Deck 25: Differential Analysis, Profitability Analysis and Capital Budgeting

Question 1

The term 'incremental cost' refers to:

A) a cost that is directly traceable to a specific cost object.
B) the difference in total costs between alternatives.
C) a cost that continues to be incurred even though there is no activity.
D) the operating profit forgone by selecting one choice instead of another.

Answer 1

B

Question 2

How often are sunk costs omitted from decision analysis?

A) Never.
B) Sometimes.
C) Always.
D) Only if immaterial.

Answer 2

C

Question 3

The directors of Tropical Cruises are concerned at the firm's latest income statement which shows a continuing decline in profits. In approaching this situation what is the first step management should take?

A) Improve the scheduling of entertainment on the ships.
B) Make key personnel changes in the marketing department.
C) Define the problem with an emphasis on the objective to be accomplished.
D) Provide the ships' employees with training in courteous behaviour to customers.

Answer 3

C

Question 4

Berkeley Company currently has idle plant capacity and wishes to make as large a profit as possible. It could use some of its facilities to produce 5 000 units of a new product that could be sold through its existing sales network. The new product would have the following estimated costs.
$$\begin{array} { l c } & \text { Per unit } \\\text { Materials } & \$ 6 \\\text { Labour } & \$ 12 \\\text { Variable factory overhead } & \$ 5 \\\text { Variable selling \& administrative costs } & \$ 3\end{array}$$
Assume the fixed factory overhead for the plant is $8 000 per month and the fixed selling and administrative costs are $1800 per month. What is the minimum price per unit that Berkeley could charge for this product without reducing overall profits?

A) $18
B) $21
C) $26
D) $20

Question 5

In differential analysis, irrelevant costs include:

A) avoidable costs.
B) differential costs.
C) opportunity costs.
D) sunk costs.

Question 6

What is the correct order for the following steps in the decision-making process?
I) Evaluate the alternatives
II) Choose a course of action
III) Gather information
IV) Define the problem

A) I, III, II, IV
B) III, II, I, IV
C) III, I, II, IV
D) IV, III, I, II

Question 7

The decision to further process a joint product is influenced by:

A) the costs of further processing.
B) common costs allocated to the product.
C) the amount of costs already incurred for the product.
D) the amount of fixed overhead which has been absorbed by the product.

Question 8

In relation to joint products the objective of the sell or process further decision is to:

A) maximise profit.
B) minimise processing.
C) maximise production.
D) maximise joint costs.

Question 9

Which of the following is irrelevant in the evaluation of a special order?

A) Idle capacity
B) Differential income
C) Differential cost
D) Average production cost

Question 10

A cost which differs between alternative courses of action is a:

A) controllable cost.
B) relevant cost.
C) non-joint cost.
D) sunk cost.

Question 11

costs, in incremental analysis, are the estimated future costs that differ between alternative courses of action.

A) Joint
B) Relevant
C) Absorption
D) Variable overhead

Question 12

If a firm has limited production capacity in one part of a sequential production operation, it can maximise profits by producing those items having the highest:

A) contribution margin per unit of the scarce resource.
B) selling price.
C) gross profit.
D) profit.

Question 13

Fern Valley Ltd reports the following data from this year's master budget:
$$\begin{array} { l c r } & \text { Per unit } & \text { Total } \\\text { Variable manufacturing cost } & \$ 18 & \\\text { Fixed manufacturing cost } & \$ 6 & \$ 24000 \\\text { Fixed selling and administrative expense } & \$ 2 & \$ 4000\end{array}$$
Fern Valley Ltd's capacity is 20 000 units per year, and the normal selling price is $35 per unit. A one-time-only order for 1200 units has been received at a special price of $30 per unit. The order would not disturb regular business. If the order is accepted, overall profit will increase by:

A) $ 4 800
B) $ 6 000
C) $ 8 000
D) $14 400

Question 14

Summer Days Corporation purchased manufacturing equipment two years ago for $180 000. The firm is considering selling the equipment outright for $140 000 or, alternatively, trading it in on new equipment for a trade-in allowance of $120 000. The sunk cost associated with the manufacturing equipment is:

A) $40 000.
B) $120 000.
C) $140 000.
D) $180 000.

Question 15

A sunk cost is a:

A) fixed cost.
B) potential benefit forgone.
C) cost that cannot be changed and is therefore not relevant to decision making.
D) cost which may be saved by not adopting an alternative.

Question 16

Which of the following is not relevant in the evaluation of a make-or-buy decision?

A) Quality control
B) Unavoidable costs
C) Alternative uses of the unused capacity
D) Potential adverse effects on business relationships

Question 17

The cost that represents the difference in total costs between two alternatives is the:

A) sunk cost.
B) direct cost.
C) opportunity cost.
D) incremental cost.

