Sample Question L1.3. A corporation is faced with the decision to choose between the two following projects:

Project   Investment   Perpetual Annual Cash Flow   Cash Flow at Risk
A             100                     20                                     50
B               80                     55                                     200

Assuming that there is no systematic risk and the projects are mutually exclusive, under what circumstances would project A be selected over project B? [source: FRM 2010 practice exam]

• a.  Project A should never be chosen because it requires a larger initial investment and generates lower perpetual annual cash flows.
• b.  Project A could be preferred over Project B if Project A’s cash flows are negatively correlated with the firm’s existing cash flows while the cash flows of Project B are highly positively correlated with the firm’s existing cash flows.
• c.  Project A should be chosen if the opportunity cost of funds is low, and Project B should be chosen otherwise.
• d.  Project A should be chosen if the net present value of the project is positive.

[my adds]

3.2. If the confidence level is 95%, what are the implied project cash flow volatilities?
3.3 Is Stulz CFaR a relative or absolute VaR?
3.4 The question says “assuming there is no systematic risk…” What does that imply about beta? Are there any non-zero betas to be found?

Answers:

• Here in forum

See the following related questions and/or threads at the bionicturtle.com forum:

• CFaR vs VaR
• NPV of huge project
• Beta is one measure with many faces

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