Finance 6301 - Chapter 9
Compute the depreciation tax shield based on the following information: EAC = $740,000; Fixed costs = $950,000; Depreciation expense = $475,000; Tax rate = 24 percent. 1. $114,000 2. $291,600 3. $63,600 4. $361,000
1. $114,000 Reason: .24 × $475,000 = $114,000
What is next year's expected cash flow if there is a 50/50 probability that it will be either $10 million or $60 million? 1. $35 million 2. $30 million 3. $40 million 4. $70 million
1. $35 million Reason: Expected cash flow = .5 × $10 million + .5 × $60 million = $35 million
Your manager has developed the following pricing equation: Price = Base price + $2 × Industry sales (in thousands) +/- $5 If the base price is $30 and industry sales are $2,000, the higher price, according to the model, would be 1. $39. 2. $20. 3. $29. 4. $69.
1. $39. Reason: $29 is the lower price. The higher price is: $30 + (2 × 2) + 5 = $39
Your manager has developed the following pricing equation: Price = Base price + $3 × Industry sales (in thousands) +/- $7 If the base price is $45 and industry sales are $5,000, the lower price, according to the model, would be 1. $53. 2. $38. 3. $60. 4. $67.
1. $53. Reason: $29 is the lower price. The higher price is: $45 + (3 × 5) - 7 = $53
A project requires an initial investment of $250,000. There is a 30 percent probability of success with a $1.2 million cash flow next year. If the project fails, the project will not generate any cash flows. What is the NPV if the discount rate is 15 percent? 1. $63,043 2. $950,000 3. -$250,000 4. $186,957
1. $63,043 Reason: NPV = -$250,000 + (.3 × $1,200,000)/1.15 = $63,043
The marketing department has projected that the firm's market share will be 15 percent of industry sales. Industry sales should total 30,000 units. If the price per unit is $150, the firm's expected sales revenue will be _______. 1. $675,000 2. $525,000 3. $4,500,000 4. $3,825,000
1. $675,000 Reason: .15 × 30,000 × $150 = $675,000
Which of the following represents the accounting profit break-even point? 1. (Fixed costs + Depreciation)/Contribution margin 2. Depreciation/Contribution margin 3. Fixed costs/Contribution margin 4. Total taxes/Contribution margin
1. (Fixed costs + Depreciation)/Contribution margin
Compute the NPV of a project that has the following end-of-year cash flow projections: Year 1 = $40,000; Year 2 = $50,000; Year 3 = -$22,000. The project requires an initial investment of $75,000 and has a discount rate of 10 percent. 1. -$13,843 2. $19,215 3. $21,156 4. -$7,409
1. -$13,843 Reason: NPV = -$75,000 + $40,000/1.1 + $50,000/1.1^2 + (-$22,000/1.1^3) = -$13,843
What is the total number of inputs that change while doing sensitivity analysis? 1. 1 2. 0 3. All inputs change
1. 1
Which of the following could make purchasing vacant land with no source of revenue a positive business decision? 1. A timing option 2. A sentimental attachment to the land by the CEO 3. Federal regulations will make the land less valuable in the future.
1. A timing option
Which of the following is the final step in the Monte Carlo method? 1. Calculate NPV 2. The Computer Draws One Outcome 3. Specify a Distribution for Each Variable in the Model 4. Specify the Basic Model
1. Calculate NPV
Which of the following defines the contribution margin? Ignore taxes. 1. Contribution Margin = Sales - Variable costs 2. Contribution Margin = Sales + Interest income 3. Contribution Margin = Sales + Capital gains 4. Contribution Margin = Sales - Fixed costs
1. Contribution Margin = Sales - Variable costs
Select all that apply Which costs are included in the numerator of the accounting profit break-even point equation? 1. Depreciation 2. Sunk costs 3. Fixed costs 4. Variable costs
1. Depreciation 3. Fixed costs
Select all that apply Which of the following are benefits of performing sensitivity analysis? 1. It can indicate whether NPV analysis should be trusted. 2. It prevents making the wrong decision. 3. It shows where more information is needed. 4. It eliminates all errors in the estimates.
1. It can indicate whether NPV analysis should be trusted. 3. It shows where more information is needed.
Select all that apply What are the two main drawbacks of sensitivity analysis? 1. It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive. 2. It does not consider interaction among variables. 3. It considers the effects of interactions among variables. 4. It is easy to compute.
