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


 Sherman Green
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1 Questions Chapter 11 1) Given a tax rate of zero, the accounting breakeven point for a project: [A] indicates when the net present value turns positive. [B] excludes depreciation in its computation. [C] is the same as the cash breakeven point. [D] indicates the point at which operating cash flow is equal to depreciation. [E] describes the point below which the sales level results in a positive net income. [A] :No, the financial break even indicates when NPV turns positive. Review section [B] :Depreciation is a part of the income statement and, therefore, a part of the accounting break even. Review section [C] :No, they are not the same thing. Review section [E] :If sales are lower than the accounting break even point, net income will be negative. Review section ) A project should automatically be accepted when the project's base case net present value is positive. [A] :Does your answer consider the possibility of forecasting risk? Review section ) The purpose of scenario analysis is to: [A] evaluate all possible cash flow forecasts. [B] evaluate all possible contingencies and prepare for the occurrence of each. [C] analyze highly negative net present value projects more closely. [D] assess the reasonableness of the cash flows that form the basis for a net present value calculation. [E] gauge the effectiveness of a capital budgeting project after it is already operating. [A] :Scenario analysis generally involves evaluating three different sets of cash flow forecasts, however, that is not the purpose of doing scenario analysis. Review section [B] :It is impossible to evaluate all possible contingencies. Review section [C] :A highly negative NPV likely warrants little additional analysis. Review section [E] :Scenario analysis does not evaluate projects already in process. Review section ) Which of the following would likely lead to the largest number of net present value calculations? [A] scenario analysis [B] sensitivity analysis [C] basecase analysis [D] simulation analysis [E] breakeven analysis [A] :This will typically lead to three NPV computations. What are they? Review section [B] :This will lead to a large number of NPV calculations, but there is at least one type of analysis that would lead to more. Review section [C] :This provides only one NPV computation. Review section [E] :This does not concentrate on NPV. Review section ) Positive net present value projects: [A] tend to be rare in a highly competitive market. [B] will likely have a source of value that is difficult to determine. [C] tend to be rare in a highly monopolistic market. [D] will typically occur in international markets, but not domestic markets. [E] are common for firms in old, well established industries. [B] :If a project has a positive NPV, you should be able to find its source of value. Review section [C] :If a firm has a monopoly then it has no competition in that area. Thus, positive NPV projects are more likely to exist. Review section 11.1.
2 [D] :There is no reason to assume an international market is less competitive than the domestic market. Review section [E] :It is likely competition will be strong in old, well established industries, making it less likely positive NPV projects can be found. Review section ) After ten years as a general auto mechanic in a local garage, Joe decides he is tired of working for others, especially since business is typically slow and he works partially on commission. Thus, he decides to open his own garage. After estimating the cash flows for his new garage, he determines that having his own garage should generate a large positive net present value. Which of the following is most likely true about his analysis? [A] The discount rate he used must be too high. [B] Unless he can find a true source of value in his new venture, he probably made a mistake in estimating his cash flows. [C] He has likely been overly optimistic about the future and has underestimated future cash flows. [D] His estimates of initial cash outlays must be understated. [E] His analysis is probably correct provided there is major competition in the auto repair business. [A] :Using a high interest rate will decrease the NPV, not increase it, so this is not the source of his positive NPV. Review section [C] :If he was overly optimistic, it is more likely he would overestimate future cash flows than underestimate them. Review section [D] :Since these are typically some of the easiest cash flows to identify, this is not likely the source of his positive NPV. Review section [E] :Are you more or less likely to find positive NPVs when major competition exists? Review section ) A firm has a 2.5 degree of operating leverage. If sales decline by 20 percent, then the operating cash flow will: [A] decline by 20 percent. [B] decline by 5 percent. [C] rise by 20 percent. [D] fall by 12.5 percent. [E] fall by 50 percent. [A] :You are forgetting to incorporate the DOL into you computation. Review section [B] :You need to review this computation in section [C] :How will operating cash flows rise if quantity sold falls? Review section [D] :You need to review this computation in section [E] :You are correct! 8) A firm that cannot raise funds in the financial markets in order to finance positive net present value projects is said to face soft capital rationing. [A] :Soft rationing deals with the allocation of funds within the organization, not with the inability to acquire external funds. Review section ) A project that is operating at its breakeven point will have a NPV of zero. [A] cash [B] accounting [C] financial [D] NPV [E] OCF [A] :At the cash break even, the operating cash flows are zero so the NPV can't also be zero. Review section [B] :At the accounting break even, net income is zero. What is operating cash flow? Review section [D] :There is no such breakeven point defined in the textbook. Review section [E] :There is no such breakeven point defined in the textbook. Review section 11.4.
