ADVANCED FINANCIAL MANAGEMENT QUESTION AND ANSWERS PART ONE

 

ANSWER 1


(a) Limitations of utility analysis


It is difficult to specify the utility function for a group of individuals who have
different risk attitudes.


In reality, utility is not measurable in numerical terms as assumed by the utility
theory. It’s more of a quantitative factor than qualitative.


It is difficult to specify the utility functions especially due to conflict of interest
between shareholders and managers who have different risk attitudes.





The utility function is only applicable at one point in time. In practice the utility of
the investor will keep on changing, a factor which renders utility theory meaningless

ANSWER 2


a) Roles played by sensitivity analysis:


It identifies critical variables that require further analysis or consideration in
project appraisal.


Sensitivity analysis improves management by exception by allowing the finance
manager to focus only on the critical variables (sensitive variables)


Sensitivity analysis helps in exposing inappropriate forecasts.


Sensitivity analysis provides information on the risk of the project


ANSWER 3




(a)
Sensitivity analysis – This a tool that allows exploration of the impact of individual
assumptions on a decision variable, such as project’s NPV by determining the effect
of changing one variable while holding all others fixed
Scenario analysis – a more complex form of sensitivity analysis that provides for
calculating the decision variable, such as NPV when a whole set of assumptions
change in a particular way

 

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