Question 18

The point in the production process at which joint products become separate products is called the point.

A) differential
B) constraint
C) split-off
D) acceptance

Question 19

The purpose of incremental analysis is to find the alternative:

A) that contributes the most to profit.
B) that brings in the most income.
C) with the lowest fixed costs.
D) with the least direct costs.

Question 20

The decision to further process a joint product is influenced by the:

A) increased costs of further processing.
B) amount of fixed overhead which has been absorbed by the product.
C) method used to allocate joint costs.
D) amount of costs already incurred for the product.

Question 21

Flash Sales provided the following information. Calculate the return on investment.
$$\begin{array} { l r } \text { Sales } & \$ 800000 \\\text { Operating profit } & \$ 46800 \\\text { Average operating assets } & \$ 520000 \\\text { Shareholders' equity } & \$ 50000 \\\text { Minimum required rate of return } & 12 \%\end{array}$$

A) 4%
B) 6%
C) 9%
D) 12%

Question 22

Capital investment proposals should be ranked in decreasing order of:

A) dollar amount required.
B) salvage value.
C) rate of return.
D) residual value expected.

Question 23

Figures for Clear Waters Company are:
$$\begin{array} { l c c } & \text { Product A } & \text { Product B } \\\text { Selling price per unit } & \$ 132 & \$ 156 \\\text { Variable cost per unit } & \underline { 108 } & \underline { \$ 4 } \\\text { Contribution margin } & \underline { \$ 24 } & \$ \underline { 72 }\end{array}$$
It requires one labour hour to produce one unit of Product A and four labour hours to produce one unit of Product B. Assume overall demand is greater than the company's capacity to produce. If labour is the constraining factor the company should concentrate production on:

A) Product B, since it has the lowest variable costs.
B) Product B, since it has the highest selling price.
C) Product B, since it has the highest contribution margin per unit.
D) Product A, since it has the highest contribution margin per labour hour.

Question 24

The information below is provided by Sparkling Clean Supplies Limited.
$$\begin{array} { l r } \text { Sales } & \$ 600000 \\\text { Operating profit } & 42000 \\\text { Average operating assets } & 240000 \\\text { Equity } & 150000 \\\text { Minimum required rate of return } & 15 \%\end{array}$$ Calculate the residual profit.

A) $4 800
B) $8 000
C) $6 000
D) $9 500

Question 25

Using the information below, calculate the residual profit.
$$\begin{array} { l r } \text { Sales } & \$ 240000 \\\text { Operating profit } & \$ 60000 \\\text { Average operating assets } & \$ 80000 \\\text { Shareholders' equity } & \$ 60000 \\\text { Minimum required rate of return } & 15 \%\end{array}$$

A) $24 000
B) $51 000
C) $48 000
D) $60 000

Question 26

A manager can improve return on assets by implementing which of the following actions?
I) Increasing sales
II) Decreasing costs
III) Decreasing assets

A) I and II only
B) II and III only
C) I and III only
D) I, II and III

Question 27

Assume the total manufacturing costs are $12 000 and that two products are produced. Information about these two products is as follows.
$\begin{array}{cc}\underline{\text { Product }} & \underline{\text { Quantity }} & \underline{\text { Net sales value} }\\A & 6000 &\$14000\\B & 4000 &7000\\\end{array}$ For inventory costing purposes what is the amount of joint costs that should be assigned to Product A on a per unit basis?

A) $1.05
B) $1.20
C) $1.75
D) $2.80

Question 28

Homestyle Company requires a return on all investments of 9%. How much will the company be willing to pay for an investment that will pay $15 000 per year for 8 years?

A) $60 228
B) $83 022
C) $86 199
D) $120 000

Question 29

Using the following information, the return on investment is:
$$\begin{array} { l r } \text { Sales } & \$ 80000 \\\text { Operating profit } & \$ 10000 \\\text { Profit margin } & 10 \% \\\text { Equity } & \$ 40000 \\\text { Minimum required rate of return } & 12 \% \\\text { Turnover of assets } & 1.4 \text { times p.a. }\end{array}$$

A) 10%
B) 12%
C) 14%
D) 16.8%

Question 30

Express Productions provides the following information.
$$\begin{array} { l r } \text { Sales } & \$ 1370000 \\\text { Operating profit } & 150000 \\\text { Average operating assets } & 1200000 \\\text { Shareholders' equity } & 1000000 \\\text { Minimum required rate of return } & 6 \%\end{array}$$
Calculate the return on investment.