3 10) You have put together a set of cash flow forecasts for a project and have found, on your first computation, that the net present value is positive. You should: I. accept the project because you are certain to increase shareholder wealth. II. try to identify some source of value in the project. III. use scenario or sensitivity analysis to investigate the project further. IV. try to assess the degree of forecasting risk there is in the project. [A] I and II only [B] I, II, and IV only [C] I, III, and IV only [D] II, III, and IV only [E] II and IV only [A] :At least one of these statements ignores the possibility that forecasting risk exists. Review section [B] :At least one of these statements ignores the possibility that forecasting risk exists. Review section [C] :At least one of these statements ignores the possibility that forecasting risk exists. Review section [E] :Correct, but there is another correct option also. Review section ) Capital intensive projects have a high degree of operating leverage. [B] :Capital intensity implies higher fixed costs relative to firms that are less capital intensive. Review section 11.5 to see how high fixed costs impact the degree of operating leverage. 12) What is the accounting breakeven for a project with a selling price of $100 per unit, variable cost of $24 per unit, fixed cost of $40,000 per year, and depreciation of $10,000 per year? Assume a discount rate of 10 percent, an initial project cash outlay of $100,000, a project life of 10 years, and a zero tax rate. [A] 527 units [B] 624 units [C] 658 units [D] 925 units [E] 1,130 units [A] :You have computed the cash breakeven. Review section [B] :If you check you will find that net income is not equal to zero at this level of output. Review section [D] :If you check you will find that net income is not equal to zero at this level of output. Review section [E] :If you check you will find that net income is not equal to zero at this level of output. Review section ) Which of the following are true concerning the financial breakeven point? I. The net present value is zero. II. The discounted payback period is equal to the life of the project. III. The internal rate of return is equal to the required return. IV. The payback period is equal to the life of the project. [A] I and II only [B] III and IV only [C] I, II, and III only [D] II, III, and IV only [E] I, II, III, and IV [A] :Correct, but there is at least one more correct option. Review section [B] :There is at least one incorrect option. Review section [D] :There is at least one incorrect option. Review section [E] :There is at least one incorrect option. Review section ) The sales level that most likely has zero earnings before interest and taxes is called the breakeven point. [A] cash [B] accounting
4 [C] financial [D] income [E] cost [A] :At the cash break even, the operating cash flows are zero so the EBIT can't also be zero. Review section [C] :If the EBIT is zero, operating cash flows will be equal to depreciation. How can this result in operating cash flows of zero? Review section [D] :There is no such breakeven point defined in the textbook. Review section [E] :There is no such breakeven point defined in the textbook. Review section ) The higher the degree of operating leverage, the greater the danger of forecasting risk. [B] :All else equal, the higher the degree of operating leverage, the more sensitive operating cash flows are to changes in sales. Does this mean forecasting risk is lower in this instance? Review section ) The projected cash flows of a project are typically defined as: [A] the most optimistic estimates that can be obtained. [B] an average of the possible cash flows from the various scenarios. [C] the largest possible cash flows. [D] the cash flows that result in a zero net present value. [E] the least likely cash flows. [A] :If you were analyzing a capital budgeting project, would you focus primarily on the best case cash flows? Review section [C] :If you were analyzing a capital budgeting project, would you focus primarily on the largest possible cash flows? Review section [D] :Are you looking for the base case cash flows or for the financial breakeven point? Review sections 11.1, 11.2 and [E] :Why would you focus on the least likely cash flows? Review section ) A firm has fixed costs of $30,000 per year, depreciation of $10,000 per year, a price per unit of $50, and an accounting breakeven point of 2,000 units. What is the firm's total variable cost at the accounting breakeven point? [A] $40,000 [B] $50,000 [C] $60,000 [D] $70,000 [E] $80,000 [A] :You must first use the accounting breakeven formula from section 11.4 to find the variable cost per unit. Did you find this to be $30? [B] :You must first use the accounting breakeven formula from section 11.4 to find the variable cost per unit. Did you find this to be $30? [D] :You must first use the accounting breakeven formula from section 11.4 to find the variable cost per unit. Did you find this to be $30? [E] :You must first use the accounting breakeven formula from section 11.4 to find the variable cost per unit. Did you find this to be $30? 18) If you see a worst case analysis for a project, the project is likely being evaluated using analysis. [A] scenario [B] sensitivity [C] basecase [D] simulation [E] multipleoutcome [B] :This may provide a worst case projection for one variable, but not for the overall project. Review section [C] :This would be an expected outcome, not a worst case projection. Review section 11.2.
