FIN Ch 11

As a practical matter, it is easier to ________ operating leverage than it is to ________ it.

increase; decrease

Which of the following is the correct equation for the degree of operating leverage? A) DOL = (1 + FC)/OCF B) DOL = 1 - FC/OCF C) DOL = 1 + FC/OCF D) DOL = 1 + FC x OCF

DOL = 1 + FC/OCF

________ analysis is the investigation of what happens to NPV when only one variable is changed.

Sensitivity

________ analysis uses a combination of scenario and sensitivity analysis.

Simulation

The possibility that errors in projected cash flows will lead to incorrect decisions is known as _____.

forecasting risk or estimation risk

The situation that occurs when a business cannot raise financing for a project under any circumstances is called ________ rationing.

hard

A firm with higher operating leverage will have ______ fixed costs relative to a firm with low operating leverage.

high

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in _____.

scenario analysis asking what-if questions

An accounting break-even point of 1,000 units means that ____.

when the firm sells 1,000 units, profits will be equal to zero

An accounting break-even point of 2,000 means the firm ____.

will start generating profits if it sells more than 2,000 units

Broadband, Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $400,000. The company now plans to perform a scenario analysis on the cash flow and NPV estimates. It will use an NPV of _____ as the base case.

$400,000

What will the shapes of total revenue and total costs be on a graph that depicts number of units on the x-axis and dollar amount (revenues and cost) on the y-axis? A) The total revenue curve will slope upward and the total cost curve will be parallel to the x-axis. B) The total revenue curve will slope upward and the total cost curve will slope downward. C) Both the total revenue and total cost curves will slope downward. D) Both the total revenue and total cost curves will slope upward.

Both the total revenue and total cost curves will slope upward.

When McDonald's decides to build a new restaurant at a particular location, which of the following competitors might also be tempted to locate new facilities in the same area? A) Abercrombie and Fitch B) Barnes and Noble C) Burger King D) Wendy's

Burger King Wendy's

Which costs are included in the numerator of the accounting profit break-even point equation?

Fixed costs Depreciation

In the context of capital budgeting, what does sensitivity analysis do?

It examines how sensitive a particular NPV calculation is to changes in underlying assumptions.

Which of the following equations correctly relates OCF to sales volume? A) OCF = (P − v) × Q + FC B) OCF = (P − v) × Q − FC C) OCF = (P + v) × Q − FC D) OCF = (P − v)/(Q − FC)

OCF = (P − v) × Q − FC

Suppose Price per Unit is $6, variable cost per unit is $2, fixed costs are $400 and the depreciation allowance per year is $500. The relationship between operating cash flow (OCF) and sales volume (Q) can be expressed as: A) OCF = 400*Q − 4 B) OCF = 400 − 4*Q C) OCF = −400 + 4*Q D) OCF = 4/Q + 500

OCF = −400 + 4*Q

________ value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect.

Present

Which of the following is a fixed cost for a garment manufacturing business? A) Rent for the building B) Labor costs C) Energy costs from running equipment D) The cost of fabric

Rent for the building

Which of the following is an example of a sunk cost? A) Purchase of inventory B) Acquisition of new equipment to manufacture the product C) Renovation of existing building to accommodate the new project D) Research and development expense incurred in the past

Research and development expense incurred in the past

In a competitive market, positive NPV projects are:

uncommon

Which of the following are examples of variable costs for a car manufacturer? A) The cost of steel B) CEO salary C) Freight costs D) Labor costs

The cost of steel Freight costs Labor costs

Which of the following are examples of variable costs for a grocery store? A) The cost of vegetables B) The cost of labor to stock shelves C) The store manager's salary D) Rent for the store

The cost of vegetables. The cost of labor to stock shelves.

Which of the following are true about variable costs? A) The variable cost per unit increases as the number of units produced increases. B) The variable cost per unit may remain constant as the number of units produced increases. C) Total variable costs increase as the total number of units produced increases.

The variable cost per unit may remain constant as the number of units produced increases.

What is the relationship between variable costs and output?

Total variable costs are directly related to the level of output.

In a graph with output on the x-axis and dollar amount (for costs and revenues) on the y-axis, what will be the shapes of variable and fixed costs?