1. It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive. 2. It does not consider interaction among variables.
Select all that apply Which of the following costs relating to a doctor's office are variable costs? 1. Lab reports for patients 2. Secretary's salary 3. Rent for the medical office 4. Medical supplies
1. Lab reports for patients 4. Medical supplies
Which of the following is the most complex technique for capital budgeting analysis? 1. Monte Carlo simulation 2. Sensitivity analysis 3. Break-even analysis 4. Scenario analysis
1. Monte Carlo simulation
Select all that apply Which of the following are reasons why NPV is considered a superior capital budgeting technique? 1. NPV considers time value of money. 2. NPV results in only one rate of return. 3. NPV properly discounts earnings. 4. NPV considers all the cash flows.
1. NPV considers time value of money. 4. NPV considers all the cash flows.
Select all that apply Which of the following are true of NPV analysis? 1. Side effects are included. 2. Opportunity costs are excluded. 3. Sunk costs are excluded. 4. Opportunity costs are included. 5. Side effects are excluded. 6. Sunk costs are included.
1. Side effects are included. 3. Sunk costs are excluded. 4. Opportunity costs are included.
Select all that apply Which of the following are steps involved in performing a Monte Carlo simulation? 1. Specifying a distribution for each variable in the model 2. Calculating NPV 3. Specifying a model 4. Drawing the decision tree 5. Generating outcomes
1. Specifying a distribution for each variable in the model 2. Calculating NPV 3. Specifying a model 5. Generating outcomes
Select all that apply Which of the following is true of the Monte Carlo model? 1. The basic property of the model is repeated outcomes. 2. The basic output for the model is a distribution of cash flow for each future year. 3. The basic output for the model is a distribution of cash flow for each past year. 4. The basic property of the model is a single outcome.
1. The basic property of the model is repeated outcomes. 2. The basic output for the model is a distribution of cash flow for each future year.
Select all that apply The present value break-even point differs from accounting profit break-even point for the following reasons: 1. The present value break-even point adjusts for the depreciation tax shield benefit. 2. The present value break-even point ignores taxes. 3. The present value break-even point considers the opportunity cost of the initial investment. 4. The present value break-even point does not differ from the accounting profit break-even point.
1. The present value break-even point adjusts for the depreciation tax shield benefit. 3. The present value break-even point considers the opportunity cost of the initial investment.
Select all that apply Which of the following are true of decision trees? 1. They are a device for identifying sequential decisions in NPV analysis. 2. Decisions are made in reverse order. 3. They ignore preliminary cash outflows. 4. They use non-discounted cash flows to make decisions.
1. They are a device for identifying sequential decisions in NPV analysis. 2. Decisions are made in reverse order.
What is the purpose of accounting profit break-even analysis? 1. To determine the level of sales at which profits are equal to zero. 2. To determine the maximum number of units that can be produced in a plant. 3. To determine the level of sales at which variable costs are fully recovered. 4. To determine the level of sales at which profits generate the minimum rate of return expected by shareholders.
1. To determine the level of sales at which profits are equal to zero.
True or False: Many capital budgeting approaches, including NPV, ignores real options. 1. True 2. False
1. True
True or False: While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time. 1. True 2. False
1. True
Contribution margin refers to the contribution made by each additional unit sold to 1. aftertax profits. 2. pretax sales. 3. dividends. 4. taxes.
1. aftertax profits.
A Monte Carlo simulation analyzes 1. the expected NPV by determining a probability distribution for each variable. 2. the impact on NPV when one of the underlying variable changes. 3. the impact on NPV under specific scenarios. 4. the sensitivity of NPV to external factors.
1. the expected NPV by determining a probability distribution for each variable.
The contribution margin per unit will increase if 1. the sales price per unit increases while the variable cost per unit decreases. 2. the sales price per unit decreases while the variable cost per unit increases. 3. fixed costs decrease. 4. both the sales price per unit and the variable cost per unit increase.
1. the sales price per unit increases while the variable cost per unit decreases.
