a306 exam 2
Calculating the present value of money is referred to as ____ cash flows
discounting
A company must make a volume trade-off decision when they
do not have enough capacity to satisfy the demand for all of its products must trade off units of one product for units of another due to limited production capacity
Because of the time value of money, projects that promise ______ returns are preferable to those that promise the opposite.
earlier
True or false: Depreciation of existing assets is relevant to decisions.
false
True or false: When a capital investment decision is being made between two or more alternatives, the project with the shortest payback period is always the most desirable investment.
false
true or false: an outcome can have just one solution
false
True or false: Opportunity costs are not found in accounting records because they are not relevant to decisions.
false Opportunity costs are not found in accounting records because they are not cash outlays. Opportunity costs are relevant to decisions.
The basic premise of the payback method is the ________, the more desirable the investment.
faster the cost of the investment is recovered
traceable fixed cost
fixed cost that can be tied to a specific segment. if the segment goes away, then that fixed cost would also disappear. (aka direct fixed costs)
When making a volume-trade off decision, managers should ignore:
fixed costs
feedback on the project
focus has been to evaluate the projects and decide which to pursue however, once a decision is made and a project chose, a post audit should be completed with actual amounts (not estimates)
Irrelevant costs include:
future costs that do not differ between alternatives sunk costs
to accept, SSR must be
greater than the ROI of the previous year
To maximize total contribution margin when a constrained resource exists, produce the products with the:
highest contribution margin per unit of the constrained resource
capacity issues-- constraints
how is the resource rationed? -- volume trade off decisions decision basis: CM per 1 unit of the constraint
To determine if a project is acceptable compare the internal rate of return to the company's:
hurdle rate
Select all that apply The payback method: ignores all cash flows that occur after the payback period. does not consider how quickly an investment is recovered does not consider the time value of money cannot evaluate projects with uneven cash flows is not a true measure of investment profitability
ignores all cash flows that occur after the payback period. does not consider the time value of money is not a true measure of investment profitability
Select all that apply The simple rate of return: ignores the time value of money fluctuates from year to year along with fluctuations in revenue and expense is calculated using cash flows rather than revenue and expense discounts future net operating income back to the present
ignores the time value of money fluctuates from year to year along with fluctuations in revenue and expense
When making a product line decision, a company may focus on lost contribution margin and avoidable fixed costs or prepare comparative _____
income statements
Company is considering a new labor saving machine to increase production efficiency. The machine rents for $3000 per year and will save $15,000 in labor costs. other costs related to the product are direct materials ($70,000), VMOH ($10,00), FMOH ($62,000). What is the financial adv/disadv if the machine is rented (how much will NOI increase/decrease)?
increase $12000
When making a decision to either buy a movie ticket or rent a DVD, the cost of the movie ticket is an example of a(n) ______ cost.
incremental/avoidable
sunk costs
incurred in past and cannot be changed not relevant to decision making
Select all that apply Typical capital budgeting cash outflows include: initial equipment investments salvage value of old equipment installation costs working capital invested cost reductions
initial equipment investments installation costs working capital invested
initial invesetment
initial investment - salvage value from sale of old equipment
Investment required/Annual net cash inflow is the formula to find the factor that enables calculation of the:
internal rate of return
Sensitivity Analysis
investigation of what happens to NPV when only one variable is changed how does our analysis change if our assumptions are a little off? how sensitive is our decision to uncertainty with our assumptions? best case, expected (most likely) case, worst case
In an equipment capital budgeting decision, recovering the original investment means that the:
investment has generated enough cash inflows to completely cover the cost of the equipment
When net cash inflow is the same every year, the equation used to calculate the factor of the internal rate of return is:
investment required/annual net cash inflow
When the annual net cash inflow is the same each year, the payback period equals the ______ required divided by the annual net cash _______
investment, inflow
managers make decisions that
involve investments today to realize future profits
When deciding whether to fly or take the train on a trip, the cost of putting your pet in a boarding facility while you are away is a(n) ______ cost.
