Chapter 011 Project Analysis and Evaluation

Size: px
Start display at page:

Download "Chapter 011 Project Analysis and Evaluation"

Transcription

1 Multiple Choice Questions 1. Forecasting risk is defined as the: a. possibility that some proposed projects will be rejected. b. process of estimating future cash flows relative to a project. C. possibility that errors in projected cash flows will lead to incorrect decisions. d. process of ascertaining the incremental cash flows for a project. e. possibility that tax rates could change over the life of a project. SECTION: 11.1 TOPIC: FORECASTING RISK TYPE: DEFINITIONS 2. Scenario analysis is defined as: a. the determination of the most likely outcome for a project. B. analyzing the changes in NPV estimates when what-if questions are posed. c. isolating the effect that one variable has on the NPV of a project. d. comparing the NPV of a project both with and without considering the effects of erosion. e. determining the acceptability of a project based solely on the project's operating cash flows. TOPIC: SCENARIO ANALYSIS TYPE: DEFINITIONS 3. An analysis of what happens to the estimate of net present value when only one variable is changed is called analysis. a. forecasting b. scenario C. sensitivity d. simulation e. break-even TOPIC: SENSITIVITY ANALYSIS TYPE: DEFINITIONS 11-1

2 4. An analysis which combines scenario analysis with sensitivity analysis is called analysis. a. forecasting b. scenario c. sensitivity D. simulation e. break-even TOPIC: SIMULATION ANALYSIS TYPE: DEFINITIONS 5. Variable costs: A. change in direct relationship to the quantity of output produced. b. are constant in the short-run regardless of the quantity of output produced. c. reflect the change in NPV when one more unit of output is produced and sold. d. are subtracted from fixed costs to compute the contribution margin. e. are inversely related to the number of units sold. TOPIC: VARIABLE COSTS TYPE: DEFINITIONS 6. Fixed costs: a. change as the quantity of output produced changes. B. are constant over the short-run regardless of the quantity of output produced. c. reflect the change in a variable when one more unit of output is produced. d. are subtracted from sales to compute the contribution margin. e. can be ignored in scenario analysis since they are constant over the life of a project. TOPIC: FIXED COSTS TYPE: DEFINITIONS 11-2

3 7. The change in revenue that occurs when one more unit of output is sold is called the revenue. A. marginal b. average c. total d. fixed e. variable TOPIC: MARGINAL REVENUE TYPE: DEFINITIONS 8. The sales level that results in a project's net income exactly equaling zero is called the break-even. a. operational b. leveraged C. accounting d. cash e. financial TOPIC: ACCOUNTING BREAK-EVEN TYPE: DEFINITIONS 9. The sales level that results in a project's operating cash flow exactly equaling zero is called the break-even. a. operational b. leveraged c. accounting D. cash e. financial SECTION: 11.4 TOPIC: CASH BREAK-EVEN TYPE: DEFINITIONS 11-3

4 10. The sales level that results in a project's net present value exactly equaling zero is called the break-even. a. operational b. leveraged c. accounting d. cash E. financial SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN TYPE: DEFINITIONS 11. Operating leverage is the: a. dependence of a firm on variable costs. b. percentage of a sales price that is needed to cover variable costs. c. percentage of the sales price which represents the contribution margin. D. degree to which a firm relies on fixed costs. e. amount of debt used to finance a project. SECTION: 11.5 TOPIC: OPERATING LEVERAGE TYPE: DEFINITIONS 12. The percentage change in operating cash flow relative to the percentage change in quantity sold is called the: a. marginal profit. B. degree of operating leverage. c. gross profit. d. net profit. e. contribution margin. SECTION: 11.5 TOPIC: DEGREE OF OPERATING LEVERAGE TYPE: DEFINITIONS 11-4

5 13. The procedure of allocating a fixed amount of funds for capital spending to each business unit is called: a. marginal spending. b. average spending. C. soft rationing. d. hard rationing. e. marginal rationing. SECTION: 11.6 TOPIC: SOFT RATIONING TYPE: DEFINITIONS 14. Hard rationing is defined as the situation where: a. two projects have the same NPV but only one project can be financed. b. firms are forced to chose one project over another. c. divisions within a firm are granted equal amounts for capital expenditures. d. divisions within a firm request more funds for capital projects than firms have available for use. E. a firm is unable to raise the funds needed for a project from any source. SECTION: 11.6 TOPIC: HARD RATIONING TYPE: DEFINITIONS 15. Forecasting risk emphasizes the point that the correctness of any decision to accept or reject a project is highly dependent upon the: a. method of analysis used to make the decision. b. initial cash outflow. c. ability to recoup any investment in net working capital. D. accuracy of the projected cash flows. e. length of the project. SECTION: 11.1 TOPIC: FORECASTING RISK 11-5

6 16. Jennie is fairly cautious when considering new opportunities and therefore analyzes each project to determine the most optimistic, the most realistic, and the most pessimistic outcome that can reasonably be expected. Jennie is using: a. forecast modeling. b. sensitivity analysis. c. break-even analysis. d. soft rationing. E. scenario analysis. TOPIC: SCENARIO ANALYSIS 17. Conducting scenario analysis on a proposed project helps managers determine the: a. impact that an individual variable has on the outcome of the project. b. initial cost that will be required to implement the project. c. actual profitable life of the project. d. level of funding available for the project. E. potential range of reasonable outcomes that might be realized. TOPIC: SCENARIO ANALYSIS 18. When conducting a best case scenario analysis, you should assume that: a. the number of units sold and the variable cost per unit are at the high end of their potential ranges. B. the salvage value will be at the high end of its possible range. c. sales quantity will be at the low end of its range while the sales price is the highest price possible. d. the variable costs per unit are at the high end of potential cost range. e. fixed costs will become variable and decrease in dollar amount. TOPIC: SCENARIO ANALYSIS 11-6

7 19. The base case values used in scenario analysis are the ones considered the most: a. optimistic. b. desired by management. c. pessimistic. d. conducive to creating a positive net present value. E. likely to occur. TOPIC: SCENARIO ANALYSIS 20. Which of the following variables will be at their highest expected level under a worst case scenario? I. fixed cost II. sales price III. variable cost IV. sales quantity a. I only b. III only c. II and III only D. I and III only e. I, III, and IV only TOPIC: SCENARIO ANALYSIS 21. When you assign the highest sales price and the lowest costs to a project, you are analyzing the project under the condition known as: a. optimistic sensitivity. b. pessimistic sensitivity. C. optimistic scenario analysis. d. pessimistic scenario analysis. e. base case scenario analysis. TOPIC: SCENARIO ANALYSIS 11-7

8 22. Which one of the following statements concerning scenario analysis is correct? a. The worst case scenario determines the maximum loss, in current dollars, that a firm could incur from a given project. b. Scenario analysis reflects the entire range of results that can be realized from a proposed investment project. c. Scenario analysis provides a clear signal to management to either accept or reject a proposed project. D. Scenario analysis provides management with a glimpse of the possible range of outcomes that could be realized from a project. e. When the base case scenario results in a positive net present value, management can be assured the proposed project will meet or exceed their expectations. TOPIC: SCENARIO ANALYSIS 23. Sensitivity analysis determines the: a. range of possible outcomes given that most variables can assume a range of values. B. degree to which the net present value reacts to changes in a single variable. c. extent of the range of net present values that can be realized from a proposed project. d. degree to which a project is reliant upon the fixed costs. e. ideal ratio of variable costs to fixed costs for profit maximization. TOPIC: SENSITIVITY ANALYSIS 24. Assume you graph the changes in net present value against the changes in the value of a single variable used in a project. The steepness of the resulting function illustrates the: a. degree of operating leverage within the project. b. trade-off of variable versus fixed costs utilized by the project. c. range of total outcomes possible from accepting a proposed project. d. contribution margin of the project at various levels of output. E. degree of sensitivity of the project's outcome to changes in the single variable. TOPIC: SENSITIVITY ANALYSIS 11-8