What is next year's expected cash flow if there is a 30 percent probability that the cash flow will be $10 million and a 70 percent probability that the cash flow will be $1 million? 1. $1 million 2. $3.7 million 3. $3 million 4. $10 million
2. $3.7 million Reason: Expected cash flow = .3 × $10 million + .7 × $1 million = $3.7 million
What is the contribution margin if the sales price per unit is $15,000, variable cost per unit is $10,000, and fixed costs are $2,000? Ignore taxes. 1. $13,000 2. $5,000 3. $25,000 4. $3,000
2. $5,000 Reason: CM = Sales price - Variable cost = $15,000 - 10,000 = $5000
A project requires an initial investment of $500,000. There is a 20 percent probability of success with a $2 million cash flow next year. If the project fails, the project will not generate any cash flows. What is the NPV if the discount rate is 10 percent? 1. -$100,000 2. -$136,364 3. $1.5 million 4. $363,636
2. -$136,364 Reason: NPV = -$500,000 + (.2 × $2,000,000)/1.1 = -$136,364
What is the basic output of a Monte Carlo simulation? 1. A single cash flow for each future year 2. A distribution of cash flows for each future year 3. A probability of success for each future year A4. single net present value estimate
2. A distribution of cash flows for each future year
What are real options? 1. The NPV of a capital budgeting project stated in real dollars. 2. Adjustments that a firm can make after a project is accepted. 3. The value of stock options awarded to project managers. 4. The NPV of a project under conditions of absolute certainty using the risk-free rate as the discount rate.
2. Adjustments that a firm can make after a project is accepted.
Select all that apply Which of the following statements are true regarding fixed and variable costs? 1. Both the fixed costs per unit and the variable costs per unit will decrease as the level of output increases. 2. Fixed costs per unit will decrease while variable costs per unit will stay constant if the level of output increases. 3. Fixed costs per unit and variable costs per unit will increase if the level of output increases. 4. Total fixed costs remain constant while total variable costs increase if the level of output increases.
2. Fixed costs per unit will decrease while variable costs per unit will stay constant if the level of output increases. 4. Total fixed costs remain constant while total variable costs increase if the level of output increases.
Which of the following can be used to calculate annual costs needed for the first step of the Monte Carlo model? 1. Fixed manufacturing costs + Variable manufacturing costs - Marketing and selling costs 2. Fixed manufacturing costs + Variable manufacturing costs + Marketing and selling costs 3. Fixed manufacturing costs + Variable manufacturing costs + Marketing and selling costs + Initial investment 4. Fixed manufacturing costs + Variable manufacturing costs
2. Fixed manufacturing costs + Variable manufacturing costs + Marketing and selling costs
Select all that apply What are the two main benefits of performing sensitivity analysis? 1. It makes it possible to make a correct decision every time. 2. It reduces a false sense of security by giving a range of values instead of a single value. 3. It is easier to perform than conventional NPV analysis. 4. It identifies the variable that has the most effect on NPV.
2. It reduces a false sense of security by giving a range of values instead of a single value. 4. It identifies the variable that has the most effect on NPV.
Which of the following addresses real-world uncertainty to the greatest extent? 1. Scenario analysis 2. Monte Carlo simulation 3. Sensitivity analysis 4. Accounting break-even
2. Monte Carlo simulation
Select all that apply Which of the following pieces of information are required in order to compute NPV? 1. Projected future debt costs. 2. The discount rate. 3. Projected future cash flows. 4. The time horizon of the project.
2. The discount rate. 3. Projected future cash flows. 4. The time horizon of the project.
Which of the following is an example of a timing option? 1. Disposing of a piece of property in an area where development prospects have failed to materialize. 2. Waiting to build a convenience store in an area where several housing developments have been proposed. 3. Building a gas station and waiting to see if that gas station is successful before building additional stations.
2. Waiting to build a convenience store in an area where several housing developments have been proposed.
A decision tree involves 1. depicting the decision-making process in a firm using an organizational chart. 2. mapping the sequential outcomes of various decisions and corresponding probabilities. 3. determining the number of decisions that need to be made before a product can be approved. 4. mapping a strategy for dealing with the competition.
2. mapping the sequential outcomes of various decisions and corresponding probabilities.
A firm will start generating positive profits when 1. total revenue exceeds the total fixed costs. 2. the total number of units sold exceeds the accounting break-even point. 3. total variable costs exceed total fixed costs. 4. total revenue exceeds the initial investment required to generate that revenue.
2. the total number of units sold exceeds the accounting break-even point.
An accounting break-even point of 1,000 means that 1. the total fixed costs are equal to $1,000. 2. when the firm sells 1,000 units, profits will be equal to zero. 3. he maximum capacity of the plant is 1,000 units. 4. when the firm generates costs of $1,000, profits will be equal to zero.
2. when the firm sells 1,000 units, profits will be equal to zero.
Compute the expected total revenues based on the following projections: Market size = 7,000 machines; Market share = 20 percent; Price per machine = $15,000. 1. $24,000,000 2. $84,000,000 3. $21,000,000 4. $15,000,000
3. $21,000,000 Reason: 7,000 × .2 × $15,000 = $21 million.