irrelevant
The internal rate of return:
is the discount rate that makes NPV equal zero for a project
capital budgeting is the set of tools companies use to evaluate ____ expenditures with ____ impacts
large, long-term
Select all that apply Typical capital budgeting decisions include: equipment selection decisions lease or buy decisions employee hiring and firing decisions cost reduction decisions product and service pricing decisions
lease or buy decisions equipment selection decisions cost reduction decisions
A capital investment project's payback period is the:
length of time it takes for the project to recover its initial cost from the net cash inflows generated
Select all that apply If the internal rate of return is: less than the hurdle rate the project should be rejected less than the hurdle rate the project is acceptable greater than the hurdle rate the project is acceptable greater than the hurdle rate the project should be rejected
less than the hurdle rate the project should be rejected greater than the hurdle rate the project is acceptable
segment margin is the best gauge of
long run profitability
The term capital budgeting is used to describe how managers plan significant investments in projects that have ______ implications.
long-term
A decision to carry out one of the activities in the value chain internally, rather than to buy externally from a supplier, is called a(n) _____ or ______ decision
make or buy
Determining whether to carry out an activity in the value chain internally or use a supplier is a ________ decision.
make or buy
most important responsibility of a manager
making decisions
Differential costs and benefits that should be considered in a decision:
may be qualitative or quantitative
The required rate of return is the ______ rate of return a project must yield to be acceptable.
minimum
The concept of the time value of money is based on the notion that a dollar today is worth (more/less) _____ than a dollar a year from now.
more
Select all that apply Capital budgeting methods that focus on cash flows rather than incremental operating income are: simple rate of return net present value payback internal rate of return
net present value payback internal rate of return
When considering accepting a special order:
normal sales must not be affected there must be idle capacity
Working capital:
often increases when a company takes on a new project
Space being used that would otherwise be idle has a(n) _______ cost of zero
opportunity
The potential benefit given up when selecting one alternative over another is a(n) ________ cost.
opportunity
units of idle capacity > units in the special order
opportunity cost-- no
Units of Idle Capacity < Units in the Special Order
opportunity cost-- yes
When planning a trip and deciding whether to drive or fly, the _________ is a sunk cost and should be ignored.
original cost of the car
The basic premise of the _____ method is that the more quickly the cost of an investment can be recovered, the more desirable the investment is.
payback
Investment required/Annual net cash inflow is the formula for 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 is the ______
payback period
If the original investment in a capital project has been recovered, the net present value will be:
positive or zero
opportunity costs
potential benefit given up when select an alternative value of the next best option
The two broad categories into which capital budgeting decisions fall are ____ decisions and ____ decisions
preference and screening
The term discounting cash flows refers to the process of calculating the ______ value of those cash flows.
present
purpose of post audit
provide feedback and validate decision
Costs and benefits that always differ between alternatives are ______ costs and benefits.
relevant
Differential revenue is an example of a(n) ______ benefit.
relevant
When making a decision only ______ costs and benefits should to be included in the analysis.
relevant
When planning a trip and deciding to drive your car or take the train, gasoline is a(n) ______ cost.
relevant
Select all that apply Capital budgeting decisions: require a great deal of analysis prior to acceptance. are day-to-day decisions made by managers. require little or no thought before being made. involve an immediate cash outlay in order to obtain a future return.
require a great deal of analysis prior to acceptance. involve an immediate cash outlay in order to obtain a future return.
The internal rate of return is compared against the minimum _____ rate of return when analyzing the acceptability of an investment project.
required (or hurdled)
cost of capital other names
required rate of return and discount rate
gross margin
revenues - cogs
When using the simple rate of return, the initial investment should be reduced by the _____ value of old equipment.
salvage
One of the two broad categories of capital budgeting decisions, a decision, relates to whether a ______ proposed project is acceptable based on a preset criterion
screening
The cost of capital serves as a ______ tool.
screening
contribution margin best gauges
short term profitability
When making a decision, qualitative differences between alternatives _______ be ignored.
should not
which method do you use?
since capital projects span long periods of time, most companies consider the time value of money and use discounting methods to screen and prioritize supplement with the simpler non-discounting approaches
A one-time order that is not considered part of the company's normal ongoing business is a _______ order.
special
A one-time sale that is not considered part of the company's normal ongoing business is referred to as a(n)
special order
Costs that have no impact on future cash flows and are irrelevant to decisions are _____ costs.