5 [D] :This may provide a number of projections, but not necessarily an overall worst case projection. Review section [E] :There is no such term relating to capital budgeting in the textbook. Review section ) What is the accounting breakeven point for a firm with total costs of $135,000, variable cost of $10 per unit, sales of 10,000 units, a selling price of $25 a unit, and depreciation of $10,000? [A] 1,667 units [B] 1,750 units [C] 1,886 units [D] 2,333 units [E] 3,000 units [A] :To find this, you must first compute fixed costs. Did you find fixed costs to be $35,000? Review section [B] :To find this, you must first compute fixed costs. Did you find fixed costs to be $35,000? Review section [C] :To find this, you must first compute fixed costs. Did you find fixed costs to be $35,000? Review section [D] :You have computed the cash breakeven, not the accounting breakeven. Review section [E] :You are correct! 20) A division within a firm that cannot obtain funds to finance positive net present value projects due to internal constraints is said to be facing hard capital rationing. [A] :Soft rationing deals with the allocation of funds within the organization. Review section ) Any time a manager replaces a variable cost with a fixed cost, the firm's effectively increases. [A] operating leverage [B] managerial options [C] projected cash flow [D] sensitivity contribution [E] total variable cost [B] :There is nothing in this statement that suggests how managerial options will be impacted. Review section [C] :There is no way to predict how this impacts upon the firm's cash flows. Review section [D] :No such term is discussed in the text. Review section [E] :Since variable costs are being replaced by fixed costs, wouldn't total variable costs decline? Review section ) A project's total fixed costs are exactly equal to its depreciation and both are greater than zero. What is the degree of operating leverage at the financial breakeven point? The project has conventional cash flows, no salvage value and no net working capital requirements. [A] less than 2 [B] 2 [C] greater than 2 [D] undefined since you can't divide by zero [E] cannot be determined without more information [B] :With fixed costs equal to depreciation, the DOL would be two at the accounting break even. Since the OCF at the financial break even would have to be larger, the DOL must therefore be smaller than 2. Review sections 11.4 and [C] :With fixed costs equal to depreciation, the DOL would be two at the accounting break even. Since the OCF at the financial break even would have to be larger, the DOL must therefore be smaller than 2. Review sections 11.4 and [D] :With fixed costs equal to depreciation, the DOL would be two at the accounting break even. Since the OCF at the financial break even would have to be larger, the DOL must therefore be smaller than 2. Review sections 11.4 and [E] :With fixed costs equal to depreciation, the DOL would be two at the accounting break even. Since the OCF at the financial break even would have to be larger, the DOL must therefore be smaller than 2. Review sections 11.4 and 11.5.
6 23) analysis investigates the impact on net present value of allowing one variable to change while holding all other variables constant. [A] Scenario [B] Breakeven [C] Strategic options [D] Simulation [E] Sensitivity [A] :In this analysis, we consider multiple combinations of changes in variables. Review section [B] :This type of analysis does not lend itself well to asking "what if" type questions. Review section [C] :In this analysis, we consider options open to management but don't investigate changes in variables. Review section [D] :In this analysis, we consider a virtually limitless set of combinations of changes in variables. Review section [E] :You are correct! 24) What is the accounting breakeven point for a project with a selling price of $50 per unit, variable cost of $35 per unit, annual fixed costs of $50,000, and depreciation of $10,000? [A] 1,160 units [B] 2,298 units [C] 3,333 units [D] 3,429 units [E] 4,000 units [A] :The accounting breakeven is computed as the sum total of the fixed costs plus depreciation divided by the contribution margin. Review section [B] :The accounting breakeven is computed as the sum total of the fixed costs plus depreciation divided by the contribution margin. Review section [C] :The accounting breakeven is computed as the sum total of the fixed costs plus depreciation divided by the contribution margin. Review section [D] :The accounting breakeven is computed as the sum total of the fixed costs plus depreciation divided by the contribution margin. Review section [E] :You are correct! 25) Which one of the following statements is accurate? [A] A project that just breaks even on an accounting basis will not pay back. [B] A project that just breaks even on an accounting basis will have a positive rate of return. [C] A project cannot earn a positive return unless its payback period is longer than the project life. [D] If the net income from a project is zero, then the operating cash flow is equal to the depreciation expense given that both interest expense and taxes are equal to zero. [E] If you only know the life of a project and the project s payback period, you can determine the financial breakeven point. [A] :Actually, this type of project will pay back. Can you estimate when? Review section [B] :The internal rate of return on a project of this type will be zero. Review section [C] :To be true, the payback period would have to be shorter than the project life. Review section [E] :How can you determine that the net present value is zero given only this information? Review section ) A project that just breaks even on basis will not pay back. I. an accounting II. a cash III. a financial [A] I only [B] II only [C] III only [D] I and II only [E] II and III only [A] :At the accounting breakeven, the payback period is equal to the life of the project. Review section [C] :The project will pay back if the NPV is zero. Review section [D] :At least one of these responses is incorrect. Review section 11.4.
7 [E] :At least one of these responses is incorrect. Review section ) A project that just breaks even on an accounting basis must have a positive net present value. [A] :None of the break even points discussed in the chapter result in a positive NPV. Review section ) Which of the following is (are) true regarding soft rationing (SR) and hard rationing (HR)? I. HR is self imposed while SR is imposed by the marketplace. II. SR affects individual parts of a company while HR affects the company as a whole. III. SR can lead to HR. [A] I only [B] II only [C] I and II only [D] I and III only [E] I, II, and III [A] :The reverse of this statement is true. Review section [C] :At least one of these statements is incorrect. Review section [D] :At least one of these statements is incorrect. Review section [E] :At least one of these statements is incorrect. Review section ) Which of the following is a possible reason for determining the accounting breakeven point? I. It provides another test of the accuracy of the sales forecasts. II. It is relatively easy to calculate and explain. III. It identifies the contribution a project will make to a firm's cash flow. IV. A project that breaks even on an accounting basis will also break even on a financial basis. [A] I and II only [B] II and IV only [C] I, II, and IV only [D] II, III, and IV only [E] I, II, III, and IV [B] :At least one of these statements is incorrect. Review section [C] :At least one of these statements is incorrect. Review section [D] :At least one of these statements is incorrect. Review section [E] :At least one of these statements is incorrect. Review section ) Which of the following describe(s) variable costs? I. costs that can be forecasted with a high degree of accuracy II. costs that are equal to zero when production is zero III. costs that change with the quantity of output [A] II only [B] I and II only [C] I and III only [D] II and III only [E] I, II, and III only [A] :There is at least one more correct option. Review section [B] :At least one of these choices is incorrect. Review section [C] :At least one of these choices is incorrect. Review section [E] :At least one of these choices is incorrect. Review section ) Suppose that a project has a degree of operating leverage of If the quantity being produced increases from 96 to 100, what is the expected percent change in operating cash flow?