9 25. As the degree of sensitivity of a project to a single variable rises, the: a. less important the variable to the final outcome of the project. b. less volatile the project's net present value to that variable. C. greater the importance of accurately predicting the value of that variable. d. greater the profit margin of the project. e. less volatile the project's outcome. TOPIC: SENSITIVITY ANALYSIS 26. Sensitivity analysis is based on: A. varying a single variable and measuring the resulting change in the NPV of a project. b. applying differing discount rates to a project's cash flows and measuring the effect on the NPV. c. expanding and contracting the number of years for a project to determine the optimal project length. d. the best, worst, and most expected situations. e. various states of the economy and the probability of each state occurring. TOPIC: SENSITIVITY ANALYSIS 27. To ascertain whether the accuracy of a variable cost estimate for a project will have much effect on the final outcome of that project, you should conduct analysis. a. leverage b. scenario c. break-even D. sensitivity e. cash flow TOPIC: SENSITIVITY ANALYSIS 11-9

10 28. Simulation analysis is based on assigning a and analyzing the results. a. narrow range of values to a single variable b. narrow range of values to multiple variables simultaneously c. wide range of values to a single variable D. wide range of values to multiple variables simultaneously e. single value to each of the variables TOPIC: SIMULATION 29. The type of analysis that is most dependent upon the use of a computer is analysis. a. scenario b. break-even c. sensitivity d. degree of operating leverage E. simulation TOPIC: SIMULATION 30. Which one of the following is most likely a fixed cost? A. office rent b. employee wages c. sales tax d. raw materials e. shipping costs TOPIC: FIXED COSTS 11-10

11 31. Which one of the following statements concerning variable costs is correct? a. Variable costs minus fixed costs equal marginal costs. b. Variable costs are equal to fixed costs when production is equal to zero. c. An increase in variable costs increases the operating cash flow. d. Variable costs are inversely related to fixed costs. E. Variable costs are inversely related to operating cash flow. TOPIC: VARIABLE COSTS 32. As the variable cost per unit increases, the: A. contribution margin decreases. b. number of units sold decreases. c. fixed cost per unit decreases. d. operating cash flow increases. e. net profit increases. TOPIC: VARIABLE COSTS 33. As additional fixed assets are purchased for a project, the project's level of fixed costs and the degree of operating leverage. A. increases; increases b. increases; decreases c. decreases; increases d. decreases; decreases e. remains constant; remains constant TOPIC: FIXED COSTS 11-11

12 34. Which one of the following is a fixed cost in the short-run? a. packaging and shipping costs b. wages for a machine operator c. the cost of raw materials d. the cost of water used in the production process E. three-year lease on a delivery truck TOPIC: FIXED COSTS 35. Management wants to offer a "Thank You" sale to its customers by offering to sell additional units of a product at the lowest price possible without affecting the firm's profits. The price management charges for these one-time sale units should be set equal to the: a. average variable cost. b. average total cost. c. average total revenue. d. marginal revenue. E. marginal cost. TOPIC: MARGINAL COST 11-12

13 36. The president of your firm would like to offer special sale prices to your best customers under the following terms: The prices will apply only to units purchased in excess of those normally purchased by the customer. The units purchased must be paid for in cash at the time of sale. The total quantity sold under these terms cannot exceed the excess capacity of the firm. The net profit of the firm should not be affected either positively or negatively. Given these conditions, the special sale price should be set equal to the: a. average variable cost. b. average total cost minus the marginal cost. c. sensitivity value of the variable cost. D. marginal cost. e. marginal cost minus the average fixed cost per unit. TOPIC: MARGINAL COST 37. The contribution margin per unit is equal to the: a. sales price per unit minus the total costs per unit. b. variable cost per unit minus the fixed cost per unit. C. sales price per unit minus the variable cost per unit. d. pre-tax profit per unit divided by the sales price. e. aftertax profit per unit divided by the sales price. TOPIC: CONTRIBUTION MARGIN 38. At the accounting breakeven point, the contribution margin must equal: a. total costs. b. fixed costs. c. the earnings before interest and taxes. D. fixed costs plus depreciation. e. depreciation. TOPIC: ACCOUNTING BREAKEVEN 11-13

14 39. Which of the following statements are correct concerning the accounting break-even point? I. The net income is equal to zero. II. The net present value is equal to zero. III. The quantity sold is equal to the total fixed costs plus depreciation divided by the contribution margin. IV. The quantity sold is equal to the total fixed costs divided by the contribution margin. A. I and III only b. I and IV only c. II and III only d. II and IV only e. I, II, and IV only TOPIC: ACCOUNTING BREAK-EVEN 40. At the accounting break-even level of sales, the operating cash flow is equal to: a. zero. B. depreciation. c. fixed costs plus depreciation. d. net income plus taxes. e. the variable costs. TOPIC: ACCOUNTING BREAK-EVEN 41. All else constant, the accounting break-even level of sales will decrease when the: a. fixed costs increase. B. depreciation expense decreases. c. contribution margin decreases. d. variable costs per unit increase. e. selling price per unit decreases. TOPIC: ACCOUNTING BREAK-EVEN 11-14

15 42. At the accounting break-even point, the: a. payback period must equal the required payback period. b. NPV is zero. C. IRR is zero. d. contribution margin equals the fixed costs. e. contribution margin is zero. TOPIC: ACCOUNTING BREAK-EVEN 43. A project has a payback period that exactly equals the project's life. The project is operating at: a. its maximum capacity. b. the financial break-even point. c. the cash break-even point. D. the accounting break-even point. e. a zero level of output. TOPIC: ACCOUNTING BREAK-EVEN 44. Roger just completed analyzing a project. His analysis indicates that the project will have a 5-year life and require an initial cash outlay of $225,000. Annual sales are estimated at $685,000 and the tax rate is 35 percent. The net present value is a negative $225,000. Based on this analysis, the project is expected to operate at the: a. maximum possible level of production. b. minimum possible level of production. c. financial break-even point. d. accounting break-even point. E. cash break-even point. SECTION: 11.4 TOPIC: CASH BREAK-EVEN 11-15

16 45. A project has a projected IRR of negative 100 percent. Which one of the following statements must also be true concerning this project? a. The discounted payback period equals the life of the project. B. The estimated sales volume is equal to the cash break-even level of sales. c. The estimated sales volume is equal to the financial break-even level of sales. d. The payback period is exactly equal to the life of the project. e. The net present value of the project is equal to zero. SECTION: 11.4 TOPIC: CASH BREAK-EVEN 46. Which of the following are characteristics of a project with sales set at the cash breakeven point? I. The project never pays back. II. The IRR equals the required rate of return. III. The NPV is negative and equal to the initial cash outlay. IV. The operating cash flow is equal to the depreciation expense. A. I and III only b. II and IV only c. I, II, and III only d. II, III, and IV only e. I, II, III, and IV SECTION: 11.4 TOPIC: CASH BREAK-EVEN 47. When the operating cash flow of a project is equal to zero, the project is operating at the: a. maximum possible level of production. b. minimum possible level of production. c. financial break-even point. d. accounting break-even point. E. cash break-even point. SECTION: 11.4 TOPIC: CASH BREAK-EVEN 11-16

17 48. The point where a project produces a rate of return equal to the required return is known as the: a. point of zero operating leverage. b. cash break-even point. c. accounting break-even point. D. financial break-even point. e. internal break-even point. SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN 49. Which of the following statements are correct concerning the financial break-even point of a project? I. The present value of the cash inflows exactly offsets the initial cash outflow. II. The payback period is equal to the life of the project. III. The NPV is zero. IV. The discounted payback period equals the life of the project. a. I and II only b. I and III only c. II and IV only d. III and IV only E. I, III, and IV only SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN 50. You would like to know the minimal level of sales that is needed for a project to be accepted based on net present value. To determine that sales level you should compute the: a. contribution margin and set that margin equal to the fixed costs. b. divided the contribution margin by (1 Tax rate). c. accounting break-even point. d. cash break-even point. E. financial break-even point. SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN 11-17

18 51. You are considering a project that you believe is quite risky. To reduce any potentially harmful results from accepting this project, you could: A. lower the degree of operating leverage. b. lower the contribution margin. c. increase the initial cash outlay. d. increase the fixed costs per unit while lowering the contribution margin. e. lower the operating cash flow of the project. SECTION: 11.5 TOPIC: OPERATING LEVERAGE 52. Which one of the following characteristics best describes a project that has a low degree of operating leverage? A. high variable costs relative to the fixed costs b. relatively high initial cash outlay c. an OCF that is highly sensitive to the sales quantity d. high level of forecasting risk e. a DOL of five or greater SECTION: 11.5 TOPIC: OPERATING LEVERAGE 53. Which one of the following will reduce the risk of a project by lowering the degree of operating leverage? a. hiring temporary workers from an employment agency rather than hiring part-time employees B. subcontracting portions of the project rather than purchasing new equipment to do all the work in-house c. leasing equipment on a long-term basis rather than buying equipment d. lowering the projected selling price per unit e. changing the proposed production method to a more capital intensive method SECTION: 11.5 TOPIC: OPERATING LEVERAGE 11-18