sunk
A cost that has already been incurred and cannot be avoided regardless of what a manager decides to do is referred to as a(n)
sunk cost
payback method
the amount of time required for a firm to recover its initial investment in a project, as calculated from cash inflows payback period= initial investment/annual net cash flows only works if cash flows are the same each year! time value: no data: cash flows
cost of capital
the average return pay LT creditors and stockholders opportunity cost of money
internal rate of return measures
the discount rate at which the net present value of the project is zero
make or buy component parts to outsource or not to outsource
the make or buy decision is a question of... -control: over suppliers and over quality -cost: economies of scale (efficiencies) -social responsibility: balancing the needs of all decision basis: select option with the lowest cost= higher NOI
capacity
the maximum volume of activity that a company can sustain with available resources
The required rate of return is:
the minimum rate of return a project must yield to be acceptable
If a company is using a resource that could be used for some other purpose, the opportunity cost of that resource is:
the profit from the best alternative use of the resource
differential/incremental costs/revenues
those that differ between option or avoidable (bc can eliminate if choosing another option)
When a constraint exists, companies need to focus on maximizing
total contribution margin
True or false: The net present value can be used to determine whether a project should be accepted.
true
True or false: To verify the internal rate of return (IRR) compute the project's net present value using the IRR as the discount rate to determine if it is zero.
true
True or false: When deciding whether to take a train or drive for a weekend trip to visit an out-of-town friend, the monthly fee a student pays to park at school is not relevant to the decision.
true
Select all that apply The net present value of a project is: used in determining whether or not a project is an acceptable capital investment. the present value of the project's salvage value. the difference between the present value of cash inflows and present value of cash outflows for a project. the present value of the project's projected annual tax savings.
used in determining whether or not a project is an acceptable capital investment. the difference between the present value of cash inflows and present value of cash outflows for a project.
When demand for products exceeds the production capacity, a ___________ - decision must be made.
volume trade-off
expected value
weighted average NPV*probability= expected value add all expected values and you get expected value of the project
When should a special order be accepted?
when the incremental revenue from the special order exceeds the incremental costs of the order
add/drop/retain segment
which products should we sell? should we discontinue a division? should we close a factory? financial and non-financial repercussions requires careful analysis of the costs and benefits. Consider impact to CM and fixed costs Decision Basis: select option that increases NOI
Current assets minus current liabilities is called
working capital
The internal rate of return is the discount rate that results in a net present value of _______ for the investment.
zero
ABC company is considering an investment to automate its production process. The new equipment will allow ABC to save $75,000 each year in labor costs. The company requires a payback period of 5 years. What is the maximum investment that can be made in the project to be selected
$375,000
annual incremental net operating income
(Annual incremental revenues - Annual incremental expenses - Annual depreciation expense of project)
straight-line depreciation method
(cost - salvage value) / useful life
Advantages of Outsourcing
- Allows company to focus on core functions - Lower cost - Save time - Use skilled workers - Economy of scale
disadvantage of outsourcing
- lose competitive advantage (allows other companies insight into your processes) - US economic concerns (removes jobs therefore loss on US economy)
capacity issues specifically consider capacity decisions that involve:
- special orders: to mitigate excess capacity (valleys) - constrained resources: to mitigate lack of resources to meet production needs (life happens)
why do companies create capital budgets
-companies do not have unlimited funds -companies have overall goals -maintain efficiency and competitiveness
Keys to Segmented Income Statements
1. A contribution format should be used because it separates fixed from variable costs and it enables the calculation of a contribution margin 2. Traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin. (allocated/shared)
Approaches to Evaluate Projects
1. Non-discounting methods - Do NOT consider the time value of money 2. Discounting methods - Do consider the time value of money
NPV method
1. compare the present value of the cash inflows with the present value of the cash outflows 2. the difference between these two streams of cash flows is called the net present value 3. if the NPV is zero or positive, accept the project
capacity issues-- constraints: What's relevant?
1. constraint (scarce resource) 2. unit contribution margin CM/scarce resource
IRR method
1. determine the discount rate that causes the NPV for the project to be zero (initial investment= PV of the net cash flows) 2. if the IRR is equal to or greater than the minimum required rate of return, accept the project
capital budgeting process
1. understand the question 2. determine the options 3. determine from the data provided what are the relevant costs 4. make the decision: screening--> ID and evaluate project based on profitability, preference --> prioritize and select --> why? bc we dont have enough money to do it all
expected value-- cost of capital
1. what is the likelihood of each case? 2. determine a weighted average or expected value for the project
View Perfect is considering an investment in a new line of windows. The project is expected to last 10 years. If the factor of the internal rate of return is 5.889, the internal rate of return is:
11% Reason: Present Value of an Annuity of $1 in Arrears - the 10 period 5.889 factor is 11%.
