Deck 10: Project Analysis

Question 1

Using a computer model to repeatedly vary the combination of project variables in order to compare NPVs is called:

A)Scenario analysis
B)Sensitivity analysis
C)NPV break-even analysis
D)Simulation analysis

Answer 1

Simulation analysis

Question 2

The capital budget "bottom up" perspective should be consistent with the firm's "top down" view through:

A)Growth in sales
B)Strategic plans
C)Current level of funds
D)Dividend policy

Answer 2

Strategic plans

Question 3

Which of the following techniques may be more appropriate to analyze projects with interrelated variables?

A)Sensitivity analysis
B)Scenario analysis
C)Break-even analysis
D)DOL analysis

Answer 3

Scenario analysis

Question 4

Which of the following would not be judged a traditional category of a capital budgeting project?

A)Machine replacement proposals
B)Salary negotiations
C)New product proposals
D)Plant expansion proposals

Question 5

If a 20 percent reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:

A)De-emphasizing that variable as a critical factor
B)Requiring a more detailed sales forecast
C)The initial sales forecasts were inflated
D)A reallocation of fixed costs to this product

Question 6

Which of the following is least likely to be responsible for a regional manager's conflict of interest in promoting a capital budgeting proposal?

A)Desire for professional advancement
B)Thorough knowledge of the region
C)Overly optimistic economic forecasts
D)The need for quick profitability

Question 7

The purpose of sensitivity analysis is to show:

A)The optimal level of the capital budget
B)How price changes affect break-even volume
C)Seasonal variation in product demand
D)How variables in a project affect profitability

Question 8

What level of management is responsible for originating capital budgeting proposals?

A)Senior management
B)Divisional management
C)Lower management
D)All levels of management

Question 9

Sensitivity analysis evaluates projects by:

A)Forecasting changes in interest rates that would increase financing costs
B)Recording profitability changes while changing one variable at a time
C)Insuring that the project sponsor has proper incentives
D)Testing for interrelated variables

Question 10

Which of the following appears to be a more likely result from using sensitivity analysis?

A)Agreement on the appropriate discount rate
B)Determine whether to finance with debt or equity
C)Isolation of pivotal factor in project profitability
D)Select the best capital budgeting project

Question 11

How much could NPV be affected by a worst-case scenario of 25 percent reduction from the $3 million in expected annual cash flows on a five-year project with 10 percent cost of capital?

A)$2,843,090
B)$3,750,000
C)$4,578,825
D)$6,155,274 $3 million x 25% = $750,000 annual reduction in cash flow
Change in NPV = $750,000

Question 12

Which of the following statements is correct concerning sensitivity analysis?

A)It ignores interrelationships between variables
B)Several variables are allowed to change concurrently
C)It considers all feasible variable combinations
D)Its results are free from ambiguity

Question 13

What happens to the NPV of a one-year project if fixed costs are increased from $400 to $600, the firm is profitable, has a 15 percent tax rate and employs a 12 percent cost of capital?

A)NPV decreases by $200.00
B)NPV decreases by $173.91
C)NPV decreases by $130.00
D)NPV decreases by $113.04

Question 14

Soft capital rationing may be beneficial to a firm if it:

A)Reduces a firm's interest expense
B)Weeds out proposals with weaker or biased NPVs
C)Allows managers to select their favourite projects
D)Increases funds to be used for other purposes

Question 15

If sensitivity analysis indicates none of the individual variables will cause a negative NPV under pessimistic conditions, then the:

A)Project is assured to be successful
B)Project's discount rate should be reduced
C)Economic forecasts are possibly overly optimistic
D)Interaction of the variables should be considered

Question 16

Forecasting inconsistencies can be minimized by:

A)Allowing managers to establish their own forecasts
B)Establishing a standardized economic forecast to be used year in, year out
C)Generating current economic forecasts that are used throughout the firm
D)Extending the current forecast into the future

Question 17

Which of the following descriptions is representative of scenario analysis?

A)One variable at a time is allowed to change
B)It isolates the unknowns that belong in the model
C)Different combinations of variables are analyzed
D)It represents the "top-down" approach

Question 18

Which of the following variables would you suspect to be least significant in a sensitivity analysis of a fast-food establishment?

