVaR is coherent.

Question 22

What property is never satisfied in the variance (and semi-variance)?

Answer 22

Monotonicity : a risk measure with variance (or semi-variance) in its formula is NEVER coherent.

Question 23

What property is not satisfied in the VaR? When is the VaR coherent?

Answer 23

Subbaditivity. When the distribution is normal, the VaR is coherent.