The factor of the internal rate of return is 5.033 for a project lasting 7 years. The internal rate of return is _____%.
9
Chapman Company sells its product for $42 per unit. The company's unit product cost based on the full capacity of 400,000 units is as follows: Direct materials $ 8 Direct labor 10 Manufacturing overhead 12 Unit product cost $30 A special order offering to buy 40,000 units has been received from a foreign distributor. The only selling costs that would be incurred on this order would be $6 per unit for shipping. The company has sufficient idle capacity to manufacture the additional units. Two-thirds of the manufacturing overhead is fixed and would not be affected by this order. Assume that direct labor is an avoidable cost in this decision. In negotiating a price for the special order, the minimum acceptable selling price per unit should be: A) $28. B) $30. C) $32. D) $36.
A. $28
What assumption underlies net present value analysis?
All cash flows generated by an investment project are immediately reinvested at a rate of return equal to the discount rate.
Andrews Co. can purchase 20,000 units of Part XYZ from a supplier for $18 per part. Andrews' per unit manufacturing costs for 20,000 units is: Cost Per Unit Total Variable manufacturing cost $12 $240,000 Supervisor salary $3 $60,000 Depreciation $1 $20,000 Allocated fixed overhead $7 $140,000 If the part is purchased, the supervisor position would be eliminated. The special equipment has no other use and no salvage value. Total allocated fixed overhead would be unaffected by the decision. Should the company buy the part or continue to make it?
Continue to make — $60,000 advantage. The avoidable costs of making the product are the variable costs plus the supervisor salary or $15 per unit. The total savings is $60,000 ($18 buy price - $12 variable cost - $3 supervisor salary = $3 advantage to make X 20,000 units).
hurdle rate
Minimum acceptable rate of return (set by management) for an investment. equal to cost of capital
One dollar earned today is worth:
More than one dollar earned at a future point in time
profitability index
Net Present Value / Investment Required
Select all that apply Which of the following are true regarding the time value of money? One dollar today is worth less than one dollar a year from now. Projects that provide earlier returns are preferable to those that promise later returns. Given the same overall dollar return, a project that lasts 20 years is preferable to a project that lasts 5 years. By collecting a project's return quickly, the investor has the opportunity to re-invest that money to earn even more.
Projects that provide earlier returns are preferable to those that promise later returns. By collecting a project's return quickly, the investor has the opportunity to re-invest that money to earn even more.
contribution margin
Sales - Variable Costs
capital budgeting-- relevant cash flows
Start up: - initial investment, including installation costs - working capital required Operations: - CASH inflows (increased rev or decreased operation expenses) - CASH outflows (additional operation expenses) Disposal - salvage value (residual value) - working capital released
Which of the following should not be included in the analysis when making a decision? Opportunity costs Sunk costs Avoidable costs Non-differential future costs
Sunk costs Non-differential future costs
Select all that apply Which of the following statements are true? The net present value method does not provide for return of the original investment. The net present value method automatically provides for return of the original investment. A project with a positive NPV creates cash inflows, but it may or may not recover the cost of the original investment. A project with a positive NPV will recover the original cost of the investment plus sufficient cash inflows to compensate for tying up funds.
The net present value method automatically provides for return of the original investment. A project with a positive NPV will recover the original cost of the investment plus sufficient cash inflows to compensate for tying up funds.
time value or money
The potential impact of inflation and interest on money
Select all that apply Which of the following statements are true? When the net present value method is used, the discount rate equals the hurdle rate. When using the internal rate of return method, the cost of capital is used as the hurdle rate. In order for a project to be acceptable, the discount rate must be higher than the minimum acceptable rate of return. The cost of capital may be used to screen out undesirable projects.
When the net present value method is used, the discount rate equals the hurdle rate. When using the internal rate of return method, the cost of capital is used as the hurdle rate. The cost of capital may be used to screen out undesirable projects.