8 [A] 2.5 percent [B] 3.1 percent [C] 4.2 percent [D] 5.5 percent [E] 6.2 percent [A] :If quantity increases, operating cash flows can't decrease. Review section [C] :You first need to compute the percent change in quantity. Did you find this to be percent? Review section [D] :You first need to compute the percent change in quantity. Did you find this to be percent? Review section [E] :You first need to compute the percent change in quantity. Did you find this to be percent? Review section ) analysis is a useful tool for directly examining the relationship between sales volume and profitability. [A] Scenario [B] Breakeven [C] Strategic options [D] Simulation [E] Contingency [A] :This does not relate specifically to changes in sales volume and profits. Review section [C] :Option analysis does not relate directly to changes in sales volume and profits. Review section [D] :This does not relate specifically to changes in sales volume and profits. Review section [E] :This does not relate specifically to changes in sales volume and profits. Review section ) A project that just breaks even on a financial basis has a profitability indicator that is equal to zero. [A] :If the PI is zero, then the NPV is zero. Is this the financial breakeven point? Review section ) Which one of the following statements is NOT correct? [A] Forecasting risk is the possibility that errors in projected cash flows lead to incorrect decisions. [B] Scenario analysis is the determination of what happens to net present value estimates if we ask "whatif" questions. [C] Sensitivity analysis is an investigation of what happens to net present value when only one variable is changed. [D] Simulation analysis is a combination of scenario and sensitivity analysis. [E] Fixed costs are costs that change when the quantity of output changes during a particular time period. [A] :This is the definition of forecasting risk. Review section [B] :This is the definition of scenario analysis. Review section [C] :This is the definition of sensitivity analysis. Review section [D] :This is the definition of simulation analysis. Review section [E] :You are correct! 35) If you are interested in finding out how sensitive your net present value estimate is to changes in the variable costs, you should use scenario analysis. [A] :What is the difference between scenario analysis and sensitivity analysis? Review section ) The higher the degree of operating leverage: I. the greater is the risk of forecasting error. II. the lower is the risk of forecasting error. III. the higher the breakeven point, regardless of the measure.
9 IV. the lower the breakeven point, regardless of the measure. [A] I only [B] I and III only [C] I and IV only [D] II and III only [E] II and IV only [A] :There is another correct choice also. Review section [C] :At least one of these two choices is incorrect. Review section [D] :At least one of these two choices is incorrect. Review section [E] :Neither of these two choices is correct. Review section ) Which of the following requires finding the point at which at the net present value of a project is equal to zero? I. finding the project s internal rate of return II. finding the point at which the internal rate of return is equal to zero III. finding the point at which the project pays back on a discounted basis IV. finding the financial breakeven point [A] I and III only [B] II and IV only [C] I, II, and III only [D] I, III, and IV only [E] I, II, III, and IV [A] :There is at least one more correct option. Review section [B] :At least one of these is incorrect. Review section [C] :At least one of these is incorrect. Review section [E] :At least one of these is incorrect. Review section ) Which of the following describes total cost? In this case, v is variable cost per unit, Q is quantity sold, VC is total variable cost, and FC is total fixed cost. [A] TC = v X Q [B] TC = v + FC X Q [C] TC = VC  FC [D] TC = v X Q + FC [E] TC = v X Q + FC X Q [A] :This would be total cost if there were no fixed costs. Review section [B] :Since fixed costs don't vary with output, they should not be related to output in this way. Review section [C] :With this formula, total costs could end up being negative, which doesn't make any sense. Review section [E] :Since fixed costs don't vary with output, they should not be related to output in this way. Review section ) What is the contribution margin of a project with a selling price of $80 per unit, variable cost of $26 per unit, fixed cost of $30,000 per year, and a sales quantity of 10,000 units? [A] $49 [B] $51 [C] $54 [D] $57 [E] $77 [A] :You should review this computation in section [B] :Fixed costs do not affect the contribution margin. Review section [D] :Fixed costs do not affect the contribution margin. Review section [E] :Variable costs, not fixed costs, affect the contribution margin. Review section ) The process of identifying the variable within a project that has the most forecasting risk is known as: [A] scenario analysis. [B] sensitivity analysis. [C] contingency planning.