19 54. The degree of operating leverage is equal to: a. FC / OCF. b. VC / OCF. C. 1 + FC / OCF. d. 1 + VC / OCF. e. 1 FC / OCF. SECTION: 11.5 TOPIC: DEGREE OF OPERATING LEVERAGE 55. Merkel Enterprises has three divisions. As part of the planning process, the CFO requested that each division submit their capital budgeting proposals for next year. These proposals all have positive net present values and fall within the long-range plans of the firm. The requests from the divisions are $6.2 million, $4.8 million, and $3.7 million, respectively. For the firm as a whole, Merkel Enterprises has a maximum of $12 million which can be spent for new projects next year. This is an example of: a. scenario analysis. b. sensitivity analysis. c. determining operating leverage. D. soft rationing. e. hard rationing. SECTION: 11.6 TOPIC: SOFT RATIONING 56. Treynor United has received requests for capital investment funds from each of their five divisions for next year. Senior management has decided to allocate the available funds based on the profitability index of each project since the company has insufficient funds to fulfill all of the requests. Management is following a practice known as: a. scenario analysis. b. sensitivity analysis. c. leveraging. d. hard rationing. E. soft rationing. SECTION: 11.6 TOPIC: SOFT RATIONING 11-19

20 57. The CFO of Tried and True is continually receiving capital funding requests from division managers. These requests are seeking funding for positive net present value projects. The CFO continues to deny all funding requests due to the financial situation of the company. Apparently, the company is: a. operating at the accounting break-even point. b. operating at the financial break-even point. C. facing hard rationing. d. operating with zero leverage. e. operating at maximum capacity. SECTION: 11.6 TOPIC: HARD RATIONING The Franklin Co. is analyzing a proposed project. The company expects to sell 3,500 units, give or take 15 percent. The expected variable cost per unit is $6 and the expected fixed costs are $15,500. Cost estimates are considered accurate within a plus or minus 5 percent range. The depreciation expense is $6,000. The sales price is estimated at $21 a unit, give or take 3 percent. The company bases their sensitivity analysis on the base case scenario. 58. What is the sales revenue under the worst case scenario? A. $60, b. $62, c. $73, d. $84, e. $87, Sales revenue for the worst case = 3, $21.97 = $60, TOPIC: SCENARIO ANALYSIS 11-20

21 59. What is the contribution margin under the base case scenario? a. $14.55 b. $14.82 C. $15.00 d. $15.45 e. $15.63 Contribution margin for the base case = $21 $6 = $15 TOPIC: SCENARIO ANALYSIS 60. What is the amount of the fixed cost per unit under the best case scenario? a. $3.47 B. $3.66 c. $3.85 d. $4.21 e. $4.43 Fixed cost per unit for the best case = ($15,500.95) / (3, ) = $3.66 TOPIC: SCENARIO ANALYSIS 11-21

22 61. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of $23. What are the earnings before interest and taxes? A. $38,000 b. $44,000 c. $50,000 d. $59,500 e. $65,000 EBIT = [($23 $6) 3,500] $15,500 $6,000 = $38,000 TOPIC: SENSITIVITY ANALYSIS 62. The company conducts a sensitivity analysis using a variable cost of $10. The total cost estimate, excluding depreciation, will be: a. $15,500 b. $19,000 c. $35,000 D. $50,500 e. $62,000 Total costs = ($10 3,500) + $15,500 = $50,500 TOPIC: SENSITIVITY ANALYSIS The Quick Producers Co. is analyzing a proposed project. The company expects to sell 10,000 units, give or take 5 percent. The expected variable cost per unit is $6 and the expected fixed cost is $29,000. The fixed and variable cost estimates are considered accurate within a plus or minus 4 percent range. The depreciation expense is $25,000. The tax rate is 34 percent. The sale price is estimated at $13 a unit, give or take 6 percent

23 63. What is the earnings before interest and taxes under the base case scenario? a. $10,560 B. $16,000 c. $22,440 d. $41,000 e. $66,000 EBIT for base case = [10,000 ($13 $6)] $29,000 $25,000 = $16,000 TOPIC: SCENARIO ANALYSIS 64. What is the earnings before interest and taxes under the worst case scenario? a. $840 B. $1,650 c. $2,810 d. $5,090 e. $8,530 EBIT for worst case = (10,000.95) [($13.94) ($6 1.04)] ($29, ) $25,000 = $1,650 TOPIC: SCENARIO ANALYSIS 11-23

24 65. What is the net income under the best case scenario? a. $5, b. $10, c. $15, D. $20, e. $24, Net income for best case = {[10, ] [($ ) ($6.96)] ($29,000.96) $25,000} {1.34} = $20, TOPIC: SCENARIO ANALYSIS 66. What is the operating cash flow for a sensitivity analysis using total fixed costs of $26,000? a. $19,000 b. $22,960 c. $29,040 d. $31,460 E. $37,540 EBIT = [(10,000 ($13 $6)] $26,000 $25,000 = $19,000 Tax = $19, = $6,460 OCF = $19,000 + $25,000 $6,460 = $37,540 TOPIC: SENSITIVITY ANALYSIS 11-24

25 67. What is the contribution margin for a sensitivity analysis using a variable cost per unit of $9? a. $3 B. $4 c. $7 d. $9 e. $13 Contribution margin = $13 - $9 = $4 TOPIC: SENSITIVITY ANALYSIS 68. Your company is reviewing a project with labor cost of $11.60 per unit, raw materials cost of $24.58 a unit, and fixed costs of $12,000 a month. Sales are projected at 10,000 units over the four-month life of the project. What are the total variable costs of the project? a. $116,000 b. $129,800 c. $141,800 D. $361,800 e. $373,800 Total variable costs = ($ $24.58) 10,000 = $361,800 TOPIC: VARIABLE COST 11-25

26 69. A project has earnings before interest and taxes of $6,500, fixed costs of $40,000, a selling price of $12 a unit, and a sales quantity of 10,000 units. Depreciation is $8,500. What is the variable cost per unit? a. $6.25 B. $6.50 c. $6.75 d. $7.00 e. $7.25 [10,000 ($12.00 v)] $40,000 $8,500 = $6,500; v = $6.50 TOPIC: VARIABLE COST 70. At a production level of 6,500 units, a project has total costs of $95,000. The variable cost per unit is $ What is the amount of the total fixed costs if the production level is increased to 7,000 units without increasing the total fixed assets? a. $19,400 b. $21,600 C. $24,800 d. $28,000 e. $30,200 Total fixed cost = $95,000 (6,500 $10.80) = $24,800 TOPIC: FIXED COST 11-26

27 71. A company is considering a project with a cash break-even point of 14,500 units. The selling price is $14 a unit and the variable cost per unit is $8. What is the projected amount of fixed costs? A. $87,000 b. $94,000 c. $109,000 d. $116,000 e. $203,000 FC at the cash break-even point = 14,500 ($14 $8) = $87,000 TOPIC: FIXED COST 72. Highland's Hats currently produces 1,500 ski hats at a total cost of $11,520. If the firm produces 1,501 ski hats, the total costs increase to $11, What is the minimal price Highland's Hats can charge for the 1,501 st ski hat without affecting the firm's profits? a. $7.65 B. $7.66 c. $7.67 d. $7.68 e. $7.69 Marginal cost of 1,501 st unit = $11, $11,520 = $7.66 TOPIC: MARGINAL COST 11-27

28 73. Choice Coffee has computed their fixed costs to be $.20 for every cup of coffee they sell given an average daily sales level of 600 cups. They charge $1.65 per cup of coffee. The variable cost per cup is $.45. What is the contribution margin per cup of coffee sold? a. $.65 b. $.90 c. $1.00 D. $1.20 e. $1.65 Contribution margin = $1.65 $.45 = $1.20 TOPIC: CONTRIBUTION MARGIN 74. Madeline's Specialty Goods is considering a project with total sales of $19,000, total variable costs of $10,400, total fixed costs of $4,500, and estimated production of 500 units. The depreciation expense is $2,600 a year. What is the contribution margin per unit? a. $12.00 B. $17.20 c. $23.80 d. $29.00 e. $34.00 Contribution margin = ($19,000 $10,400) / 500 = $17.20 TOPIC: CONTRIBUTION MARGIN 11-28

