Chapter 11 Project Analysis and Evaluation

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

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

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

DOL

capital rationing

The situation that exists if a firm has positive NPV projects but cannot find the necessary financing.

Total fixed costs remain constant while total variable costs ___ if the level of output increases.

increase

For all practical purposes, it is easier to _____.

increase operating leverage than to decrease it

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

OCF = (P − v) × Q − FC

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

increase; decrease

hard rationing

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

soft rationing

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

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

operating

___ analysis uses a combination of scenario and sensitivity analysis.

Simulation

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

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

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

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

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

(Fixed costs + Depreciation)/Contribution margin

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

what-if questions

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

rationing

Which of the following are true about depreciation expense?

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

A firm will start generating profits when ___.

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

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

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

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

sensitivity analysis

Investigation of what happens to NPV when only one variable is changed.

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.

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 is a fixed cost for a tire manufacturing business?

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

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

Rent for the building

financial break-even

The sales level that results in a zero NPV.

cash break-even

The sales level that results in a zero operating cash flow.

accounting break-even

The sales level that results in zero project net income.

Ultimately, we are more interested in cash flow than accounting income

True

When a business does hard rationing, the firm's DCF analysis breaks down

True

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

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 contribution margin per unit will increase if ____.

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

simulation analysis

A combination of scenario and sensitivity analysis.

In a competitive market, positive NPV projects are:

uncommon

Which of the following costs relating to a doctor's office are variable costs?

Medical supplies Lab reports for patients

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

be close to

operating leverage

The degree to which a firm or project relies on fixed costs.

scenario analysis

The determination of what happens to NPV estimates when we ask what-if questions.

variable costs

Costs that change when the quantity of output changes.

fixed costs

Costs that do not change when the quantity of output changes during a particular time period.

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

financial

In simulation analysis, a combination of _____ analysis and _____ analysis is used.

scenario; sensitivity

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.

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

Freight costs Labor costs The cost of steel

A fixed cost is a cost that _____.

remains constant as the level of business activity changes

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

True

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

Research and development expense incurred in the past

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

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

the necessary financing

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

Sensitivity

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

zero

marginal cost

The change in costs that occurs when there is a small change in output

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

cash

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

DOL = 1 + FC/OCF

forecasting risk

The possibility that errors in projected cash flows will lead to incorrect decisions. Also known as estimation risk.

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

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

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

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

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

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

financial; accounting

What is the relationship between variable costs and output?

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

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

Fixed costs Depreciation

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.

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 has a better distribution channel than its competition. Palmer can produce the product more cheaply than its competition. Palmer has a better product than its competition.

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 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.

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

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

high

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

hard

A firm will start generating positive accounting profits _____.

beyond the break-even sales point

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 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.

1,000,000

What is a sunk cost?

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

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.

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

Scenario

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.

degree of operating leverage (DOL)

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

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

Which of the following are true about variable costs?

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

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.

Opportunity costs are irrelevant costs when doing capital budgeting analysis.

True

While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time.

True

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

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

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

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

cash flow accounting income

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 ___.

incorrect

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

___ 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

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. Multiple choice question. simulation

sensitivity analysis