10 [D] breakeven analysis. [E] discretionary analysis. [A] :Does this isolate the effect of changes in a single variable? Review section [C] :Have we discussed contingency planning? Review section [D] :Does this isolate the effect of changes in a single variable? Review section [E] :We have not discussed any analysis that goes by this name. Review section ) analysis combines analysis and analysis. [A] Scenario; sensitivity; simulation [B] Sensitivity; simulation; scenario [C] Breakeven; scenario; simulation [D] Simulation; scenario; sensitivity [E] Simulation; sensitivity; breakeven [A] :Which of these three types of analysis would likely lead to the largest number of NPV calculations? That is likely to be the one that combines the other two together. Review section [B] :Which of these three types of analysis would likely lead to the largest number of NPV calculations? That is likely to be the one that combines the other two together. Review section [C] :Breakeven analysis does not combine scenario and simulation analysis. Review section [E] :Breakeven analysis does not combine with sensitivity analysis to form simulation analysis. Review section ) Which of the following describes accounting breakeven? In this case, v is variable cost per unit, Q is quantity sold, VC is total variable cost, D is depreciation, and FC is total fixed cost. [A] Q = (FC + D) / (P  v) [B] Q = (FC  D) / (P + v) [C] Q = (P X v) / (FC + D) [D] Q = FC + [D / (P  v)] [E] Q = FC / (P  v) [B] :Construct a simple income statement and you will see that this is not the correct statement of the accounting breakeven point. Review section [C] :Construct a simple income statement and you will see that this is not the correct statement of the accounting breakeven point. Review section [D] :Construct a simple income statement and you will see that this is not the correct statement of the accounting breakeven point. Review section [E] :This is the cash break even, not the accounting break even. Review section ) analysis allows a firm to analyze the outcome of various situations developed by asking "what if" questions. I. Scenario II. Sensitivity III. Simulation IV. Breakeven [A] I and II only [B] II and III only [C] I, II, and III only [D] I, II, and IV only [E] I, II, III, and IV [A] :Correct, but there is at least one more correct option. Review section [B] :Correct, but there is at least one more correct option. Review section [D] :At least one of these choices is incorrect. Review section [E] :At least one of these choices is incorrect. Review section ) Soft rationing, if it persists, is most likely bad for stockholders.
11 [B] :If soft rationing persists, positive net present value projects are likely being rejected, which is bad for stockholders. Review section ) What is the cash break even point for a project with a selling price of $100 per unit, variable cost of $24 per unit, fixed cost of $40,000 per year, and depreciation of $10,000 per year? Ignore taxes. [A] 527 units [B] 624 units [C] 658 units [D] 741 units [E] 1,130 units [B] :If you construct an income statement you will find that operating cash flow is not equal to zero at this level of output, so this cannot be the cash breakeven point. Review section [C] :You have computed the accounting breakeven. Review section [D] :If you construct an income statement you will find that operating cash flow is not equal to zero at this level of output, so this cannot be the cash breakeven point. Review section [E] :If you construct an income statement you will find that operating cash flow is not equal to zero at this level of output, so this cannot be the cash breakeven point. Review section ) A project that just breaks even on a financial basis has a discounted payback equal to the project's life. [B] :If a project's discounted payback is equal to the project's life, the NPV is zero. Would the NPV be zero at the financial breakeven point? Review section ) Simulation analysis is a combination of scenario and sensitivity analysis. [B] :This is a true statement. Review section ) A project has a required return of 10 percent and a zero tax rate. At the accounting breakeven point, the: [A] net present value is positive. [B] net income is positive. [C] project s operating cash flow is equal to the depreciation expense. [D] project's cash flow is equal to zero each year. [E] price per unit and variable cost per unit are equal to one another. [A] :The NPV is not positive at the accounting breakeven. What is it instead? Review section [B] :Net income is zero at the accounting breakeven. Review section [D] :Cash flow is equal to depreciation at the accounting breakeven. Review section [E] :If this were true, accounting net income would almost certainly be negative, not zero. Can you explain why? Review section ) You want to determine how changes in the price of a product affect a project's net present value and internal rate of return. To determine this impact, you should use analysis. [A] scenario [B] sensitivity [C] basecase [D] simulation [E] multipleoutcome [A] :Does this investigate the changes in NPV as one variable is changed? Review section 11.2.