29 75. Your company is considering a new project with estimated depreciation of $630, fixed costs of $5,000, and total sales of $10,050. The variable cost per unit are estimated at $3.75. What is the accounting break-even level of production? a. 1,100 units B. 1,179 units c. 1,216units d. 1,298 units e. 1,347 units Accounting break-even Q = ($5,000 + $630) / [($10,050 / Q) $3.75]; Q = 1, = 1,179 TOPIC: ACCOUNTING BREAK-EVEN 76. The accounting break-even production quantity for a project is 5,850 units. The fixed costs are $27,400 and the contribution margin is $7. What is the projected depreciation expense? a. $0 b. $12,836 c. $12,914 d. $13,224 E. $13,550 Depreciation at the accounting break-even = (5,850 $7) $27,400 = $13,550 TOPIC: ACCOUNTING BREAK-EVEN 11-29

30 77. A project has an accounting break-even point of 1,600 units. The fixed costs are $3,200 and the depreciation expense is $200. The projected variable cost per unit is $ What is the projected sales price? a. $9.65 b. $14.75 c. $18.35 d. $20.50 E. $22.63 Accounting break-even Q = 1,600 = ($3,200 + $200) / (P $20.50); P = $22.63 TOPIC: ACCOUNTING BREAK-EVEN 78. A proposed project has fixed costs of $3,700, depreciation expense of $1,400, and a sales quantity of 1,500 units. What is the contribution margin if the projected level of sales is the accounting break-even point? a. $2.47 b. $2.64 c. $3.10 D. $3.40 e. $3.71 Contribution margin = ($3,700 + $1,400) / 1,500 = $3.40 TOPIC: ACCOUNTING BREAK-EVEN 11-30

31 79. The Baltimore Co. would like to add a new product to complete their lineup. They want to know how many units they must sell to limit their potential loss to their initial investment. What is this quantity if their fixed costs are $14,000, the depreciation expense is $2,800, and the contribution margin is $1.25? a. 2,240 units b. 6,880 units c. 8,960 units D. 11,200 units e. 13,440 units Cash break-even point = $14,000 / $1.25 = 11,200 SECTION: 11.4 TOPIC: CASH BREAK-EVEN 80. The Handelcreek Co. is considering expanding their operations. Fixed costs are estimated at $86,000 a year. The variable cost per unit is estimated at $ The estimated sales price is $34.00 per unit. What is the cash break-even point of this project? a. 2,529 units b. 4,649 units C. 5,548 units d. 7,114 units e. 9,740 units Cash break-even point = $86,000 / ($34.00 $18.50) = 5, = 5,548 SECTION: 11.4 TOPIC: CASH BREAK-EVEN 11-31

32 81. A project has a contribution margin of $6, projected fixed costs of $14,000, projected variable cost per unit of $14, and a projected financial break-even point of 6,000 units. What is the operating cash flow at this level of output? A. $22,000 b. $34,000 c. $46,000 d. $62,000 e. $70,000 Operating cash flow at the financial break-even point = (6,000 $6) $14,000 = $22,000 SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN 82. The Colby Brothers have been busy analyzing a new product. They have determined that an operating cash flow of $18,200 will result in a zero net present value, which is a company requirement for project acceptance. The fixed costs are $11,650 and the contribution margin is $7.40. The company feels that they can realistically capture five percent of the 75,000 unit market for this product. Should the company develop the new product? Why or why not? a. Yes; The project has an expected internal rate of return of 100 percent. b. Yes; The expected level of sales exceeds the required number of units. c. Yes; The project is expected to sell 324 units more than the required number of units. D. No; The expected level of sales is less than the required level of 4,034 units. e. No; The annual sales would need to exceed 4,521 units to be acceptable. Financial break-even point = ($11,650 + $18,200) / $7.40 = 4, = 4,034 units. Expected sales = 75, = 3,750 units. The project should not be accepted because the expected level of sales is less than the financial break-even point. SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN 11-32

33 83. ABC, Inc. is considering a project with a discounted payback just equal to the project's life. The projections include a sales price of $13, variable cost per unit of $10.50, and fixed costs of $5,000. The operating cash flow is $6,300. What is the break-even quantity? a. 3,869 units b. 3,913 units c. 4,340 units D. 4,520 units e. 4,610 units Financial break-even point = ($5,000 + $6,300) / ($13 $10.50) = 4,520 units SECTION: 11.4 TOPIC: FINANCIAL BREAK-EVEN 84. A coworker is in charge of a project that has a degree of operating leverage of 2.0. What will happen to the operating cash flows if your coworker decreases the number of units sold by 10 percent? a. 10 percent decrease B. 20 percent decrease c. 5 percent increase d. 10 percent increase e. 20 percent increase Percentage change in OCF = 2.0 (.10) =.20 = 20 percent decrease SECTION: 11.5 TOPIC: OPERATING LEVERAGE 11-33

34 85. The department manager has noted that every time the sales quantity increases by 6 percent for a particular project, the operating cash flow for the project increases by 9 percent. What is the degree of operating leverage for this project if the contribution margin is $2? a..67 B c d e Degree of operating leverage =.09 /.06 = 1.50 SECTION: 11.5 TOPIC: OPERATING LEVERAGE 86. The fixed costs of a project are $6,000. The depreciation expense is $4,500 and the operating cash flow is $18,000. What is the degree of operating leverage for this project? A b c d e Degree of operating leverage = 1 + ($6,000 / $18,000) = 1.33 SECTION: 11.5 TOPIC: OPERATING LEVERAGE 11-34

35 87. Donald and Sons manage a product with a 3.0 degree of operating leverage. Sales of the product are expected to increase by 10 percent next year. What is the expected change in the operating cash flow for this product for next year? a. 3.3 percent increase b. 10 percent increase C. 30 percent increase d. 10 percent decrease e. 30 percent decrease Percentage change in OCF = =.30 = 30 percent increase SECTION: 11.5 TOPIC: OPERATING LEVERAGE Essay Questions 88. What is operating leverage and why is it important in the analysis of capital expenditure projects? The textbook defines operating leverage as "the degree to which a firm or project relies on fixed costs". The more capital intensive a firm becomes, the higher the firm's degree of operating leverage. The degree of operating leverage determines the percentage change in a firm's operating cash flow relative to the percentage change in sales quantity. Thus, capital intensive firms are more susceptible to forecasting risk. AACSB TOPIC: REFLECTIVE THINKING SECTION: 11.5 TOPIC: OPERATING LEVERAGE 11-35

36 89. What is forecasting risk and why is it important to the analysis of capital expenditure projects? Forecasting risk, as defined by the textbook, is "the possibility that errors in projected cash flows will lead to incorrect decisions". For example, cash flows that are overly optimistic might result in a projected positive NPV and lead to project acceptance, when in reality, the project should have been rejected. AACSB TOPIC: REFLECTIVE THINKING SECTION: 11.1 AND 11.2 TOPIC: FORECASTING RISK 90. How do the accounting, cash, and financial break-even points differ from one another? The accounting break-even point is the level of sales required for a firm to just cover its fixed operating costs and depreciation expense resulting in a zero net income. The cash break-even point is the level of sales at which the firm covers its cash fixed operating costs causing the operating cash flow to equal zero. The financial break-even point is the level of sales which causes the NPV of a project to equal zero which indicates that the project has no wealth implications for the firm. AACSB TOPIC: REFLECTIVE THINKING AND 11.4 TOPIC: BREAK-EVEN ANALYSIS 91. What is the benefit of scenario analysis if it does not always produce a clear accept or reject decision for a proposed project? Sometimes scenario analysis provides a fairly clear indicator that a project should be either accepted or rejected. Frequently however, no clear cut accept or reject decision is indicated. However, scenario analysis does provide managers with a general feel for the volatility and potential range of outcomes that might be realized if a project is accepted. This understanding helps managers decide whether or not a project is acceptable to their firm at a particular point in time. AACSB TOPIC: REFLECTIVE THINKING TOPIC: SCENARIO ANALYSIS 11-36

37 92. Consider the following statement by a project analyst: "I analyzed a project using best case, worst case, and most expected case scenario analysis. I computed break-evens and degrees of operating leverage. I conducted sensitivity analysis and simulation analysis. I computed NPV, IRR, payback, AAR, and PI. In the end, I have over a hundred different estimates and am more confused than ever. I would have been better off just sticking with my first estimate and going with my gut feel." Critique this statement. Project analysis, in all of its various forms, is designed to help project analysts ask the right questions and gain information regarding the potential range of outcomes, the volatility of those outcomes, and the pros and cons of a project. By conducting this analysis, the analyst gains a better understanding of the situation by asking the right questions. However, the final results of the analysis are subject to error especially if the cash flow forecasts are questionable. AACSB TOPIC: REFLECTIVE THINKING SECTION: 11.7 TOPIC: EVALUATION 11-37

2) A project should automatically be accepted when the project's base case net present value is positive.

