Financial Management & Policy - Chapter 11

Compute net accounting profit based on the following information: revenues = $4,000, variable costs = $1,600, fixed costs = $700, depreciation = $300, tax rate = 21%

**$1,106 ([4,000 - 1,600 - 700 - 300]*[1-0.21) -$1,371 -$1,360 -$1,343

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

inaccurate

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 -$360,000 -$220,000 -$440,000

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

**rent for the building -labor costs -the cost of fabric -energy costs from running equipment

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

**repeated random drawings -an educated guess -multiple forecasts -actual events

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

**total fixed costs remain constant while total variable costs increase if the level of output increases **fixed costs per unit will decrease while variable costs per unit will stay constant if the level of output increases -fixed costs per unit and variable costs per unit will increase if the level of output increases -both the fixed costs per unit and the variable costs per unit will decrease as the level of output increases

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

**research and development expense incurred in the past -purchase of inventory -acquisition of new equipment to manufacture the product -renovation of existing building to accommodate the new project

The NPVs in the table below were generated using sensitivity analysis. Where should managers focus their attention? Pessimistic Expected Market share -$1,310 $2,000 Variable costs $1,000 $2,000 Fixed costs $1,800 $2,000 Initial costs $1,850 $2,000

**retaining market share -controlling variable costs -controlling fixed costs -controlling initial investment costs

What is scenario analysis?

**scenario analysis determines the impact on NPV of a set of events relating to a specific scenario -scenario analysis determines the probability of occurrence of various future events that could affect the project -scenario analysis determines the impact on NPV of a change in a single variable -scenario analysis maps out the various steps involved in the manufacturing process

Rank of each of the following in order from most important to least important as they pertain to project analysis

1. cash flow 2. accounting income

You are in the business of manufacturing watches. The parts for each of these watches costs an average of $25. Your period costs for the month are $3,000. What will be the monthly total variable costs if you manufacture 100 watches?

**$2,500 (100*25) -$5,500 -$25 - -$500

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

**the cost of steel **freight costs **labor costs -CEO salary

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

**will start generating profits if it sells more than 2,000 units -has total costs (including depreciation) of $2,000 -will start generating losses if it sells more than 2,000 units -will start generating profits if its total revenue reaches $2,000

In a simulation, there are various possibilities. If the computer randomly picks industry sales of 10 million units and a market share of 25%, calculate total revenue based on the following two equations: price = $100 + 0.05*Industry unit sales in millions revenue = market share percentage*industry unit sales*price

**$262.5 million ({$100+(0.05x10)} x (0.25x10 million)) -$2.5 million -$1,050 million -$25 million

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

**1 -0 -all inputs change

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

false

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

true

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

true

If Kellogg's introduces a new brand of cereal, it will most likely lead to _____ in its sales of existing cereals

** erosion, i.e., a decrease -synergy, i.e., an increase -no change

What will the taxes be for a firm that reports an accounting profit break-even point of 3,000 units with values at that point of: fixed costs = $50,000, depreciation = $10,000, sales price per unit = $50, and variable cost per unit = $30? Assume a tax rate of 21%

**$0 (because EBIT is $0) -$12,000 -$200,000 -$2,000

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 _____

**$675,000 ([30,000*150]*0.15) -$3,825,000 -$525,000 -$4,500,000

If fixed costs are $3,500 and the operating cash flow is $4,500, then the degree of operating leverage (DOL) is:

**1.78 (DOL = 1 + (FC / OCF) =1 + (3,500 / 4,500)) -0.78 -2.28 -2.00

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?

**Burger King **Wendy's -Barnes and Noble -Abercrombie and Fitch

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 -hard -exceptional -food

For all practical purposes, it is easier to:

**increase operating leverage than to decrease it -decrease operating leverage than to increase it -break even that it is to lose money

Dang Corporation has fixed costs of $2,000,000, operating cash flow of $18,000,000, and depreciation expense of $500,000. Its product sells for $20 and variable costs are $8. What is the cash break-even for Dang?