You are in the business of manufacturing dog collars. The estimated variable costs for each of the collars is $3.75. Fixed costs for the month are $3,000. What will be the total monthly costs if you manufacture 1,200 collars? 1. $3,000 2. $4,500 3. $7,500 4. $1,500
3. $7,500 Reason: Total variable costs = $3.75 × 1,200 = $4,500 Total fixed costs = $3,000 Total costs = $4,500 + $3,000 = $7,500
Compute net accounting profit based on the following information: sales revenue = $50,000; variable costs = $35,000; fixed costs = $5,000; depreciation expense = $1,000; and tax rate = 15%. 1. $8,500 2. $9,000 3. $7,650 4. $8,865
3. $7,650 Net profit = 50,000 - 35,000 - 5,000 - 1,000 - 1,350 = $7,650.
A firm has a 50 percent probability of obtaining regulatory approval to enter an overseas market. If it enters that market, there is a 20 percent probability of successfully gaining significant market share. What is the probability of successfully entering the overseas market? 1. 8% 2. 1% 3. 10% 4. 20%
3. 10% Reason: Probability = .5 × .2 = 10%
Calculate the accounting break-even point for a firm that reports the following information: Sales per unit = $40,000; Variable cost per unit = $25,000; Fixed costs (excluding depreciation) = $960,000; Depreciation = $25,000. 1. 68.31 units 2. 64 units 3. 65.67 units 4. 63.33 units
3. 65.67 units Reason: ($960,000 + 25,000)/($40,000 - 25,000) = 65.67 units
Which one of the following is an example of a situation in which sensitivity analysis increases the false sense of security among managers? 1. All pessimistic estimates of NPV are negative. 2. All optimistic estimates of NPV are negative. 3. All pessimistic estimates of NPV are positive. 4. All optimistic estimates of NPV are positive.
3. All pessimistic estimates of NPV are positive.
Select all that apply Which of the following are true of the option to abandon? 1. Choosing to abandon is cowardly and should be avoided. 2. It decreases the value of any potential project. 3. It increases the value of any potential project. 4. Choosing to abandon can often save companies a large amount of money.
3. It increases the value of any potential project. 4. Choosing to abandon can often save companies a large amount of money.
Which of the following formulas can be used to determine total revenue for a firm using Monte Carlo simulation? 1. Market size × Price per unit 2. Market share × Price per unit 3. Market size × Market share × Price per unit 4. Market size × Market share
3. Market size × Market share × Price per unit
Which of the following statements is true in the context of comparing accounting profit and present value break-even points? 1. Accounting profit is superior because the financial statements report profits and not present value. 2. The superiority of a particular technique will vary from firm to firm depending on the unique circumstances of the firm. 3. Present value is superior to accounting profit because it considers the opportunity cost of the initial investment. 4. Both techniques are equally good.
3. Present value is superior to accounting profit because it considers the opportunity cost of the initial investment.
Select all that apply Which of the following are true of side effects? 1. Side effects are classified as either opportunity costs or sunk costs. 2. Side effects are ignored in NPV analysis. 3. Synergy occurs when a new project increases the cash flows of existing projects. 4. Erosion occurs when a new product reduces sales and cash flows of existing products.
3. Synergy occurs when a new project increases the cash flows of existing projects. 4. Erosion occurs when a new product reduces sales and cash flows of existing products.
A probability distribution 1. shows the expected range of values associated with any variable, such as labor or materials cost. 2. shows the range of values that lie between the average value and the most optimistic value. 3. shows the range of distribution for any variable and assigns probabilities to each value identified within that range. 4. is based on real outcomes.
3. shows the range of distribution for any variable and assigns probabilities to each value identified within that range.
Select all that apply Sensitivity analysis is also known as 1. break-even analysis 2. simulation analysis. 3. what-if analysis. 4. profit and loss analysis. 5. bop (best, optimistic and pessimistic) analysis.
3. what-if analysis. 5. bop (best, optimistic and pessimistic) analysis.