2) A project should automatically be accepted when the project's base case net present value is positive. Questions Chapter 11 1) Given a tax rate of zero, the accounting break-even point for a project: [A] indicates when the net present value turns positive. [B] excludes depreciation in its computation. [C]

More information

Key Concepts and Skills

Key Concepts and Skills Key Concepts and Skills Chapter 9 Making Capital Investment Decisions Understand how to determine the relevant cash flows for a proposed investment Understand how to analyze a project s projected cash

More information

Finance for Cultural Organisations Lecture 9. Capital Budgeting: Project Analysis and Evaluation

Finance for Cultural Organisations Lecture 9. Capital Budgeting: Project Analysis and Evaluation Finance for Cultural Organisations Lecture 9. Capital Budgeting: Project Analysis and Evaluation Lecture 9. Capital Budgeting: Project Analysis & Evaluation Understand forecasting risk and sources of value

More information

Chapter. Project Analysis and Evaluation. McGraw-Hill/Irwin. Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter. Project Analysis and Evaluation. McGraw-Hill/Irwin. Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 11 Project Analysis and Evaluation McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Key Concepts and Skills Understand forecasting risk and sources of value

More information

Lecture 8 (Chapter 11): Project Analysis and Evaluation

Lecture 8 (Chapter 11): Project Analysis and Evaluation Lecture 8 (Chapter 11): Project Analysis and Evaluation Discounted cash flow analysis is a very powerful tool, but it is not easy to use. We have already seen one difficulty: How do we identify the cash

More information

1) quantifies in dollar terms how stockholder wealth will be affected by undertaking a project under consideration.

1) quantifies in dollar terms how stockholder wealth will be affected by undertaking a project under consideration. Questions in Chapter 9 concept.qz 1) quantifies in dollar terms how stockholder wealth will be affected by undertaking a project under consideration. [A] Discounted payback analysis [B] The average accounting

More information

AGENDA LEARNING OBJECTIVES ANALYZING PROJECT CASH FLOWS. Chapter 12. Learning Objectives Principles Used in This Chapter

AGENDA LEARNING OBJECTIVES ANALYZING PROJECT CASH FLOWS. Chapter 12. Learning Objectives Principles Used in This Chapter Chapter 12 ANALYZING PROJECT CASH FLOWS AGENDA Learning Objectives Principles Used in This Chapter 1. Identifying Incremental Cash Flows 2. Forecasting Project Cash Flows 3. Inflation and Capital Budgeting

More information

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Basic 1. To calculate the payback period, we need to find the time that the project has recovered its initial investment. After two years, the

More information

11.3 BREAK-EVEN ANALYSIS. Fixed and Variable Costs

11.3 BREAK-EVEN ANALYSIS. Fixed and Variable Costs 385 356 PART FOUR Capital Budgeting a large number of NPV estimates that we summarize by calculating the average value and some measure of how spread out the different possibilities are. For example, it

More information

CHAPTER 7. Fundamentals of Capital Budgeting. Chapter Synopsis

CHAPTER 7. Fundamentals of Capital Budgeting. Chapter Synopsis CHAPTER 7 Fundamentals of Capital Budgeting Chapter Synopsis 7.1 Forecasting Earnings A firm s capital budget lists all of the projects that a firm plans to undertake during the next period. The selection

More information

Chapter 7: Net Present Value and Other Investment Criteria

Chapter 7: Net Present Value and Other Investment Criteria FIN 301 Class Notes Chapter 7: Net Present Value and Other Investment Criteria Project evaluation involves: 1- Estimating the cash flows associated with the investment project (ch. 8) 2- Determining the

More information

Finance for Cultural Organisations Lecture 8. Capital Budgeting: Making Capital Investment Decisions

Finance for Cultural Organisations Lecture 8. Capital Budgeting: Making Capital Investment Decisions Finance for Cultural Organisations Lecture 8. Capital Budgeting: Making Capital Investment Decisions Lecture 8. Capital Budgeting: Making Capital Investment Decisions Understand how to determine the relevant

More information

Capital Budgeting II. Professor: Burcu Esmer

Capital Budgeting II. Professor: Burcu Esmer Capital Budgeting II Professor: Burcu Esmer 1 Cash Flows Last chapter introduced valuation techniques based on discounted cash flows. This chapter develops criteria for properly identifying and calculating

More information

Economic Feasibility Studies

Economic Feasibility Studies Economic Feasibility Studies ١ Introduction Every long term decision the firm makes is a capital budgeting decision whenever it changes the company s cash flows. The difficulty with making these decisions

More information

CAPITAL BUDGETING. Net Present Value and Other Investment Criteria

CAPITAL BUDGETING. Net Present Value and Other Investment Criteria CAPITAL BUDGETING Net Present Value and Other Investment Criteria Net Present Value (NPV) Net present value is the difference between an investment s market value (in today s dollars) and its cost (also

More information

Pro Forma Income Statements Sales $50,000 Var. costs 30,000 Fixed costs 5,000 Depreciation 7,000 EBIT $8,000 Taxes (34%) 2,720 Net income $5,280

Pro Forma Income Statements Sales $50,000 Var. costs 30,000 Fixed costs 5,000 Depreciation 7,000 EBIT $8,000 Taxes (34%) 2,720 Net income $5,280 Project Analysis: Suppose we want to prepare a set of pro forma financial statements for a project for Norma Desmond Enterprises. In order to do so, we must have some background information. In this case,

More information

Net Present Value (NPV)

Net Present Value (NPV) Investment Criteria 208 Net Present Value (NPV) What: NPV is a measure of how much value is created or added today by undertaking an investment (the difference between the investment s market value and

More information

CHAPTER 6. Problems and Questions

CHAPTER 6. Problems and Questions 1 CHAPTER 6 Problems and Questions 1. A small manufacturing firm, which has limited access to capital, has a capital rationing constraint of $150 million and is faced with the following investment projects

More information

Study Unit 8. CVP Analysis and Marginal Analysis

Study Unit 8. CVP Analysis and Marginal Analysis Study Unit 8 CVP Analysis and Marginal Analysis SU- 8.1 Cost-Volume-Profit (CVP) Analysis - Theory CVP = Break-even analysis Allows us to analyze the relationship between revenue and fixed and variable

More information

Lecture 5 (Chapter 9) Investment Criteria. Some Problems

Lecture 5 (Chapter 9) Investment Criteria. Some Problems Lecture 5 (Chapter 9) Investment Criteria Up to now, we have analyzed how to finance a firm (capital structure) Today we switch to analyzing what to do with the money once we ve got it (capital budgeting

More information

Chapter 7 Fundamentals of Capital Budgeting

Chapter 7 Fundamentals of Capital Budgeting Chapter 7 Fundamentals of Capital Budgeting Copyright 2011 Pearson Prentice Hall. All rights reserved. Chapter Outline 7.1 Forecasting Earnings 7.2 Determining Free Cash Flow and NPV 7.3 Choosing Among

More information

Multiple Choice Questions (45%)

Multiple Choice Questions (45%) Multiple Choice Questions (45%) Choose the Correct Answer 1. The following information was taken from XYZ Company s accounting records for the year ended December 31, 2014: Increase in raw materials inventory

More information

Session #5 Capital Budgeting - II Damodaran - Chapter 9: 6,12,16,18 Chapter 10: 2,10,16(a&b) Chapter 11: 6,12,14

Session #5 Capital Budgeting - II Damodaran - Chapter 9: 6,12,16,18 Chapter 10: 2,10,16(a&b) Chapter 11: 6,12,14 Session #5 Capital Budgeting - II Damodaran - Chapter 9: 6,12,16,18 Chapter 10: 2,10,16(a&b) Chapter 11: 6,12,14 I. Additional Issues in Capital Budgeting. A. Capital rationing: Use profitability index

More information

Chapter 8: Fundamentals of Capital Budgeting

Chapter 8: Fundamentals of Capital Budgeting Chapter 8: Fundamentals of Capital Budgeting-1 Chapter 8: Fundamentals of Capital Budgeting Big Picture: To value a project, we must first estimate its cash flows. Note: most managers estimate a project

More information

Midterm exam financiering/finance.