A)Sales
B)Depreciation schedule
C)Labour cost
D)Food cost

Question 19

If sensitivity analysis concludes that the largest impact on profits would come from changes in the sales level, then:

A)Fixed costs should be traded for variable costs
B)Variable costs should be traded for fixed costs
C)The project should not be undertaken
D)Additional marketing analysis may be beneficial before proceeding

Question 20

Which of the following capital budgeting proposals is most likely to display a conflict of interests?

A)The proposal with the highest NPV
B)The proposal with the longest payback period
C)The proposal with highest IRR and quickest payback
D)The proposal to solve pollution problems

Question 21

Calculate the break-even level of sales, assuming: $1.4 million fixed costs, $400,000 depreciation expense, and variable costs-to-sales ratio of 65 percent.

A)$2,769,231
B)$2,857,143
C)$4,000,000
D)$5,142,857 Break-even sales =

Question 22

Market demand allowed Acme Corp.to raise its price by 20 percent to $60.What is the new level of break-even revenues if fixed charges including depreciation are $1 million and variable costs were 70 percent of the old price?

A)$2,000,000
B)$2,400,000
C)$2,857,143
D)$3,333,333 old price =

Question 23

What is the maximum percentage of variable costs in relation to sales that a firm could experience and still break even with $5 million revenue, $1 million fixed costs, and $500,000 depreciation?

A)30 percent
B)70 percent
C)80 percent
D)90 percent

Question 24

What is the break-even level of revenues for a firm with $6 million in sales, variable costs of $3.9 million, fixed costs of $1.2 million, and depreciation of $1 million?

A)$3,428,571
B)$6,100,000
C)$6,285,700
D)$6,557,377 Variable costs =

Question 25

How much does each additional sales dollar contribute toward profit for a firm with $5 million break-even level of revenues and $1.5 million in fixed costs including depreciation?

A)$0.30
B)$0.33
C)$0.50
D)$0.67 Break-even level of revenues =

Question 26

Which of the following is not subtracted from sales revenues to determine pretax profit?

A)Depreciation
B)Fixed costs
C)Interest expense
D)Variable costs

Question 27

Which of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?

A)A decrease in the estimated annual sales
B)An increase in the discount rate
C)An increase in the initial investment
D)A decrease in the fixed costs

Question 28

A firm with 60 percent of sales going to variable costs, $1.5 million fixed costs, and $500,000 depreciation would show what accounting profit with sales of $3 million? Ignore taxes.

A)Zero loss
B)$370,000 loss
C)$666,667 Loss
D)$800,000 loss

Question 29

Fixed costs including depreciation have increased at Leverage, Inc.from $4 million to $6 million in an effort to reduce variable costs.What must the new variable-cost percentage be to leave break-even at $20 million?

A)60 percent
B)65 percent
C)70 percent
D)75 percent Old: = $20 million
$\rightarrow$ Variable costs = 80%
New: = $20 million
X = 30%

Question 30

The difference between an NPV break-even level of sales and an accounting break-even level of sales is:

A)The consideration of opportunity cost
B)The consideration of depreciation expense
C)Allowing the sales level to vary in response to changes in demand
D)The inclusion of income taxes

Question 31

The break-even level of sales represents the point where:

A)Fixed costs are covered
B)Variable costs are covered
C)Fixed costs and variable costs are covered
D)Fixed costs, variable costs, and depreciation are covered

Question 32

Approximately how much was paid to invest in a project that has an NPV break-even level of sales of $5 million, cash flows determined by: .1
*sales - $300,000, a six-year life, and an 8 percent discount rate?

A)$416,667
B)$924,500
C)$1,016,678
D)$2,311,450 PV (cash flows) = investment

Question 33

What effect will a reduction in the cost of capital have on the accounting break-even level of revenues?

