Test 4
Prairie, Inc. produces a single product. It has an annual capacity of 10,000 units, but currently uses only 80% of it. Each unit is sold for $50 and requires direct material worth $30 and direct labor worth $5. Manufacturing overhead cost is $10 per unit of which 70% is variable. What is Prairie's total incremental cost incurred to produce each unit?
$42 Total incremental cost = $42 = $30 + $5 + ($10 × 70%).
Identify the simplifying assumptions usually made in net present value analysis.
All cash flows other than the initial investment occur at the end of periods. All cash flows generated by the investment project are immediately reinvested at a rate of return greater than the discount rate.
Project A is a six-year project. The project has a total cash inflow of $200,000. The present value of such inflows is $150,000. The project requires an initial investment of $150,000.
Present value of cash inflows ($150,000) is the same as the present value of the cash outflows ($150,000). Hence, the net present value is zero ($150,000 - $150,000 = $0).
Project B is a five-year project. The project has a total cash inflow of $350,000. The present value of such inflows is $275,000. The project requires an initial investment of $200,000 and additional working capital of $25,000.
Present value of cash inflows ($275,000) is higher than the present value of the cash outflows ($200,000 and $25,000). Hence, the net present value is positive ($275,000 - $200,000 - $25,000 = $50,000).
Project C is a ten-year project. The project has a total cash inflow of $300,000. The present value of such inflows is $275,000. The project requires an initial investment of $250,000 and additional working capital of $30,000.
Present value of cash inflows ($275,000) is lower than the present value of the cash outflows ($250,000 and $30,000). Hence, the net present value is negative ($275,000 - $250,000 - $30,000 = -$5,000)
_____ is anything that will be different (or change) between two alternatives.
Relevant information
An investment proposal with an initial investment of $100,000 generates annual net cash inflow of $20,000 for a period of 10 years. The project has a net present value of $10,000. What is this investment proposal's payback period?
The investment proposal has a payback period of 5 years ($100,000 ÷ $20,000).
general rule
Variable costs (and revenue) tend to be relevant because they change in total. Fixed costs tend to be irrelevant because they do not change in total between alternatives
sell or process further decision
a decision as to whether a joint product should be sold at the split off point or sold after further processing
intermediate product
a product that is in the process of being made
The simple rate of return is obtained by dividing the ________ by the initial investment in the project.
annual incremental net operating income
A machine or a process that is a constraint is working _____
at full capacity
Cost of machinery purchased for the Orange County division
avoidable
Rent paid for the division's regional office
avoidable
Wages paid to the division's employees who will be downsized if the division is dropped
avoidable
If some products must be cut back because of a constraint, the key to maximizing profits is to favor the products that provide the highest ______
contribution margin per unit of the constrained resource
joint costs
costs that are incurred up to the split off point in a process that produces joint products
Depreciation charges that result from making an investment should be ignored when determining the annual incremental net operating income for the simple rate of return calculation.
false
Joint costs already incurred up to the split-off point are relevant in decisions concerning what to do from the split-off point onward.
false
When the cash flows associated with an investment project change from year to year, the payback period is determined by dividing the total investment required by the annual net cash inflow.
false
When using the total cost approach to decide whether to renovate or purchase a replacement for a machine, select the alternative with the _____________ net present value.
higher
the best way to handle a constrained resource is to
increase the capacity of the bottleneck
The ________ is defined as the discount rate at which the present value of a project's cash inflows will equal the present value of its cash outflows.
internal rate of return
When the net cash inflow is the same every year, the factor of the internal rate of return is determined by dividing the ________ by the annual net cash inflow.
investment required
________ are made by selecting the cheapest alternative and do not involve any revenues.
least cost decisions
if a company has more than one potential constraint, the proper combination of products can be found by use of a quantitative method known as
linear programming
When using the internal rate of return method to rank competing investment projects, an investment that has an internal rate of return of 20% is ________ than an investment that has an internal rate of return of 17%.
more desirable
The project profitability index is calculated by dividing the ______ of the project by the investment required.
net present value
In instances where the net present value and the internal rate of return do not agree on the acceptability of a project, it is better to go with the ______.
net present value method
joint products
products that are produced from a common input
When ranking competing projects with different initial investments, the investment with a higher ________ is always more desirable.
project profitability index
High Roller Inc. is trying to decide whether to buy a private jet or to lease one. The finder's fee is incurred only if the private jet is bought. The finder's fee is a ________ cost for this decision.
relevant
the only information required to make a decision is information that is ___
relevant
Costs that differ between alternatives and impact the decisions that are made.
relevant costs
Sheraton Corporation is trying to decide whether to buy new machinery or to upgrade its existing machinery to meet the increasing demand. The cost of the existing machine is a(n) ________ cost.
sunk
Costs that have already been incurred and cannot be eliminated regardless of the alternative chosen.
sunk costs
historical costs are
sunk costs
joint costs are what type of cost?
sunk costs
It is profitable to continue processing a joint product after the split-off point as long as
the incremental revenue from such processing exceeds the incremental processing cost incurred after the split off point
The payback period
the length of time that it takes for a project to recover its initial cost from the net cash inflows that it generates and is expressed in year.s
split-off point
the manufacturing stage at which joint products can be identified as separate products
Product lines or segments may look unprofitable because they are distorted by
the presence of common fixed costs.
The _______ allows for the comparison of an unlimited number of alternatives side by side to determine the best alternative.
total cost approach
A postaudit can help reduce the tendency to inflate the benefits or downplay the costs in a proposal because it involves checking whether or not expected results are actually realized.
true
When the project does not have constant net incremental income over its useful life, the simple rate of return computed will fluctuate from year to year.
true
If incremental revenue from further processing exceeds incremental costs from such processing incurred after the split-off point, it is profitable to continue processing such joint products after the split-off point.
true It is profitable to continue processing a joint product after the split-off point so long as the incremental revenue from such processing exceeds the incremental processing cost incurred after the split-off point.
Cost of the private jet purchased for the company management's use
unavoidable
General management expenses allocated to the Orange County division
unavoidable
Good Buy is currently producing and marketing a product. The manager at Good Buy is considering a contract manufacturer's offer to supply the same product. Marketing costs involved in selling the product are ________ costs.
unavoidable
Future costs that do not vary based on the alternative chosen.
unavoidable costs
Prairie, Inc. produces one single product. It has an annual capacity of 10,000 units, but currently uses only 80% of it. Each unit is sold for $50 and requires direct material worth $30 and direct labor worth $5. Manufacturing overhead cost is $10 per unit of which 70% is variable. Should a special order to sell 1,000 units at $44 be accepted?
yes The incremental revenue generated by the special order is $44,000 (= $44 per unit × 1,000 units). The incremental cost is $42,000 (= (direct materials of $30 per unit + direct labor of $5 per unit + variable manufacturing overhead of $7 per unit) × 1,000 units). Since the incremental net operating income generated by this special order is $2,000 (= $44,000 − $42,000), the special order should be accepted.
Superware, Inc. produces multiple products out of a common input. Geratin is one such product, which has a sales value of $15,000 at the split-off point. Joint costs allocated to Geratin are $12,000. Sales value of Geratin increases to $25,000 after further processing, and this processing will cost $7,000. Should Geratin be processed further?
yes process further Incremental revenue of $10,000 ($25,000 - $15,000) exceeds incremental costs of $7,000 by $3,000. Hence, Geratin should be processed further.