Midterm exam financiering/finance. <Front page> Midterm exam financiering/finance Question 1 An agency problem can be alleviated by: A) requiring all organizations to be sole proprietorships. B) compensating managers in such a way that

More information

Chapter 7: Fundamentals of Capital Budgeting

Chapter 7: Fundamentals of Capital Budgeting Chapter 7: Fundamentals of Capital Budgeting-1 Chapter 7: Fundamentals of Capital Budgeting Big Picture: To value a project, we must first estimate its cash flows. Note: most managers estimate a project

More information

Quantitative Marketing Analysis

Quantitative Marketing Analysis Quantitative Marketing Analysis CLASS 2 09.16.13 Revenue (sales) Income Statement Sections 5 Expenses Cost of goods sold (FC and VC) Operating expenses (generally FC) Profit 1 EXHIBIT 2.4: PRO FORMA INCOME

More information

Financial Analysis, Modeling, and Forecasting Techniques. Course #5710B/QAS5710B Course Material

Financial Analysis, Modeling, and Forecasting Techniques. Course #5710B/QAS5710B Course Material Financial Analysis, Modeling, and Forecasting Techniques Course #5710B/QAS5710B Course Material TECHNIQUES OF FINANCIAL ANALYSIS, MODELING, AND FORECASTING Delta Publishing Company Copyright 2011 by DELTA

More information

Corporate Finance. Slide 1 咨询热线 : 学习平台 : lms.finance365.com

Corporate Finance. Slide 1 咨询热线 : 学习平台 : lms.finance365.com Corporate Finance Capital Budgeting Cost of Capital Measures of Leverage Dividends and Share Repurchases Working capital management Corporate Governance of Listed Companies Slide 1 Capital Budgeting Slide

More information

CHAPTER 10 MAKING CAPITAL INVESTMENT DECISIONS

CHAPTER 10 MAKING CAPITAL INVESTMENT DECISIONS CHAPTER 10 MAKING CAPITAL INVESTMENT DECISIONS Answers to Concepts Review and Critical Thinking Questions 1. In this context, an opportunity cost refers to the value of an asset or other input that will

More information

Chapter 9 Cash Flow and Capital Budgeting

Chapter 9 Cash Flow and Capital Budgeting Chapter 9 Cash Flow and Capital Budgeting MULTIPLE CHOICE 1. Gamma Electronics is considering the purchase of testing equipment that will cost $500,000. The equipment has a 5-year lifetime with no salvage

More information

CHAPTER 10 & 11 The Basics of Capital Budgeting & Cash Flow Estimation

CHAPTER 10 & 11 The Basics of Capital Budgeting & Cash Flow Estimation CHAPTER 10 & 11 The Basics of Capital Budgeting & Cash Flow Estimation Should we build this plant? 10-1 Capital Budgeting Overview Project Classifications Analysis Methods/Decision Rules Comparison of

More information

Part 7. Capital Budgeting

Part 7. Capital Budgeting Part 7. Capital Budgeting What is Capital Budgeting? Nancy Garcia and Digital Solutions Digital Solutions, a software development house, is considering a number of new projects, including a joint venture

More information

Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization

Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization T9.1 Chapter Outline Chapter 9 Net Present Value and Other Investment Criteria Chapter Organization! 9.1 Net Present Value! 9.2 The Payback Rule! 9.3 The Average Accounting Return! 9.4 The Internal Rate

More information

Answers to Concepts Review and Critical Thinking Questions

Answers to Concepts Review and Critical Thinking Questions Answers to Concepts Review and Critical Thinking Questions 1. A payback period less than the project s life means that the NPV is positive for a zero discount rate, but nothing more definitive can be said.

More information

Chapter 9: Net Present Value and Other Investment Criteria. Faculty of Business Administration Lakehead University Spring 2003 May 20, 2003

Chapter 9: Net Present Value and Other Investment Criteria. Faculty of Business Administration Lakehead University Spring 2003 May 20, 2003 Chapter 9: Net Present Value and Other Investment Criteria Faculty of Business Administration Lakehead University Spring 2003 May 20, 2003 Outline 9.1 Net Present Value 9.2 The Payback Rule 9.3 The Average

More information

Chapter 13 The Basics of Capital Budgeting Evaluating Cash Flows

Chapter 13 The Basics of Capital Budgeting Evaluating Cash Flows Chapter 13 The Basics of Capital Budgeting Evaluating Cash Flows ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 13-1 a. The capital budget outlines the planned expenditures on fixed assets. Capital budgeting

More information

CFA Level I. Study Session 11. Introduction. Dividends and Share Repurchases: Basics Working Capital Management The Corporate Governance

CFA Level I. Study Session 11. Introduction. Dividends and Share Repurchases: Basics Working Capital Management The Corporate Governance CFA Level I Study Session 11 Reading 36 Reading 37 Reading 38 Reading 39 Reading 40 Reading 41 Introduction Capital Budgeting Cost of Capital Measures of Leverage Dividends and Share Repurchases: Basics

More information

FIN 534 Quiz 8 (30 questions with answers) 99,99 % Scored

FIN 534 Quiz 8 (30 questions with answers) 99,99 % Scored FIN 534 Quiz 8 (30 questions with answers) 99,99 % Scored Find needed answers here - http://uoptutor.com/product/fin-534-quiz-8-30-questions-withanswers-9999-scored/ FIN 534 Quiz 8 (30 questions with answers)

More information

UNIT2:- Session 1-3 :- Cost analysis for planning and decision making :-

UNIT2:- Session 1-3 :- Cost analysis for planning and decision making :- UNIT2:- Session 1-3 :- Cost analysis for planning and decision making :- * Cost classification and approach :- A- Marginal costing :- - variable and fixed. - Variable cost is charged to the product unit.

More information

MCQ of Corporate Finance

MCQ of Corporate Finance MCQ of Corporate Finance 1. Which of the following is not one of the three fundamental methods of firm valuation? a) Discounted Cash flow b) Income or earnings - where the firm is valued on some multiple

More information

6 Investment Decisions

6 Investment Decisions 6 Investment Decisions BASIC CONCEPTS AND FORMULAE 1. Capital Budgeting Capital budgeting is the process of evaluating and selecting long-term investments that are in line with the goal of investor s wealth

More information

Homework #3 BUSI 408 Summer II 2013

Homework #3 BUSI 408 Summer II 2013 Homework #3 BUSI 408 Summer II 2013 This assignment is due 12 July 2013 at the beginning of class. Answer each question with numbers rounded to two decimal places. For relevant questions, identify the

More information

Solutions to Chapter 3. Accounting and Finance

Solutions to Chapter 3. Accounting and Finance Solutions to Chapter 3 Accounting and Finance 1. Sophie s Sofas Liabilities & Assets Shareholders Equity Cash $ 10,000 Accounts payable $ 17,000 Accounts receivable 22,000 Long-term debt 170,000 Inventory

More information

Capital Budgeting continued: Overview: (1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows

Capital Budgeting continued: Overview: (1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Capital Budgeting continued: Overview: (1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Chapter 7: 1,4,6,7,20,25 Chapter 8: 1,3,5,8,13 (clarification for problem 13b:

More information

Lecture 7 - Capital Budgeting: Decision Criteria

Lecture 7 - Capital Budgeting: Decision Criteria Lecture 7 - Capital Budgeting: Decision Criteria What is Capital Budgeting? Analysis of potential projects. Long-term decisions; involve large expenditures. Very important to a firm s future. The Ideal

More information

Identify how changes in volume affect costs

Identify how changes in volume affect costs Chapter 18 Identify how changes in volume affect Total variable change in direct proportion to changes in the volume of activity Unit variable cost remains constant Units produced 3 5 Total direct materials

More information

Net present value is the difference between a project s value and its costs.