A)It raises the break-even level
B)It reduces the break-even level
C)It has no effect on the break-even level
D)This cannot be determined without knowing the length of the investment horizon

Question 34

Break-even revenues on an accounting basis typically indicate a:

A)Negative NPV for the firm
B)Positive NPV for the firm
C)High degree of operating leverage
D)Downturn in the business cycle

Question 35

What is the effect on break-even level of revenues for each dollar of increase in fixed costs plus depreciation for a firm with 70 percent variable costs?

A)An increase of $0.30.
B)An increase of $1.00.
C)An increase of $1.43.
D)An increase of $3.33 Break-even level of revenue =

Question 36

The break-even level of revenues represents the point at which the firm has:

A)Zero pretax profit
B)Zero net present value
C)Covered all opportunity costs
D)covered all fixed and variable costs

Question 37

Calculate the NPV break-even level of sales for a project requiring an investment of $3,000,000 and providing as cash flows: .15 *sales less $250,000.Assume the project will generate these cash flows for 10 years and that the discount rate is 10 percent.

A)$3,254,890
B)$3,504,890
C)$4,921,549
D)$19,686,667 PV cash flows = investment
6)14457(.15 sales - 250,000) = $3,000,000
)92169 sales - 1,536,142.50 = $3,000,000
)92169 sales = $4,536,142.50

Question 38

Calculate the ratio of variable-costs-to-sales for a firm with: $3,000,000 accounting break-even revenues, $1.2 million fixed costs, and $450,000 depreciation.

A)40 percent
B)45 percent
C)55 percent
D)60 percent Break even =

Question 39

If the level of sales is less than that calculated as the NPV break-even level, then the:

A)Project will break even only in accounting terms
B)Project's NPV will be greater than zero but less than the opportunity cost of capital
C)Project will have a negative NPV
D)Discount rate should be reduced

Question 40

If forecasted sales exceed the break-even level but are less than the NPV break-even level, the project has a:

A)Positive NPV but earns less than the discount rate
B)Negative NPV but earns more than the discount rate
C)Net loss on the income statement
D)Net profit on the income statement

Question 41

The option for a firm to expand future production has value because:

A)Future production will be profitable
B)The option requires no investment today
C)The future holds uncertainty
D)Today's production costs are lower than in the future

Question 42

What happens to a firm with high operating leverage when the overall level of sales is very high?

A)The firm has higher levels of fixed costs
B)The firm will enjoy high profits
C)The firm will not break even in accounting terms
D)The firm will have a reduced level of fixed costs

Question 43

For a firm with a DOL of 3.5, an increase in sales of 6 percent will:

A)Increase pretax profits by 3.5 percent
B)Decrease pretax profits by 3.5 percent
C)Increase pretax profits by 21.0 percent
D)Increase pretax profits by 1.71 percent

Question 44

Which of the following statements is likely to be correct for a decision tree which indicates a 30 percent chance of making a $250,000 profit and a 70 percent chance of sustaining a $140,000 loss?

A)The decision should be "yes" whenever the amount of possible profit exceeds the amount of possible loss
B)The decision should be "no" whenever there is a possibility of loss
C)The expected value is positive before discounting
D)The expected value is negative before discounting

Question 45

If a decision tree indicates an expected NPV of $1 million, then:

A)At least one of the outcomes had a negative NPV
B)All of the outcomes had a positive NPV
C)$1 million Is the firm's minimum guaranteed profit
D)The project still contains uncertainty

Question 46

What percentage change in sales occurs if profits increase by 3 percent when the firm's degree of operating leverage is 4.5?

A)0.33 percent
B)0.67 percent
C)1.5 percent
D)3.33 percent DOL =
=
=

Question 47

When management selects production technologies that include a high proportion of fixed costs, they:

A)Decrease their DOL
B)Increase their DOL
C)Decrease their NPV break-even level of sales
D)Reduce the NPV of their cash flows

Question 48

If pretax profits decrease by 13.8 percent when the DOL is 3.8, then the decrease in sales is:

A)0.28 percent
B)2.75 percent
C)3.63 percent
D)10.00 percent DOL =
3)8 =
3)8X = -13.8%
X = 3.63%

Question 49

What is the fixed-cost expenditure for a firm with a DOL of 4.5 that generates pretax profits of $1 million and has $600,000 in depreciation expense?

