FIN SB Ch 11

The break-even point adjusts for time value of money, whereas the break-even point does not.

Blank 1: financial Blank 2: accounting

As a practical matter, it is easier to (decrease/increase) operating leverage than it is to (decrease/increase) it.

Blank 1: increase Blank 2: decrease

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?

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

Which of the following is a fixed cost for a tire manufacturing business?

Building rent of $10,000/month Manager's salary of $98,000/year

Which of the following defines the contribution margin per unit? Ignore taxes.

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

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

DOL

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 is a fixed cost for a garment manufacturing business?

Rent for the building

Which of the following is an example of a sunk cost?

Research and development expense incurred in the past

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

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

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

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

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

asking what-if questions scenario analysis

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

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

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

zero

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

financial

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

forecasting

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

forecasting risk estimation risk

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

hard rationing

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

high

A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are

inaccurate

A potential problem with DCF analysis is that a project may appear to have a positive NPV because the estimated cash flows are ______.

inaccurate

For all practical purposes, it is easier to _____.

increase operating leverage than to decrease it

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

what

The basic approach to evaluating cash flow and NPV estimates involves asking _____.

what-if questions

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 Reason: The NPV of the scenario originally estimated is usually used as the base case.

Which of the following represents the accounting profit break-even point?

(Fixed costs + Depreciation)/Contribution margin

What is the total number of inputs that change while doing sensitivity analysis?

1

Broadband, Inc. has estimated preliminary cash flows for a project and found that the NPV for those cash flows is $1,000,000. 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.

1,000,000Reason: The NPV of the scenario originally estimated is usually used as the base case.

Rank each of the following in order from most important to least important as they pertain to project analysis: Instructions Choice 1 of 2. cash flow toggle button cash flow Choice 2 of 2. accounting income toggle button accounting income

1. Cash flow2. Accounting income

What are the two main benefits of performing sensitivity analysis?

It identifies the variable that has the most effect on NPV. It gives a range of values for NPV instead of a single value, so it gives a more realistic picture.

What are the two main drawbacks of sensitivity analysis?

It may increase the false sense of security among managers if all pessimistic estimates of NPV are positive. It does not consider interaction among variables.

Which of the following are examples of variable costs for a car manufacturer?

Labor costs Freight costs The cost of steel

Which of the following equations correctly relates OCF to sales volume?

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:

OCF = −400 + 4*Q

Which of the following is a legitimate reason for a project to have a positive NPV for Palmer Corporation?

Palmer can produce the product more cheaply than its competition. Palmer has a better product than its competition. Palmer has a better distribution channel than its competition. No: Palmer's managers expect to rate of return on the project equal to its cost of capital. Reason: If the project's rate of return is equal to its cost of capital, the NPV will be equal to zero.

Which of the following statements is true in the context of comparing accounting profit and present value break-even point?

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

Which of the following are examples of fixed costs for a car repair shop performing oil changes and other repairs?

Salary for the shop manager Monthly rent for the shop Insurance for the shop

What is the difference between scenario analysis and sensitivity analysis?

Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at at time.

What is scenario analysis?

Scenario analysis determines the impact on NPV of a set of events relating to a specific scenario.

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

Sensitivity

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 Reason: Soft rationing occurs when units in a business are allocated a certain amount of financing for capital budgeting.

Which of the following are examples of variable costs for a grocery store?

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

The financial break-even point differs from the accounting break-even point for which of the following reasons?

The financial break-even point adjusts for time value of money.

Which of the following is an opportunity cost in the context of a vacant building that a firm currently owns?

The potential rental income lost by using the empty building for a project

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

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

What is the relationship between variable costs and output?

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

True or false: Depreciation expense on a specific asset could be a fixed dollar amount or a variable dollar amount.

True

True or false: Ultimately, we are more interested in cash flow than accounting income.

True

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

True

True or false: Opportunity costs are irrelevant costs when doing capital budgeting analysis.

True: Reason: They are relevant costs, as opportunity costs represent costs that would not have been incurred if the project had not been undertaken.

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

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?

Wendy's Burger King

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

operating

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

present

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

rationing

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

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

analysis determines the impact on NPV of a set of events relating to a specific situation.

scenario

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

scenario

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

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

soft rationing

Capital rationing exists when a company has identified positive NPV projects but can't find _____.

the necessary financing

The contribution margin per unit will increase if ____.

the sales price per unit increases while the variable cost per unit decreases

Corporate managers care about the break-even point because it indicates the level _____.

to which sales can fall before a project will start losing money

In a competitive market, positive NPV projects are:

uncommon

A legitimately positive NPV may be due to all of the following except _____.

a poll showing your customers prefer your product, when actual data shows that is not the case

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

be close to

A firm will start generating positive accounting profits _____.

beyond the break-even sales point

Which of the following are true about depreciation expense?

It affects the accounting profit break-even point. It is a noncash expense. It affects cash flows.

A firm with higher operating leverage will have (low/high) fixed costs relative to a firm with low operating leverage.

high

Which of the following is the correct equation for the degree of operating leverage?

DOL=1+FC/OCF

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

Depreciation Fixed costs

A contribution margin of $35 means that ____.

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

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

variable

Total fixed costs remain constant while total variable costs (decrease/increase) if the level of output increases.

increase

Which of the following statements are true regarding fixed and variable costs?

Fixed costs per unit will decrease while variable costs per unit will stay constant if the level of output increases. Total fixed costs remain constant while total variable costs increase if the level of output increases.