Variable costs will be upward sloping while fixed costs will be parallel to the x-axis

Financial break-even is the sales level that results in _____.

an NPV of zero

From a managerial perspective, highly uncertain projects can be dealt with by keeping the degree of operating leverage _____.

as low as possible

To be considered good, projected cash flows should _____ actual cash flows.

be close to

A firm will start generating positive accounting profits _____. A) below the break-even sales point B) beyond the break-even sales point C) at the break-even sales point D) at the point at which revenues exceed total fixed costs

beyond the break-even sales point

A positive NPV exists when the market value of a project exceeds its cost. Unfortunately, most of the time the market value of a project _____.

cannot be observed

The sales level that results in a zero operating cash flow is called the ________ break-even.

cash

The _____ is the percentage change in operating cash flow relative to the percentage change in quantity sold.

degree of operating leverage (DOL)

Evans Corporation estimated that the cash flows last year from a particular project would be $40,000, but the actual cash flow turned out to be $37,500. Evans Corporation should _____.

not expect cash flow estimates to be exactly right every time

The degree to which a firm or project relies on fixed costs is called the ________ leverage

operating

West Corporation estimated cash flows for a project, evaluated those cash flows using NPV, and determined that the project was acceptable. Unfortunately West Corporation lost money on the project. This may have been avoided had they assessed the ______ of the cash flow estimates.

reliability

A fixed cost is a cost that _____.

remains constant as the level of business activity changes

In a simulation, the average NPV and the spread of NPVs around the average are determined by _____.

repeated random drawings

Corporate managers care about the break-even point because it indicates the level to which _____ can fall before a project will start losing money.

sales

The Omega Division of Alpha Corporation has been allocated $4 million for capital spending but has identified $4.6 million in positive NPV projects. Omega's manager thinks he can convince the company to fund the additional $0.6 million dollars because Omega uses _______ rationing to control overall spending.

soft

The situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting is called ________ rationing.

soft

When a project breaks even on an accounting basis, the cash flow for that period will equal _____.

the depreciation allowance for that period

The ________ cost is equal to the quantity of output times the cost per unit of output.

variable

The basic approach to evaluating cash flow and NPV estimates involves asking ________-if questions.

what

Ultimately, we are more interested in cash flow than accounting income. True or False?

True

Which of the following are reasons why NPV is considered a superior capital budgeting technique?

NPV considers time value of money. NPV considers all the cash flows.

When a business does hard rationing, the firm's DCF analysis breaks down. True or False?

True

The possibility that errors in projected cash flows will lead to incorrect decisions is called , ________ or estimation risk.

forecasting (risk)

What is the purpose of accounting profit break-even analysis?

To determine the level of sales at which profits are equal to zero.

The cash break-even is the sales level that results in a ______ operating cash flows.

zero

What is a sunk cost?

A cost incurred in the past that is irrelevant to the capital investment decision process.

When using _______________ all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable.

sensitivity analysis

A firm will start generating profits when ___.

the total number of units sold exceeds the accounting break-even point

A situation in which a firm has positive NPV projects but cannot find the necessary financing is called capital ________.

rationing

Which of the following statements is true in the context of comparing accounting profit and present value break-even point? A) The superiority of a particular technique will vary from firm to firm depending on the unique circumstances of the firm. B) Accounting profit is superior because the financial statements report profits and not present value. C) Both techniques are equally good. D) Present value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect.

Present value is superior to accounting profit because it adjusts for time value and considers the depreciation tax shield effect.

A contribution margin of $35 means that ____.

each sale of an additional unit will contribute $35 toward paying fixed costs

The ________ break-even is the sales level that results in a zero NPV.

financial

________ analysis involves estimating the best-case, worst-case, and base-case cash flows and calculating the corresponding NPVs.

Scenario

Which of the following defines the contribution margin per unit? Ignore taxes. A) Contribution Margin per Unit = Sales price - Variable cost per unit B) Contribution Margin per Unit = Sales price - Depreciation expense C) Contribution Margin per Unit = Sales price - Fixed costs D) Contribution Margin per Unit = Sales price +capital gain

Contribution Margin per Unit = Sales price - Variable cost per unit