A)$1.1 million
B)$2.1 million
C)$2.9 million
D)$3.9 million DOL = 1 +
4)5 = 1 +
3)5 =
$3)5 million = fixed costs + $600,000

Question 50

A firm with $600,000 fixed costs and $200,000 depreciation is expected to produce $225,000 in profits.What is its DOL?

A)3.56
B)3.67
C)4.56
D)4.67 DOL = 1 +
= 1 +
= 1 + 3.56

Question 51

If a firm's DOL is 4.0 when its profit is $2,000,000 and its depreciation is $500,000, how much fixed cost does it have?

A)$5,000,000
B)$5,500,000
C)$6,000,000
D)$7,500,000 DOL = 1 +
4 = 1 +
3 =

Question 52

The opportunity to abandon a project inexpensively is likely to have more value when the product:

A)Incurs high fixed costs of production
B)Incurs high variable costs of production
C)Is generating a positive NPV
D)Has a steady degree of operating leverage

Question 53

A decision tree shows a 30 percent probability of $2 million in returns and a 70 percent chance of $1 million in returns.What is the maximum you would invest today in this project if the cash in-flow occurs one year in the future and the discount rate is 10 percent?

A)$818,182
B)$1,181,818
C)$1,300,000
D)$1,363,636 NPV = - investment
0 = - investment

Question 54

A firm with high operating leverage is expected to:

A)Have high variable costs
B)Have low fixed costs
C)Have a high degree of profitability
D)Perform better when sales are high

Question 55

Which of the following offers the most plausible scenario for a firm that maintained a constant degree of operating leverage when its level of fixed costs doubled?

A)Depreciation expense increased
B)Variable cost percentage decreased
C)Sales revenues declined
D)Pretax profits decreased

Question 56

Fixed costs:

A)Are a constant percentage of sales revenues
B)Vary with the level of depreciation expense
C)Are constant with changes in the level of output
D)Are inversely related to the level of output

Question 57

According to decision-tree analysis, investment projects should be discontinued when:

A)The probability of success is less than 50 percent
B)NPV is calculated to be negative
C)DOL increases from previous levels
D)The possibility of a failing outcome exists

Question 58

The opportunity to alter production technology gives managers:

A)The flexibility to adapt to changing situations
B)increased cash flow from operations
C)The opportunity to expand production
D)The ability to expand product lines

Question 59

Which of the following sources would most likely be responsible for persistent "project cost over-runs"?

A)Rapidly rising inflation
B)Delays in obtaining contracts and permits
C)Lack of raw materials
D)Forecasting bias by the sponsoring manager

Question 60

Students, and managers alike, are continually reminded to avoid negative-NPV projects.Which of the following projects may be acceptable even at a loss?

A)A capacity expansion project
B)A cost-reduction project
C)A pollution-control project
D)A machine replacement project

Question 61

A manufacturer contemplates a change in technology that would reduce fixed costs from $800,000 to $600,000, and reduce depreciation expense from $125,000 to $100,000.However, the ratio of variable costs to sales will increase from 68 percent to 80 percent.What will happen to break-even level of revenues?

A)A reduction to the level of $875,000
B)A reduction to the level of $2,890,625
C)An increase to the level of $3,500,000
D)An increase to the level of $3,625,000 Break even = (600,00 + 100,000)/.2

Question 62

Positive NPV projects most often occur because:

A)Analysts select sufficiently low discount rates
B)Most projects are unique and innovative
C)cash-flow projections are extended into the future
D)Of competitive advantages held by firms

Question 63

Selecting the lowest cost technology:

A)Will result in the highest long-run NPV
B)Could rule out future flexibility
C)Will minimize the cost of future upgrades
D)May not permit future expansion

Question 64

When the level of fixed costs is decreased, the break-even level of revenues:

A)Will automatically decrease
B)Will automatically increase
C)May or may not be changed, depending on variable costs
D)Will remain unchanged, because fixed costs cannot be altered

Question 65

One characteristic of scenario analysis is that:

A)It allows only one variable at a time to change
B)It limits variation to only three of the more likely variable combinations
C)All or nearly all variations are analyzed, regardless of likelihood
D)Managers generate each variation by hand

Question 66

The DOL measures the percentage change in ______, given a percentage change in _____.