A screening decision:
a decision as to whether a proposed investment project is acceptable
projects that promise earlier returns are preferable to those that promise later returns. why?
a dollar today is worth more than a dollar in the future
special order
a one-time order that is not considered part of the company's normal ongoing business
intangible benefits in capital budgeting
absolute value npv/ pv factor of annuity
companies occasionally must decide whether to accept a special order or not. what is the decision basis?
accept if increases NOI
Choose whether each of the following would be acceptable or unacceptable: A project with a positive net present value would be ____ and a project with a negative net present value would be _____
acceptable, unacceptable
Synonyms for the simple rate of return are the ______ rate of return and the ______ rate of return.
accounting, unadjusted
The simple rate of return is also referred to as the ____ or ____ rate of return.
accounting, unadjusted
advantages and disadvantages of IRR method
advantages: - considers the time value of money disadvantages: - does not consider the size of projects
advantages and disadvantages of NPV method
advantages: - considers time value of money - considers all cash flows disadvantages: - cannot compare projects with different initial investments
advantages and disadvantages of SSR method
advantages: - simple to calculate disadvantages: - focuses on NOI not cash flows therefore may fluctuate from year to year - ignores the time value of money
advantages and disadvantages of payback method
advantages: - simple to calculate - identifies projects that recoup initial investment quickly disadvantages: - ignores the time value of money - ignores cash flows after the payback period
SSR method
annual incremental net operating income/initial investment
segment
any part of an organization or any activity in an organization that a manager seeks cost, revenue, or profit data
constrained resource
anything that is needed to operate the business, such as cash, employees, machines, or facilities
common fixed cost
arise because of the overall operation of the company and would not disappear if any particular segment were eliminated (indirect fixed costs) (incurred regardless!)
The cost of capital is the:
average rate of return a company must pay to its long-term creditors and shareholders for the use of their funds.
A cost that can be eliminated in whole or in part by choosing one alternative over another is a(n) ______ cost.
avoidable
When computing the simple rate of return, the annual incremental net operating income in the numerator should ______ the investment's depreciation charges.
be reduced by
To screen out undesirable investments, ________ use(s) the cost of capital.
both the net present value and internal rate of return methods
companies anticipate the imbalance and look to mitigate the peaks and valleys (level the load). These gaps exist because
capacity is fixed in the short term
Another term for the minimum required rate of return is the cost of
capital
How managers plan significant investments in projects that have long term implications such as purchasing new equipment or introducing new products is called:
capital budgeting
in the short term
companies deal with gaps between demand and supply
Anything that prevents you from getting more of what you want is a(n)
constraint
When a shortage or limited resource of some type restricts a company's ability to satisfy demand, the company has a(n) ______
contraint (bottleneck)
how to solve for segment margin
contribution margin - traceable fixed costs
If some products must be cut back because of a constraint, produce the products with the highest:
contribution margin per unit of constrained resource
Northern Optical ordinarily sells the X-lens for $50. The variable production cost is $10, the fixed production cost is $18 per unit, and the variable selling cost is $1. A customer has requested a special order for 10,000 units of the X-lens to be imprinted with the customer's logo. This special order would not involve any selling costs, but Northern Optical would have to purchase an imprinting machine for $50,000. There is ample idle capacity to fulfill the order and the imprinting machine has no further use after this order. What is the minimum price Northern Optical will accept? a. $34 b. $29 c. $16 d. $15
d. $15
When making make-or-buy decisions, managers should consider a. alternative uses for any facility currently being used to make the product b. the costs of direct materials included in making the product c. qualitative factors such as whether the supplier can deliver the item on time and to the company's quality standards d. all of the above
d. all of the above
which of the following could be a constrained resource a. direct materials b. factory space c. machine hours d. all of the above
d. all of the above
The first step in decision making is to:
define the alternatives
post audit
detect an undesirable project that was accepted. can show shortcomings in cash flows CANNOT be used to detect a good project that was thrown out
Select all that apply Capital budgeting decisions include: increasing the salary of the current company president determining which equipment to purchase among available alternatives acquiring a new facility to increase capacity deciding to replace old equipment choosing to lease or buy new equipment hiring new factory workers purchasing new equipment to reduce cost
determining which equipment to purchase among available alternatives acquiring a new facility to increase capacity deciding to replace old equipment choosing to lease or buy new equipment purchasing new equipment to reduce cost
Net present value is the:
difference between the present value of a project's cash inflows and the present value of the project's cash outflows
A future cost that is not the same between any two alternatives is known as a(n) _______ ,incremental, or avoidable cost
differential
Focusing on future costs and benefits that are not the same between alternatives is:
differential analysis
The key to effective decision making is:
differential analysis
Company is considering a new labor saving machine to increase production efficiency. The machine rents for $3000 per year and will save $15,000 in labor costs. other costs related to the product are direct materials ($70,000), VMOH ($10,00), FMOH ($62,000). What are the relevant costs for this decision?
direct labor and rent on new machine