Net present value is the difference between a project s value and its costs. 1 2 Net present value is the difference between a project s value and its costs. We need to calculate the Present Value of future cash flows (discounted by the opportunity cost of capital) and subtract

More information

Project cash flows and NPVs may be estimated under different assumptions to improve the decision process.

Project cash flows and NPVs may be estimated under different assumptions to improve the decision process. FIN 301 Class Notes Chapter 9: Project Analysis WHAT-IF Analysis Project cash flows and NPVs may be estimated under different assumptions to improve the decision process. Sensitivity Analysis A. Changing

More information

Chapter 010 Making Capital Investment Decisions

Chapter 010 Making Capital Investment Decisions Multiple Choice Questions 1. The changes in a firm's future cash flows that are a direct consequence of accepting a project are called cash flows. A. incremental b. stand-alone c. after-tax d. net present

More information

The application of linear programming to management accounting

The application of linear programming to management accounting The application of linear programming to management accounting Solutions to Chapter 26 questions Question 26.16 (a) M F Contribution per unit 96 110 Litres of material P required 8 10 Contribution per

More information

Incremental Analysis and Decision-making Costs

Incremental Analysis and Decision-making Costs Management Accounting 161 Incremental Analysis and Decision-making Costs Nature of Incremental Analysis Decision-making is essentially a process of selecting the best alternative given the available information

More information

Break-even analysis. On page 256 of It s the Business textbook, the authors refer to an alternative approach to drawing a break-even chart.

Break-even analysis. On page 256 of It s the Business textbook, the authors refer to an alternative approach to drawing a break-even chart. Break-even analysis On page 256 of It s the Business textbook, the authors refer to an alternative approach to drawing a break-even chart. In order to survive businesses must at least break even, which

More information

Cash Flow Estimation. Cash Flows in General. Asking the Right Question

Cash Flow Estimation. Cash Flows in General. Asking the Right Question 1 2 Chapter Outline Cash Flows in General Compute Project s NPV Cash Flow Estimation Cash Flows in General Measuring Incremental Cash Flows Cash flows should be measured on an incremental basis Incremental

More information

Chapter 8. Using Discounted Cash Flow Analysis to Make Investment Decisions

Chapter 8. Using Discounted Cash Flow Analysis to Make Investment Decisions Chapter 8 Using Discounted Cash Flow Analysis to Make Investment Decisions 8-2 Topics Covered Discounted Cash Flows (not Accounting Profits) Incremental Cash Flows Treatment of Inflation Separate Investment

More information

Issues in Capital Budgeting

Issues in Capital Budgeting Lecture: Week V 1 Issues in Capital Budgeting What is Capital Budgeting? The process of making and managing expenditures on long-lived assets. Allocating available capital amongst investment opportunities.

More information

Chapters 11&12 -- Capital Budgeting

Chapters 11&12 -- Capital Budgeting Chapters 11&12 -- Capital Budgeting Capital budgeting Project classifications Capital budgeting techniques Cash flow estimation Risk analysis in capital budgeting Optimal capital budget Capital budgeting

More information

Chapter 9. Year Revenue COGS Depreciation S&A Taxable Income After-tax Operating Income 1 $20.60 $12.36 $1.00 $2.06 $5.18 $3.11

Chapter 9. Year Revenue COGS Depreciation S&A Taxable Income After-tax Operating Income 1 $20.60 $12.36 $1.00 $2.06 $5.18 $3.11 Chapter 9 9-1 We assume that revenues and selling & administrative expenses will increase at the rate of inflation. Year Revenue COGS Depreciation S&A Taxable Income After-tax Operating Income 1 $20.60

More information

Fixed costs. Contribution margin ratio

Fixed costs. Contribution margin ratio SOLUTIONS TO EXERCISES EXERCISE 3-1 (20 minutes) 1. Fixed costs B E point in units = Contribution margin per unit $180,000 $180,000 = = = 7,500 units $40 - $16 $24 B E point in sales dollars = Fixed costs

More information

How to Forecast Your Revenue and Sales A Step by Step Guide to Revenue and Sales Forecasting in a Small Business

How to Forecast Your Revenue and Sales A Step by Step Guide to Revenue and Sales Forecasting in a Small Business How to Forecast Your Revenue and Sales A Step by Step Guide to Revenue and Sales Forecasting in a Small Business By BizMove Management Training Institute Other free books by BizMove that may interest you:

More information

TOPIC 1 Cash Flow Estimation

TOPIC 1 Cash Flow Estimation COURSENOTES: TOPIC 1 Cash Flow Estimation COURSE TITLE: FINANCIAL MANAGEMENT COURSE CODE: BFB3013 PREPARED BY: ASSOC. PROF. MOHD KHIR ASHARI 1 1.0 Introduction: Topic 1 Cash Flows Estimation 1.1 Capital

More information

Shree Guru Kripa s Institute of Management

Shree Guru Kripa s Institute of Management COST ACCOUNTING & FINANCIAL MANAGEMENT Reg. No.. Total Number of Printed Pages: 5 Date: 30.03.2016 Maximum Marks: 100 Question 1 is compulsory (4 5 = 20 Marks). Answer any 5 from the remaining 6 (16 5

More information

Chapter 09 - Using Discounted Cash-Flow Analysis to Make Investment Decisions

Chapter 09 - Using Discounted Cash-Flow Analysis to Make Investment Decisions Solutions to Chapter 9 Using Discounted Cash-Flow Analysis to Make Investment Decisions 1. Net income = ($74 $42 $10) [0.35 ($74 $42 $10)] = $22 $7.7 = $14.3 million Revenues cash expenses taxes paid =

More information

Strategy and Analysis in Using NPV. How Positive NPV Arises

Strategy and Analysis in Using NPV. How Positive NPV Arises Strategy and Analysis in Using NPV (Text reference: Chapter 8) Topics how positive NPV arises decision trees sensitivity analysis scenario analysis break-even analysis investment options AFM 271 - Strategy

More information

Chapter 2: Capital Budgeting Techniques

Chapter 2: Capital Budgeting Techniques Chapter 2: Introduction 2.1 Introduction In order to assess the feasibility of any investment project, some capital budgeting techniques should be used to evaluate that project. This part illustrates the

More information

Financial Statement and Cash Flow Analysis

Financial Statement and Cash Flow Analysis Chapter 2 Financial Statement and Cash Flow Analysis Answers to Concept Review Questions 1. What role do the FASB and SEC play with regard to GAAP? The FASB is a nongovernmental, professional standards

More information

Corporate Finance, Fall 03 E. Hotchkiss Exam # 1

Corporate Finance, Fall 03 E. Hotchkiss Exam # 1 Corporate Finance, Fall 03 E. Hotchkiss Exam # 1 Name: Please read each question carefully, and neatly write all answers on this exam paper. It is very important that you show all work so that you can

More information

Capital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows

Capital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Capital Budgeting continued: Overview:(1) Estimating cash flows (2) CB examples (3) Dealing with uncertainty of cash flows Chapter 7: 1,5,7,8,27,32 Chapter 8: 1,3,5,8,13 (clarification for problem 13b:

More information

Stocker Grazing or Grow Yard Feeder Cattle Profit Projection Calculator Users Manual and Definitions

Stocker Grazing or Grow Yard Feeder Cattle Profit Projection Calculator Users Manual and Definitions Stocker Grazing or Grow Yard Feeder Cattle Profit Projection Calculator Users Manual and Definitions The purpose of this decision aid is to help facilitate the organization of stocker or feeder cattle

More information

Overview of Lecture 9

Overview of Lecture 9 Overview of Lecture 9 Taxes The Tax Code Calculating after-tax cash flows What Discount Rate to Use? Materials covered: Reader, Lecture 7 BM Chapter 6, pp. 121-134. M. Spiegel and R. Stanton, 2000 1 Review:

More information

Principles of Managerial Finance Solution Lawrence J. Gitman CHAPTER 3. Cash Flow and Financial Planning