12 [C] :This does not relate changes in price to changes in NPV. Review section [D] :Does this investigate the changes in NPV as one variable is changed? Review section [E] :There is no such term relating to capital budgeting in the textbook. Review section ) Which of the following statements regarding net present value (NPV) analysis is correct? [A] The actual worth of any NPV calculation depends on the accuracy of the cash flow projections used. [B] NPV calculations are fairly reliable even when the cash flows used are highly questionable. [C] Negative NPV projects should be scrutinized to make sure there is a sound economic basis underlying them. [D] Positive NPV projects that have relatively low levels of fixed costs should be more heavily scrutinized than projects with relatively high levels of fixed costs. [E] NPV calculations are fairly reliable even when an inappropriate discount rate is used. [B] :How can the NPV be reliable if it is based on unreliable data? Review section [C] :If the input data is considered fairly reliable, then further analysis of a negative NPV project is generally not warranted. Review section [D] :Actually, the opposite of this statement is correct. Review section [E] :Using the wrong discount rate will lead to an incorrect NPV. Review section ) A project with conventional cash flows that just breaks even on an accounting basis: [A] pays back on a discounted basis. [B] has an operating cash flow that exceeds the amount of the depreciation. [C] has an internal rate of return that is equal to zero. [D] has a positive net present value. [E] has a profitability index that is greater than one. [A] :Remember, the NPV is negative at the accounting break even. Review section [B] :At the accounting break even point the OCF is equal to depreciation. Review section [D] :Since the cash flows are equal to depreciation, how can the NPV be positive? Review section [E] :Since the cash flows are equal to depreciation, how can the PI be greater than 1? Review section ) A financial manager reviewing a project is concerned about the level of forecasting risk in the project's forecasted cash flows. The manager should use analysis to identify the variable that presents the highest degree of forecasting risk. [A] scenario [B] simulation [C] sensitivity [D] breakeven [E] strategic options [A] :This type of analysis does not allow for isolating the variable that causes the highest degree of potential forecasting risk. Review section [B] :This type of analysis does not allow for isolating the variable that causes the highest degree of potential forecasting risk. Review section [D] :This relates output to profitability. It does not allow for isolating the variable that causes the highest degree of potential forecasting risk. Review section [E] :This relates to options open to management. It does not allow for isolating the variable that causes the highest degree of potential forecasting risk. Review section ) Mondo Mfg. has a degree of operating leverage of 2.5. If the sales quantity falls by 10 percent, Mondo's operating cash flow should: [A] decrease by 10 percent. [B] decrease by 25 percent. [C] increase by 10 percent. [D] increase by 25 percent. [E] not change at all. [A] :You are forgetting to incorporate the DOL into you computation. Review section [C] :How will operating cash flows rise if quantity sold falls? Review section [D] :How will operating cash flows rise if quantity sold falls? Review section 11.5.
13 [E] :Since the firm obviously has fixed costs, how is it that quantity sold can fall but there will be no impact on operating cash flows? Review section ) A project that just breaks even on basis will have a payback period that is shorter than the life of the project. I. an accounting II. a cash III. a financial [A] I only [B] II only [C] III only [D] I and II only [E] II and III only [A] :The payback at this level of output will exactly equal the project's life. Review section [B] :The project will not pay back at this level of output since cash inflows are zero. Review section [D] :At least one of these responses is incorrect. Review section [E] :At least one of these responses is incorrect. Review section ) A project has a selling price of $30, a variable cost of $10, fixed costs of $25,000, depreciation of $5,000, and a tax rate of 34 percent. What is the operating cash flow at the accounting breakeven point? [A] $1,750 [B] $5,000 [C] $15,000 [D] $25,000 [E] $35,000 [A] :If you construct an income statement, you will find that net income is not equal to zero at this level of operating cash flow as required by the accounting breakeven. Review section [C] :If you construct an income statement, you will find that net income is not equal to zero at this level of operating cash flow as required by the accounting breakeven. Review section [D] :If you construct an income statement, you will find that net income is not equal to zero at this level of operating cash flow as required by the accounting breakeven. Review section [E] :If you construct an income statement, you will find that net income is not equal to zero at this level of operating cash flow as required by the accounting breakeven. Review section ) Which one of the following statements concerning simulation analysis is correct? [A] In simulation analysis, several different variables can be allowed to take on a large number of values. [B] An advantage of simulation analysis is that once the results of simulation analysis are in there is often no clear decision rule to follow. [C] Simulation analysis is very complex and costly to perform. [D] Powerful computers are making the task of simulation analysis ever more complicated. [E] In simulation analysis, the probability of occurrence of different cases is generally very difficult to assess. [B] :This is certainly not an advantage. Review section [C] :Given the power and speed of today's computers, simulation analysis is no longer costly and complex. Review section [D] :Today's more powerful computers actually make it much easier to do simulation analysis. Review section [E] :Simulation analysis helps us in assigning probabilities to the possible outcomes. Review section ) A project that has a negative net present value will also: I. have a discounted payback period less than its life. II. exceed its accounting breakeven point. III. have an internal rate of return that is less than the required return. IV. have a profitability ratio that is less than 1.0. [A] I and III only [B] III and IV only [C] II and III only [D] I, III, and IV only [E] I, II, III, and IV
