FIN 357 Ch 11

for all practical purposes, it's easier to:

increase operating leverage than to decrease it

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

the depreciation allowance for that period

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

the necessary financing

A real estate agent has leased 10 rooms in a resort area for $100,000 for the summer season. She hopes to rent these rooms and generate profit for her business. What will the fixed costs be for the real estate agent if only 6 rooms are occupied because of excessive rains?

$100,000 she is paying this no matter what bc rent is a fc

Broadband, Inc. has estimated preliminary cash flows for a project and found that the NVP 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

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

*Forecasting risk *Estimation risk

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

- depreciation - fixed costs

which of the following is a legitimate reason for a project to have a positive NPV for Palmer Corporation?

- palmer has a better product than its competition - palmer has a better distribution channel than its competition - palmer can produce the product more cheaply than its competition

Which of the following are true about depreciation expense?

1) it affects the accounting profit break even point 2) it affects cash flows 3) it is a non cash expense

contribution margin referes to the contribution made toward paying ___ by each additional unit sold

FC

in the context of capital budgeting, what does sensitivity analysis do?

It examines how sensitive a particular NVP calculation is to changes in underlying assumptions.

which of the following are reasons why NPV is considered a superior capital budgeting technique?

NPV considers all the cash flows; NPV considers time value of money

price/u = $6 vc = $2 fc = $400 d = $500 the relationship btwn OCF and Q can be expressed as:

OCF = (P - v) * Q - FC = (6-2)*Q-400 -400 + 4*Q

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 the 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.

financial break-even is the level of sales that results in:

a zero NPV

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

as low as possible

when a business does hard rationing, the firm's DCF analysis ______.

breaks down and the best course of action is ambiguous

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 estimated cash flows are ______.

inaccurate

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 estimates to be exact each time

An accounting break-even point of 1,000 means the firm ____________.

profits = 0 when units = 1,000

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

The Omega Division of Alpha Corporation has been allocated $4 million for capital spending but has identified $4.6 million in positive NVP 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

compute the NPV of a project that has the following end-of-year cash flow projections: Year 1 = $40,000; Year 2 = $50,000; Year 3 = -$22,000. The project requires an initial investment of $75,000 and has a discount rate of 10 percent

-$13,843

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

1.78 DOL = 1FC/OCF = 1 3500/4500 = 1.78

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 percent is 5.0188.

5990 OCF necessary to recover initial investment is: 4,000,000 / 5.0188 = 797,003.37 Q = (FC * OCF)/(P-v) = (1,000,000 * 797,003.37) / (500-200) ~ 5990

an R&D expense incurred in the past is an example of a

sunk cost

in a competitive market, positive NPV projects are...

uncommon