Deck 10: Project Analysis

Question 1

The economic break-even level of sales will be higher than the accounting break-even level.

Answer 1

True

Question 2

The level of sales at which project NPV is zero is referred to as the accounting break-even point.

Answer 2

False

Question 3

Managers that accept projects that only break even on an accounting basis are helping their shareholders.

Answer 3

False

Question 4

The option to abandon a project becomes more valuable as the possible outcomes become more varied.

Question 5

Operating leverage increases with fixed cost.

Question 6

Scenario analysis allows managers to look at different and sometimes inconsistent combinations of variables.

Question 7

Conflicts of interest between shareholders and managers may result in the sacrifice of attractive capital budgeting proposals.

Question 8

What-if analysis is not crucial to capital budgeting.

Question 9

"What-if" questions ask what will happen to a project in various circumstances.

Question 10

Competitive advantage is an important element of many successful capital budgeting proposals.

Question 11

A project that simply breaks even on an accounting basis gives you your money back but does not cover the opportunity cost of the capital tied up in the project.

Question 12

A project that breaks even in accounting terms will surely have a negative NPV.

Question 13

A capital budget shows a proposed list of investments.

Question 14

The strategic planning portion of the capital budgeting process is essentially a "bottom-up" process.

Question 15

The inputs that are most worth refining before you commit to a project are the ones that have the greatest potential to alter project NPV.

Question 16

While sensitivity analysis is forward-looking,scenario analysis attempts to reconstruct and analyze the past.

Question 17

What-if analysis can help identify the inputs that are most worth refining before you commit to a project.

Question 18

Sensitivity analysis takes into consideration the interrelationship of variables.

Question 19

The degree of operating leverage (DOL)shows the relationship between sales and pretax profits.

Question 20

Scenario analysis allows managers to look at different but consistent combinations of interrelated variables.

Question 21

The greater the DOL,the greater the protection against operating losses during economic downturns.

Question 22

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 23

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

A) $818,182
B) $1,181,818
C) $1,300,000
D) $1,363,636

Question 24

The capital budget should be consistent with the firm's:

A) growth in sales.
B) strategic plans.
C) current level of debt.
D) dividend policy.

Question 25

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 26

A project that has zero EVA:

A) has a positive NPV.
B) has an NPV of zero.
C) has a negative NPV.
D) all of these.

Question 27

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

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

Question 28

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 29

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 35% tax rate,and employs a 12% 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 30

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 31

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%
B) 70%
C) 80%
D) 90%

Question 32

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 the highest IRR and quickest payback
D) The proposal to solve pollution problems cited by the EPA

Question 33

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 favorite projects.
D) increases funds to be used for other purposes.

Question 34

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

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

Question 35

Which of the following industry has low operating leverage?

A) Steel
B) Railroads
C) Electric utilities
D) Autos

Question 36

A firm with 60% 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 37

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

Question 38

If a large proportion of costs is fixed,a shortfall in sales has a magnified effect on profits.From the previous statement we know that the risk of a project is affected by the degree of operating leverage.

Question 39

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 35% 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.

Question 40

The clothing industry is considered to have a high degree of operating leverage.

Question 41

Which of the following statements is likely to be correct for a decision tree that indicates a 30% chance of making a $250,000 profit and a 70% 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 42

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) ensuring that the project sponsor has proper incentives.
D) testing for interrelated variables.

Question 43

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 44

Positive NPV projects exist 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) firms hold competitive advantages.

Question 45

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 46

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 47

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

Question 48

Which of the following appears to be a more suitable investment?

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

Question 49

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 50

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 51

Which of the following may be responsible for a fair share of the perennial "project cost overruns"?

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

Question 52

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 53

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

A) deemphasizing that variable as a critical factor.
B) requiring a more detailed sales forecast.
C) that the initial sales forecasts were inflated.
D) reallocating fixed costs to this product.

Question 54

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 55

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 56

Income that is measured after deduction of the cost of capital is called:

A) operating income.
B) operating profit.
C) economic income.
D) economic profit.

Question 57

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

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

Question 58

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 59

The option 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) generates a positive NPV.
D) has a steady degree of operating leverage.

Question 60

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% to 80%.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

Question 61

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

Question 62

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

A) project is ensured 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 63

If forecasted sales exceed the break-even level but are less than the economic 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 64

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 65

Approximately how much was paid to invest in a project that has an economic break-even level of sales of $5 million,cash flows determined by .1 * sales - $300,000,a 6-year life,and an 8% discount rate?

A) $416,667
B) $924,575
C) $1,016,678
D) $2,311,450

Question 66

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 67

Calculate the economic 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%.

A) $3,254,890
B) $3,504,890
C) $4,921,549
D) $19,686,667

Question 68

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 69

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 70

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%.

A) $2,769,231
B) $2,857,143
C) $4,000,000
D) $5,142,857

Question 71

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 72

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

Question 73

What is the accounting 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) $6,285,714
D) $6,557,377

Question 74

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% 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

Question 75

The accounting 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 76

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

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

Question 77

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) the allowance of the sales level to vary in response to changes in demand.
D) the inclusion of income taxes.

Question 78

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%
B) 45%
C) 55%
D) 60%

Question 79

How much could NPV be affected by a worst-case scenario of 25% reduction from the $3 million in expected annual cash flows on a 5-year project with 10% cost of capital?

A) $2,843,090
B) $3,750,000
C) $4,578,825
D) $6,155,274

Question 80

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) Labor cost
D) Food cost