A)Fixed costs; sales
B)Profits; fixed costs
C)Profits, sales
D)Operating leverage; fixed costs

Question 67

One of the problems inherent in sensitivity analysis is that:

A)NPVs do not change once a project is introduced
B)Most projects are equally sensitive to all variables
C)It can be difficult to define the range of outcomes
D)The cost of conducting the analysis is excessive

Question 68

The accounting break-even point is that level of sales where:

A)Sales revenue equals variable costs
B)Sales revenue equals variable plus fixed costs
C)EBIT equals depreciation expense, and, thus cash flow equals zero
D)EBIT equals zero

Question 69

In a graphic depiction of accounting break-even analysis, the larger the slope of the total cost line, the:

A)Higher the level of fixed costs
B)Higher the level of total revenue
C)Higher the number of units sold
D)Higher the percentage of variable costs

Question 70

What is the level of profits for a firm in which DOL = 5 and fixed costs including depreciation = $300,000?

A)$60,000
B)$75,000
C)$1,200,000
D)$1,500,000 DOL = 1 +
5 = 1 +
4 =

Question 71

The opportunity to abandon a project loses some of its value when:

A)Fixed costs are high
B)Markets are extremely competitive
C)The future is relatively certain
D)Secondary markets exist and are active

Question 72

The accounting break-even point for a firm is a function of its:

A)Net cash flows and depreciation expense
B)Fixed costs and profit on each sale
C)Variable costs and its tax liability
D)Revenues and fixed costs

Question 73

Recognizing that it may be in managers' best interests to be overly optimistic when proposing projects, how might firms effectively control this impulse?

A)Employ capital rationing
B)Discontinue investment proposals
C)Fire managers after their first mistake
D)Fund all project proposals

Question 74

Which of the following appears to be the most suitable investment?

A)Revenues cover fixed and variable costs
B)Investment breaks even in an accounting sense
C)Investment breaks even in an NPV sense
D)Revenues exceed cost of goods sold

Question 75

The greater the ratio of variable costs to sales, the:

A)More each additional sale contributes to coverage of fixed costs
B)Lower the level of profitability
C)More units must be sold to cover fixed charges
D)Lower the benefit of conducting a sensitivity analysis

Question 76

What happens to the NPV of a one-year project if fixed costs are increased from $400 to $600, the firm is not profitable, has a 15% tax rate and employs a 12% cost of capital?

A)NPV decreases by $200.00
B)NPV decreases by $178.57
C)NPV decreases by $130.00
D)NPV decreases by $113.04 Increase fixed costs by $200
Present value of $200 at 12% for 1 year = $178.57.

Question 77

Firms that lack competitive advantages will:

A)Have difficulty finding positive NPV projects for investment
B)Be forced to capture larger market shares to be profitable
C)Avoid the need to conduct sensitivity analyses
D)Be forced to operate with a high degree of operating leverage

Question 78

How much depreciation expense exists in a firm that has a break-even level of revenues of $2 million, fixed costs of $400,000, and a 60 percent ratio of variable costs to sales?

A)$144,000
B)$266,667
C)$400,000
D)$666,667 $2,000,000 =
800,000 = 400,000 + Dep

Question 79

What is the NPV break-even for a project costing $4,000,000 and generating cash flows according to .30 *sales - $450,000? Assume the project will last 10 years and requires a discount rate of 12 percent.

A)$2,093,654
B)$2,359,047
C)$3,859,798
D)$13,783,333 5.6502(.3 sales - 450,000) = 4,000,000
1)69506 sales - 2,542,590 = 4,000,000
1)69506 sales = 6,542,590

Question 80

A 4 year project is estimated to produce a product with the following information: selling price = $57 per unit; variable costs are $32 per unit; fixed costs are $9,000; required return is 12%; initial investment = $18,000.Calculate the accounting break-even.

A)597
B)540
C)525
D)490