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