**166,667 units (QC = (FC)/(P - v) =2,000,000/(20-8)) -$166,667 - -1,333,333 -125,000

Compute the accounting break-even point for a firm reporting the following information: fixed costs = $50,000, depreciation = $10,000, sales price per unit = $50, variable cost per unit = $30

**3,000 units (QA = (FC + D)/(P - v) =(50,000+10,000)/(50-30)) -2,500 units -1,200 units -2,000 units

In a graph with output on the x-axis and dollar value 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 -both variable and fixed costs will be parallel to the x-axis -both variable and fixed costs will be upward sloping -variable costs will be upward sloping while fixed costs will be parallel to the y-axis

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

**what-if questions -for assistance from the federal government -random questions about the cash flow assumptions

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

**the depreciation allowance for that period -net income for that period -revenues for that period -net working capital for that period

The financial break-even point differs from the accounting break-even point for the following reasons:

**the financial break-even point adjusts for time value of money -the financial break-even point is usually lower than the accounting break-even point -the financial break-even point does not differ from the accounting break-even point

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 -the level of sales at which the firm can enjoy maximum tax benefits -the level sales they will need to make to enjoy leadership in the industry -the level of sales at which depreciation expense will be fully written off

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

**the necessary financing -negative cash flows -positive IRRs -irreducible equations

The contribution margin per unit will increase if _____

**the sales price per unit increases while the variable cost per unit decreases -both the sale price per unit and the variable cost per unit increases -fixed costs decrease -the sales price per unit decreases while the variable cost per unit increases

A firm will start generating profits when _____

**the total number of units sold exceeds the accounting break-even point -total revenue exceeds the initial investment required to generate that revenue -total revenue exceeds the total fixed costs -total variable costs exceed fixed costs

In a competitive market, positive NPV projects are:

**uncommon -unlimited -easy to find

Mac Company requires a 15% return on its investments. It is considering launching a new ergonomic chair that will sell for $500 and cost $200 per unit to make. Fixed costs will be $1 million per year, and the initial investment for the new product will be $4 million. The company expects the project to last for 10 years, after which there will be innovations that will cause the product to be obsolete. Calculate the financial break-even point for the new product. The ten-year annuity factor at 15% is 5.0188.

**5,990 (QF = (FC + OCF*)/(P - v) OCF = 4,000,000 / 5.0188 = 797,003.27 QF = (1,000,000+797,003.27)/(500-200) -4,000,000 -5,018 -797,008

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 -NPV properly discounts earnings -NPV results in only one rate of return

Suppose price per unit is $6, variable cost per unit $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 -OCF = 400*Q - 4 -OCF = 4/Q + 500 -OCF = 400 - 4*Q

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

**Paimer has a better distribution channel than its competition **Paimer can produce the product more cheaply than its competition **Paimer has a better product than its competition -Paimer's managers expect to rate of return on the project equal to its cost of capital -Paimer has an optimistic manager who estimates sales will be higher than its competition's

Financial break-even is the sales level that results in:

**an NPV of zero -a positive IRR -a positive NPV -an IRR that is less than the NPV

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

**as low as possible -a well kept secret -fixed -as high as possible

A firm will start generating positive accounting profits

**beyond the break-even sales point -below the break-even sales point -at the break-even sale point -at the point at which revenues exceed total fixed costs

A contribution margin of $35 means that _____

**each sale of an additional unit will contribute $35 toward paying fixed costs -the firm has to generate $35 in sales to reach the accounting break-even point -the firm generates a net profit of $35 on each unit sold -each additional sale will add $35 to the total revenues

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 -the superiority of a particular technique will vary from firm to firm depending on the unique circumstances of the firm -accounting profit is superior because the financial statements report profits and not present value -both techniques are equally good

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 -principality -additivity -fungibility

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 -fruitless endeavors -rocket science

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 -break-even analysis -simulation

Which of the following statements are true about variable costs?

**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 -total variable costs remain constant as the total number of units produced increases -the variable cost per unit increases as the number of units produced increases

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

**high -indeterminate -insufficient -low

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

**insurance for the shop **salary for the shop manager **monthly rent for the shop -oil for oil changes

What are the two main drawbacks of sensitivity analysis?

**it does not consider interaction among variables **it may increase the false sense of security among managers if all pessimistic estimates of NPV are positive -it is easy to compute -it considers the effects of interactions among variables

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 -it examines the sensitivity of profits to changes in market share -it examines the sensitivity of management to the possibility that a project will be rejected -it examines the increase in the cost of a project when the cost of capital increases

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 $337,500. Evans Corporation should:

**not expect cash flow estimates to be exactly right every time -give up estimating cash flows -expect cash flows estimates to exactly right every time

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

**forecasting risk **estimation risk -guess and bless -managerial incompetence

What is 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

**65.67 units (QA = (FC + D)/(P - v) =(960,000+25,000)/(40,000-25,000)) -64 units -68.31 units -63.33 units

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 value for NPV instead of a single value, so it gives a more realistic picture -it is easier to perform that conventional NPV analysis -it makes it possible to make a correct decision every time