14 [A] :At least one of these choices is incorrect. Review section [C] :At least one of these choices is incorrect. Review section [D] :At least one of these choices is incorrect. Review section [E] :At least one of these choices is incorrect. Review section ) A project has a selling price of $40 per unit, a variable cost of $20 per unit, fixed costs of $95,000 per year, and depreciation of $35,000 per year. The sales quantity is 10,000 units per year. What is the degree of operating leverage if the tax rate is zero percent? [A] 0.9 [B] 1.3 [C] 1.5 [D] 1.9 [E] 2.4 [A] :You must first compute operating cash flow. Did you find this to be $105,000? Then use the DOL formula from section 11.5 [B] :You must first compute operating cash flow. Did you find this to be $105,000? Then use the DOL formula from section 11.5 [C] :You must first compute operating cash flow. Did you find this to be $105,000? Then use the DOL formula from section 11.5 [E] :You must first compute operating cash flow. Did you find this to be $105,000? Then use the DOL formula from section ) Which one of the following is a fixed cost over a given time period? [A] sales commissions [B] salary of the chief financial officer [C] manufacturing labor cost [D] shipping expense [E] the cost of electricity [A] :Won't this cost change when sales change, making it a variable cost? Review section [C] :Won't this cost generally change directly with sales, making it a variable cost? Review section [D] :Won't this cost generally change directly with sales, making it a variable cost? Review section [E] :This cost will likely change as output increases or decreases during a period making it a variable cost. Review section ) If a division of a firm finds an exceptionally worthwhile positive net present value project they still will not be able to obtain funding if they are under hard rationing. [B] :Hard rationing is the inability of a firm to raise capital for a project under any circumstances. Review section ) Which of the following is (are) true about a project that breaks even on a cash basis and has an initial cash outflow of $100,000? I. The project has a zero internal rate of return. II. The project has a negative net present value. III. The project has a zero net present value. IV. The project has an internal rate of return equal to the firm's required return. [A] I only [B] II only [C] III only [D] II and III only [E] II, III, and IV only [A] :Since operating cash flows equal zero at the cash breakeven, the IRR must be negative. Review section 11.4.
15 [C] :Since operating cash flows equal zero at the cash breakeven, the IRR must be negative. What is the net present value in this case? Review section [D] :At least one of these is incorrect. Review section [E] :At least one of these is incorrect. Review section ) A project that is operating at its breakeven point has operating cash flow equal to zero. [A] cash [B] accounting [C] financial [D] sales [E] cost [B] :At the accounting break even, net income is zero. What is operating cash flow? Review section [C] :How can a project have a NPV of zero if operating cash flows are equal to zero? Review section [D] :There is no such breakeven point defined in the textbook. Review section [E] :There is no such breakeven point defined in the textbook. Review section ) A project that has an IRR equal to just breaks even on a financial basis. [A] zero percent [B] its AAR [C] its required return [D] 100 percent [E] 100 percent [A] :The project breaks even on an accounting basis in this case. Review section [B] :The IRR and the AAR may be the same at the financial breakeven point, however, it would merely be a coincidence. There is a better choice. Review section [D] :There is no breakeven point that results in an IRR of 100 percent. Review section [E] :The project breaks even on a cash basis in this case. Review section ) A firm that faces capital rationing must select a subset of capital projects based on some ranking criterion. The capital budgeting technique best suited for this is the: [A] net present value. [B] internal rate of return. [C] profitability index. [D] average accounting return. [E] payback. [A] :This can be used to rank projects, but there is a better tool for use when funds are limited. Review sections 11.6 and 9.6. [B] :There is a better tool for use when funds are limited. Review sections 11.6 and 9.6. [D] :This is not the best of the capital budgeting decision rules listed. There is a better tool for use when funds are limited. Review sections 11.6 and 9.6 [E] :This is not the best of the capital budgeting decision rules listed. There is a better tool for use when funds are limited. Review sections 11.6 and ) Costs that result from a small change in output are called costs. [A] fixed [B] marginal [C] average [D] special [E] product [A] :These costs don't change as output varies. Review section [C] :Average costs may or may not change with small changes in output. There is a better choice. Review section [D] :The textbook doesn t mention such a cost. There is a better choice than this. Review section [E] :Product costs may or may not change with small changes in output. There is a better choice. Review section 11.3.