A) 6.5%
B) 12.5%
C) 11.0%
D) 15.0%

Question 31

The following are examples of a capital investment decision except for:

A) Acquire a new company
B) Upgrade old equipment
C) Introduce a new product line
D) Downsize the workforce

Question 32

If $10 000 is invested at 8%, which calculation will provide the answer to how much will it grow to at the end of four years?

A) $10 000 / 0.7350
B) $10 000 x 3.3121
C) $10 000 x 0.9259 x 4
D) ($10 000 / 3.3121) x 4

Question 33

What amount must be deposited today at 6% p.a. to grow to $15 000 in five years?

A) $2 830.20
B) $3 560.92
C) $11 209.50
D) $15 000.00

Question 34

The time value of money concept is given consideration in long-range investment decisions by:

A) using the payback method and at least one other method to make an evaluation.
B) assuming equal annual cash flow patterns.
C) investing only in short term projects.
D) assigning greater value to more immediate cash flows.

Question 35

Discounting calculates the value of an amount to be received?

A) future
B) payback
C) historical
D) present

Question 36

What amount must be deposited today at 10% to grow to $8 000 in three years?

A) $3 216.86
B) $7 272.80
C) $6 010.40
D) $8 000.00

Question 37

represents the number of sales dollars generated by each dollar invested in assets.

A) Assets invested
B) Asset turnover
C) Profit margin
D) Number of sales

Question 38

Using the following information, calculate the residual profit.
$$\begin{array} { l r } \text { Sales } & \$ 750000 \\\text { Profit } & \$ 50000 \\\text { Average operating assets } & \$ 300000 \\\text { Shareholders' equity } & \$ 120000 \\\text { Minimum required rate of return } & 8 \%\end{array}$$

A) $26 000
B) $40 400
C) $46 000
D) $ Nil

Question 39

Capital budgeting decisions must be carefully considered for the following reasons, except for:

A) the large outlay of money.
B) the discounting of cash flows.
C) the long-term commitment of resources.
D) the risk that external conditions may alter over the long-term period of the investment.

Question 40

Return on investment equals:

A) profit margin x asset turnover.
B) asset turnover x residual profit.
C) profit margin x return on equity.
D) selling price x cost of investment.

Question 41

Which of the following is not a component of the cost of capital?

A) Debt
B) Cost of sales
C) Preference shares
D) Retained earnings

Question 42

An increase in the discount rate:

A) will reduce present values.
B) will increase present values.
C) will have no effect on net present value.
D) may either increase or decrease present values, depending on the state of the economy.

Question 43

Regina Corporation estimates that it can save $6 500 a year in cash operating costs for the next eight years if it buys a special purpose machine at a cost of $32 000. No residual value is expected. The firm's minimum desired rate of return is 9%. Compute the net present value (to the nearest whole dollar).

A) $3 976
B) $624
C) $7 631
D) $20 000

Question 44

Depreciation affects net cash flows in which of the following ways?

A) Reduces cash inflows
B) Reduces taxation payable
C) Increases taxation payable
D) Increases cash outflows

Question 45

Forever Clean Corporation is considering a project with annual after-tax cash flows of $6000 per year for 6 years. The company's cost of capital is 6%. Using the net present value method, what is the maximum amount that the company should invest? (Round to the nearest whole dollar).

A) $24 000
B) $25 380
C) $29 504
D) $36 000

Question 46

An investment will return net after-tax cash inflows of $8 000 per year for 6 years. The desired rate of return is 14%. What is the total present value of the future cash flows?

A) $27 464.80
B) $31 109.60
C) $21 868.80
D) $48 000.00

Question 47

The weighted average of the cost of obtaining funds in the form of debt and/or equity is known as the:

A) cost of debt.
B) cost of capital.
C) cost of borrowing.
D) cost of investment.

Question 48

Ignoring tax effects, which of the following items is not relevant to capital investment?

A) Depreciation
B) Cost savings
C) Net income
D) Disposal value

Question 49

Which of the following is irrelevant to capital investment analysis?

A) Net cash flows
B) Investment cost
C) Carrying value
D) Residual value

Question 50

The net present value method of evaluating proposed investments:

A) discounts cash flows at the minimum rate of return.
B) measures a project's time adjusted rate of return.
C) ignores cash flows beyond the payback period.
D) applies to only mutually exclusive investment proposals.