Compute net accounting profit based on the following information: Revenues = $4,000; Variable costs = $1,600; Fixed costs = $700; Depreciation = $300; Tax rate = 20 percent. 1. $1,372 2. $1,400 3. $1,360 4. $1,120
4. $1,120 Reason: Profit = ($4,000 - 1,600 - 700 - 300)(1 - .2) = $1,120
You are in the business of manufacturing watches. The estimated variable costs for each of these watches costs is $25. Fixed costs for the month are $8,000. What will be the total monthly costs if you manufacture 400 watches? 1. $10,000 2. $2,000 3. $8,000 4. $18,000
4. $18,000 Reason: Total variable costs = $25 × 400 = $10,000 Total fixed costs = $8,000 Total costs = $10,000 + $8,000 = $18,000
Consider a project that will payoff $2 million if it is successful and nothing if it is not successful. If the probability of success is 20 percent, what is the project's expected payoff? 1. $0 2. $1,000,000 3. $2,000,000 4. $400,000
4. $400,000 Reason: .2 × $2 million + .8 × $0 = $400,000
Consider a project that will payoff $1.5 million if it is successful and nothing if it is not successful. If the probability of success is 30 percent, what is the project's expected payoff? 1. $1,050,000 2. $0 3. $1,500,000 4. $450,000
4. $450,000 Reason: 0.3 × $1.5 million + 0.7 × $0 = $450,000
Compute the depreciation tax shield based on the following information: Depreciation expense = $40,000; Net profit before depreciation expense = $60,000; Tax rate = 20 percent. 1. $4,000 2. $12,000 3. $5,000 4. $8,000
4. $8,000 Reason:.20 × $40,000 = $8,000
A firm has a 40 percent probability of obtaining approval to enter a new regional market. If it enters that market, there is a 30 percent probability of successfully gaining significant market share. What is the probability of successfully entering the regional market? 1. 1.2% 2. 10% 3. 30% 4. 12%
4. 12% Reason:Probability = .4 × .3 = 12%
Compute the accounting break-even point for a firm reporting the following information: Fixed costs = $50,000; Depreciation = $10,000; Sale price per unit = $50; Variable cost per unit = $30. 1. 2,000 units 2. 1,200 units 3. 2,500 units 4. 3,000 units
4. 3,000 units Reason: ($50,000 + 10,000)/($50 - 30) = 3,000 units
In the context of capital budgeting, what does sensitivity analysis do? 1. It examines the sensitivity of profits to changes in market share. 2. It examines the sensitivity of management to the possibility that a project will be rejected. 3. It examines the increase in the cost of a project when the cost of capital increases. 4. It examines how sensitive a particular NPV calculation is to changes in underlying assumptions.
4. It examines how sensitive a particular NPV calculation is to changes in underlying assumptions.
Which of the following is not true of NPV? 1. It uses cash flows rather than profits. 2. It uses all cash flows. 3. It is a superior capital budgeting technique. 4. It ignores time value of money.
4. It ignores time value of money.
What is the difference between scenario analysis and sensitivity analysis? 1. There is no difference between scenario analysis and sensitivity analysis. 2. Scenario analysis considers only one scenario while sensitivity analysis focuses on interaction among a group of variables. 3. Both scenario and sensitivity analysis focus on examining the impact on NPV if one of the underlying variables changes. 4. Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time.
4. Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time.
What is scenario analysis? 1. Scenario analysis maps out the various steps involved in the manufacturing process. 2. Scenario analysis determines the probability of occurrence of various future events that could affect the project. 3. Scenario analysis determines the impact on NPV of a change in a single variable. 4. Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.
4. Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.
Which of the following is an example of an option to abandon? 1. Withdrawing an offer to take over a firm 2. Ignoring sunk costs when determining the cash flows of a potential project 3. Retaining a project for its planned duration 4. Stopping production of a product if sales fall below a certain level
4. Stopping production of a product if sales fall below a certain level
A firm will start generating positive accounting profits 1. at the point at which revenues exceed total fixed costs. 2. at the break-even sales point. 3. below the break-even sales point. 4. beyond the break-even sales point.
4. beyond the break-even sales point. Reason: A firm will start generating accounting profits beyond the break-even sales point. At the break-even sales level, accounting profit will be zero. Below that number, accounting profit will be negative.
A probability distribution in the context of sales refers to 1. allocating firm sales to various divisions within the firm. 2. determining the probability of reaching a specified sales break-even point. 3. identifying various levels of expected sales. 4. identifying various levels of sales and assigning a probability of occurrence to each level.
4. identifying various levels of sales and assigning a probability of occurrence to each level.
Survey results indicate that the Monte Carlo simulation technique is 1. not used by any firm. 2. used by all firms. 3. used by approximately 50 percent of firms. 4. used by about 15 percent of firms.
4. used by about 15 percent of firms.