Principles of Managerial Finance Solution Lawrence J. Gitman CHAPTER 3. Cash Flow and Financial Planning Principles of Managerial Finance Solution Lawrence J. Gitman CHAPTER 3 Cash Flow and Financial Planning INSTRUCTOR S RESOURCES Overview This chapter introduces the student to the financial planning process,

More information

Cash Flow Estimation. Topics to be covered

Cash Flow Estimation. Topics to be covered Cash Flow Estimation Topics to be covered Discount Cash Flow, Not Profit Discount Incremental Cash Flow - Include all direct effects. - Forget Sunk Costs - Include Opportunity Costs - Recognize the Investment

More information

1.1 Introduction. Chapter 1: Feasibility Studies: An Overview

1.1 Introduction. Chapter 1: Feasibility Studies: An Overview Chapter 1: Introduction 1.1 Introduction Every long term decision the firm makes is a capital budgeting decision whenever it changes the company s cash flows. Consider launching a new product. This involves

More information

1) In words, an equity multiplier of 2 means that for every $1:

1) In words, an equity multiplier of 2 means that for every $1: Questions in [New Questions] 1) In words, an equity multiplier of 2 means that for every $1: [A] of debt, a firm has $2 in equity. [B] in equity, a firm has $2 in debt. [C] in assets, a firm has $2 in

More information

5. Capital budgeting (part 1)

5. Capital budgeting (part 1) 1 5. Capital budgeting (part 1) In this chapter, we will apply the tools discussed in the previous chapter. The focus in this chapter is developing estimates of the cash flows that should be considered.

More information

Breakeven Analysis. Breakeven for Services.

Breakeven Analysis. Breakeven for Services. Dollars and Sense Introduction Your dream is to operate a profitable business and make a good living. Before you open, however, you want some indication that your business will be profitable, if not immediately

More information

Chapter 9 Making Capital Investment Decisions Introduction

Chapter 9 Making Capital Investment Decisions Introduction Chapter 9 Making Capital Investment Decisions Introduction The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted These cash flows

More information

Chapter 10. Capital Budgeting Techniques. Copyright 2012 Pearson Prentice Hall. All rights reserved.

Chapter 10. Capital Budgeting Techniques. Copyright 2012 Pearson Prentice Hall. All rights reserved. Chapter 10 Capital Budgeting Techniques Copyright 2012 Pearson Prentice Hall. All rights reserved. Overview of Capital Budgeting Capital budgeting is the process of evaluating and selecting long-term investments

More information

Why Use Net Present Value? The Payback Period Method The Discounted Payback Period Method The Average Accounting Return Method The Internal Rate of

Why Use Net Present Value? The Payback Period Method The Discounted Payback Period Method The Average Accounting Return Method The Internal Rate of 1 Why Use Net Present Value? The Payback Period Method The Discounted Payback Period Method The Average Accounting Return Method The Internal Rate of Return Problems with the IRR Approach The Profitability

More information

Net Present Value and Capital Budgeting. What to Discount

Net Present Value and Capital Budgeting. What to Discount Net Present Value and Capital Budgeting (Text reference: Chapter 7) Topics what to discount the CCA system total project cash flow vs. tax shield approach detailed CCA calculations and examples project

More information

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING

CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.

More information

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2.

DUKE UNIVERSITY Fuqua School of Business. FINANCE 351 - CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2. DUKE UNIVERSITY Fuqua School of Business FINANCE 351 - CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Two years ago, you put $20,000 dollars in a savings account earning

More information

CHAPTER 6 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

CHAPTER 6 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA CHAPTER 6 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Answers to Concepts Review and Critical Thinking Questions 1. Assuming conventional cash flows, a payback period less than the project s life means

More information

Financing Entrepreneurial Ventures Part 1 Financial Plan & Statements

Financing Entrepreneurial Ventures Part 1 Financial Plan & Statements Financing Entrepreneurial Ventures Part 1 Financial Plan & Statements Barbara Peitsch Program Director, Univ. of Michigan Peter Scott Professor of Entrepreneurship/Consultant August 2015 Economic Empowerment

More information

Week- 1: Solutions to HW Problems

Week- 1: Solutions to HW Problems Week- 1: Solutions to HW Problems 10-1 a. Payback A (cash flows in thousands): Annual Period Cash Flows Cumulative 0 ($5,000) ($5,000) 1 5,000 (0,000) 10,000 (10,000) 3 15,000 5,000 4 0,000 5,000 Payback

More information

NPV = -C 0 +C 1 =(1+r)+C 2 =(1+r) 2

NPV = -C 0 +C 1 =(1+r)+C 2 =(1+r) 2 Net Present Value and Other Investment Criteria Capital budgeting decisions are based on the following criterias: a) Net present value b) The payback period c) The discounted payback period d) The average

More information

Capital Budgeting. Financial Modeling Templates

Capital Budgeting. Financial Modeling Templates Financial Modeling Templates http://spreadsheetml.com/finance/capitalbudgeting.shtml Copyright (c) 2009-2014, ConnectCode All Rights Reserved. ConnectCode accepts no responsibility for any adverse affect

More information

Cash Flow Analysis Venture Business Perspective

Cash Flow Analysis Venture Business Perspective Cash Flow Analysis Venture Business Perspective Cash Flow (CF) Analysis What is CF and how is determined? CF Operating CF Free CF Managing CF Cash Conversion Cyclical CF Break-even Valuing venture businesses

More information

On September 27, 2010, Southwest Airlines announced that it

On September 27, 2010, Southwest Airlines announced that it Cash Flows and Capital Budgeting 11 Learning Objectives 1 Explain why incremental after-tax free cash flows are relevant in evaluating a project and calculate them for a project. 2 Discuss the five general

More information

Chapter 6. Making Capital Investment Decisions 6-0. Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 6. Making Capital Investment Decisions 6-0. Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 Making Capital Investment Decisions McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 6-0 What is capital budgeting? Should we build this plant? Chapters

More information

CHAPTER 21 CAPITAL BUDGETING AND COST ANALYSIS

CHAPTER 21 CAPITAL BUDGETING AND COST ANALYSIS CHAPTER 21 CAPITAL BUDGETING AND COST ANALYSIS 21-1 No. Capital budgeting focuses on an individual investment project throughout its life, recognizing the time value of money. The life of a project is

More information

Total shares at the end of ten years is 100*(1+5%) 10 =162.9.

Total shares at the end of ten years is 100*(1+5%) 10 =162.9. FCS5510 Sample Homework Problems Unit04 CHAPTER 8 STOCK PROBLEMS 1. An investor buys 100 shares if a $40 stock that pays a annual cash dividend of $2 a share (a 5% dividend yield) and signs up for the

More information

1.040 Project Management

1.040 Project Management MIT OpenCourseWare http://ocw.mit.edu 1.040 Project Management Spring 2009 For information about citing these materials or our Terms of Use, visit: http://ocw.mit.edu/terms. Project Financial Evaluation

More information

Chapter 9 Capital Budgeting Decision Models

Chapter 9 Capital Budgeting Decision Models Chapter 9 Capital Budgeting Decision Models LEARNING OBJECTIVES (Slide 9-2) 1. Explain capital budgeting and differentiate between short-term and long-term budgeting decisions. 2. Explain the payback model

More information

CHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS

CHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS CHAPTER 7 MAKING CAPITAL INVESTMENT DECISIONS Answers to Concepts Review and Critical Thinking Questions 1. In this context, an opportunity cost refers to the value of an asset or other input that will

More information

Project Valuation for Managers

Project Valuation for Managers Project Valuation for Managers An Essential Skill Corporate Finance By Cameron Hall Key Messages The job of managers is to create value. Value in a firm comes from two sources: current operations and new

More information

Capital Budgeting: Decision. Example. Net Present Value (NPV) FINC 3630 Yost

Capital Budgeting: Decision. Example. Net Present Value (NPV) FINC 3630 Yost Capital Budgeting: Decision Criteria Example Consider a firm with two projects, A and B, each with the following cash flows and a 10 percent cost of capital: Project A Project B Year Cash Flows Cash Flows

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Suvey of Macroeconomics, MBA 641 Fall 2006, Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Modern macroeconomics emerged from

More information

Investment Decisions and Capital Budgeting

Investment Decisions and Capital Budgeting Investment Decisions and Capital Budgeting FINANCE 350 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University 1 Issues in Capital Budgeting: Investment How should capital

More information