Question 51

Rank these investments in order of payback period showing the best project first.
$\bullet$ Investment A - 4.2 years
$\bullet$ Investment B - 2.8 years
$\bullet$ Investment C - 3 years
$\bullet$ Investment D - 5.1 years

A) B, C, A, D
B) A, C, B, D
C) B, A, D, C
D) D, A, C, B

Question 52

Rank these investments in order of profitability, showing the best project first.
$\bullet$ Investment A - NPV, $0
$\bullet$ Investment B - NPV, $186 550
$\bullet$ Investment C - NPV, $325 851
$\bullet$ Investment D - NPV, $66 437

A) A, D, B, C
B) D, C, A, B
C) C, B, D, A
D) B, C, A, D

Question 53

Rosewood Limited is considering purchasing new equipment with an initial cost of $175 000 and an estimated annual income of $60 000. Cash operating expenses are expected to be $12 000 per year. Straight-line depreciation will be used over the five-year life of the asset and a salvage value of $25 000 is to be considered in computing depreciation. Assuming the income tax rate is 30%, what is the amount of annual tax savings from depreciation? (Assume the straight-line depreciation method is used for both accounting and tax purposes.)

A) $23 100
B) $11 700
C) $9 000
D) $4 200

Question 54

Data for Van Guard Designs are:
Investment in new equipment $90 000
Net annual cash inflows 12 500
Salvage value of the new equipment 8 000
Life of the new equipment 10 years
Calculate the net present value of the machine assuming the cost of capital is 6% (ignore taxes and round answer to nearest whole dollar).

A) $(15 733)
B) $(2 466)
C) $2 001
D) $6 468

Question 55

Green Acres Winery is considering a project with annual after-tax cash flows of $10 000 per year for 7 years. The company's cost of capital is 8%. Using the net present value method, what is the maximum amount that the Green Acres should invest?

A) $70 000
B) $40 845
C) $64 813
D) $52 064

Question 56

Forrest Ltd is evaluating an investment proposal using the payback method. Cash inflows are expected to be $8000 in year 1, $8700 in year 2, $6000 in year 3, and $4800 in year 4. The initial investment required is $18 000. Assuming even cash inflows within each year what is the payback period?

A) 2.06 years
B) 3.00 years
C) 2.22 years
D) 2.50 years

Question 57

Which of the following items is a non-cash expense?

A) Rates
B) Salaries
C) Depreciation
D) Income taxes

Question 58

Which of the following statements concerning the return on average investment method of capital budgeting is incorrect?

A) It is easy to use.
B) It measures profit in the same way as the income statement.
C) It considers profits over the useful life of the investment.
D) It distinguishes between investments requiring an immediate payment of cash and those where payment is in the future.

Question 59

The method of project selection that brings the time value of money into capital investment analysis is the:

A) accounting rate of return method.
B) net present value method.
C) payback method.
D) return on average investment method.

Question 60

Which of the following is not an advantage of the payback method of capital budgeting?

A) It can be used to separate investments when other methods show similar returns.
B) The sooner cash is recovered the sooner it can be reinvested.
C) A quick payback period reduces the risk of the investment.
D) It looks at returns over the whole life of the investment.

Question 61

Which of the following statements concerning the internal rate of return method of capital budgeting is correct?

A) When the internal rate of return method is employed a direct relationship will exist between the interest rate chosen and the present value of future cash flows.
B) The interest rate that will discount future cash flows so that their present value is exactly equal to the cost of the investment is the cost of capital.
C) The internal rate of return is the discount rate that will produce a positive net present value for the investment.
D) When the net present value is equal to zero, the cost of capital (discount rate) and the internal rate of return are equal.

Question 62

Equipment A costing $64 000 is expected to generate $12 000 annually in cash inflows during its life of 10 years. Equipment B costing $130 000 is expected to generate $18 000 annually in cash inflows during its life of 7 years. Equipment C costing $90 000 is expected to generate $13 000 annually in cash inflows during its life of 9 years. Rank the three investments from best to worst (1 to 3) in terms of payback period.

A) B=1, C=2, A=3
B) C=1, A=2, B=3
C) A=1, C=2, B=3
D) A=1, B=2, C=3

Question 63

Machinery costing $72 000 is expected to generate $14 000 annually in cash inflows during its life of 8 years. The payback in years is:

A) 5.1 years.
B) 9.0 years.
C) 5.5 years.
D) 1.8 years.

Question 64

Beauchamp Advertising is considering the purchase of a special purpose machine for $56 000. It is expected to have a useful life of 7 years with no salvage value. The firm's accountant estimates savings in cash operating costs of $9 800 per year. Calculate the pay-back period.

A) 8 years
B) 6 years
C) 5.7 years
D) 4.4 years

Question 65

Which of the following is not true for the payback method of investment analysis?

A) It does not consider the time value of money.
B) The longer the payback period the better.
C) It does not consider project profitability.
D) It is relatively simple to calculate.