16 66) Which of the following are correct statements concerning breakeven analysis? I. Accounting breakeven is the sales level that results in zero project net income. II. The cash breakeven is the sales level that results in a zero operating cash flow. III. The financial breakeven is the sales level that results in a zero net present value. IV. Of the three breakevens, the financial breakeven level of sales is generally the highest. [A] I and II only [B] I, II, and III only [C] II, III, and IV only [D] I, III, and IV only [E] I, II, III, and IV [A] :All of these statements are correct. Review section [B] :All of these statements are correct. Review section [C] :All of these statements are correct. Review section [D] :All of these statements are correct. Review section [E] :You are correct! 67) The situation that is most likely to exist if a project is accepted is known as the: [A] worst case scenario. [B] best case scenario. [C] base case scenario. [D] sales sensitivity situation. [E] variable cost sensitivity situation. [A] :Couldn t things be worse than you actually expect? Wouldn t that become the worst case scenario? Review section [B] :Couldn t things turn out better than you actually expect? Wouldn t that become the best case scenario? Review section [D] :What is the difference between scenario analysis and sensitivity analysis? Review section [E] :What is the difference between scenario analysis and sensitivity analysis? Review section ) If the degree of operating leverage is 1.05 and operating cash flow rises from $10,000 to $12,500, what is the percentage change in sales? [A] 18.6 percent [B] 19.2 percent [C] 22.3 percent [D] 23.8 percent [E] 26.3 percent [A] :You must first compute the percent change in operating cash flow. Did you find this to be 25 percent? Review section [B] :You must first compute the percent change in operating cash flow. Did you find this to be 25 percent? Review section [C] :You must first compute the percent change in operating cash flow. Did you find this to be 25 percent? Review section [E] :Did you multiply when you should have divided? Review section ) Which of the following statements are true concerning scenario analysis? I. A positive net present value for a project's worst case scenario guarantees you a positive return from the project. II. The base case scenario generally represents an average estimate of the net present value. III. If the net present value of the best case scenario is negative then it is probably unnecessary to create base and worst case scenarios. IV. Scenario analysis is less apt than sensitivity analysis to determine which variable has the greatest impact on the projected net present value. [A] I and II only [B] II and IV only [C] III and IV only [D] I, II, and III only [E] II, III, and IV only
17 [A] :At least one of these is incorrect. Review section [B] :Correct, but there is at least one more correct option. Review section [C] :Correct, but there is at least one more correct option. Review section [D] :At least one of these is incorrect. Review section [E] :You are correct! 70) The degree of operating leverage is equal to the percentage change in the operating cash flow divided by the percentage change in sales quantity. [B] :DOL does relate the sensitivity of OCF to changes in sales quantity. Review section ) A firm's total fixed costs are exactly equal to its depreciation, and both are greater than zero. The tax rate is zero percent. At the accounting breakeven point, the degree of operating leverage: [A] is equal to 1. [B] is equal to 2. [C] is greater than 2. [D] is undefined since you can't divide by zero. [E] cannot be determined without more information. [A] :You have found the ratio of fixed costs to operating cash flows, but now you need to review the formula. Review section [C] :You need to review this computation in section [D] :There is no division by zero in this case since operating cash flow is assumed to be greater than zero. Review section [E] :Yes, it is possible to find the DOL. You need to review this computation in section ) Which one of the following is generally the LEAST subject to forecasting risk? [A] projected sales [B] initial investment [C] projected fixed costs [D] price per unit [E] total variable costs [A] :This is important to forecast, but there is at least one other choice that is likely to be less subject to forecasting risk. Review section [C] :Of the choices given this is probably one of the least subject to forecasting risk, however, there is at least one other choice that is likely to be less subject to forecasting risk. Review section [D] :This is important to forecast, but there is at least one other choice that is likely to be less subject to forecasting risk. Review section [E] :There is at least one other choice that is likely to be less subject to forecasting risk. Review section ) A firm has identified positive net present value projects costing a combined total of $240,000. The firm allocates only $200,000 to be used for capital investment even though it has the ability to fund the entire $240,000. This is an example of: [A] implementing the degree of operating leverage limitation. [B] limiting sales to the cash breakeven point. [C] hard rationing imposed internally. [D] soft rationing being utilized. [E] capital intensity limitation policy. [A] :There was no mention of this type of policy in the textbook. Review section [B] :You can not draw this conclusion from the information given. Review section [C] :Hard rationing is externally driven. How does hard rationing vary from soft rationing? Review section [E] :There was no mention of this type of a policy in the textbook. Review section 11.6.
18 74) Which of the following describe(s) fixed costs? I. costs which are constant for a given period of time II. costs that are equal to zero when production is zero III. costs that change with the quantity of output [A] I only [B] II only [C] I and II only [D] I and III only [E] II and III only [B] :If the cost changes as output changes, it is not fixed. Review section [C] :At least one of these choices is incorrect. Remember that if the cost changes as output changes, it is not fixed. Review section [D] :At least one of these choices is incorrect. Remember that if the cost changes as output changes, it is not fixed. Review section [E] :At least one of these choices is incorrect. Remember that if the cost changes as output changes, it is not fixed. Review section ) A project that just breaks even on an accounting basis has a discounted payback period equal to its life. [A] :If a project's discounted payback is equal to the project's life, the NPV is zero. Is this the same NPV you get at the accounting break even? Review section ) Which one of the following is a variable cost over a given time period? [A] sales commissions [B] salary of the chief financial officer [C] automobile lease expense [D] wages for the cleaning crew [E] insurance for the corporation's buildings [B] :This expense will not likely change as sales change, at least in the short run. Review section [C] :This expense will not likely change as sales change. Review section [D] :This expense will not likely change as sales change, at least in the short run. Review section [E] :This expense will not likely change as sales change. Review section ) risk refers to the possibility that you make a bad decision because of errors in the projected cash flows. I. Scenario II. Forecasting III. Leverage [A] I only [B] II only [C] I and III only [D] II and III only [E] I, II, and III [A] :There is no such risk defined in the textbook. Review section [C] :At least one of these choices is incorrect. Review section [D] :At least one of these choices is incorrect. Review section [E] :At least one of these choices is incorrect. Review section ) Which of the following will decrease if you decrease the level of fixed costs, all else equal? I. operating leverage II. accounting breakeven III. operating cash flow IV. cash breakeven [A] I and II only
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