Deck 10: Flexible Budgets, Standard Costs and Variance Analysis

Question 1

The simple rate of return is the same as the internal rate of return

Answer 1

False

Question 2

Only three years after purchasing a machine, Greenwich Engineering has been given details of a new and improved model. This new model will increase output and help reduce costs. The existing machine cost £150,000 and was being depreciated straight-line over an eight-year period. Current estimated scrap value for the existing machine is only £20,000. The estimated scrap value for the existing machine in 5 years is £14,900.
Details of new machine
Costs of new machine £180,000.
Expected life of the machine is 5 years.
At the end of 5 years the estimated scrap value is £15,000.
There will also be an additional cost of £5,000 to send workers on a training course for the new machine. The training will be required before the machine is delivered.
Additional annual fixed costs of £15,000 will be incurred if the new machine is purchased. This cost is included in the fixed overhead cost per unit given below. Finally the management accountant has estimated that additional working capital of £80,000 will be required if the new machine is purchased.
A comparison of the existing and new model is given below: $\begin{array}{|l|c|c|}\hline & \text { Existing Machine } & \text { New Machine } \\\hline \text { Capacity (units) } & 150,000 & 160,000 \\\hline & £ & £ \\\hline \text { Selling price per unit } & 2.62 & 2.95 \\\hline \text { Cost per unit } & & \\\hline \text { Labour } & 1.00 & 0.90 \\\hline \text { Materials } & 0.60 & 0.48 \\\hline \text { Fixed overheads } & 0.20 & 0.18 \\\hline\end{array}$
The required return is 10 per cent Calculate the annual savings for the new machine

A)£81,200.
B)£83,200
C)£101,000.
D)£95,000.

Answer 2

£83,200

Question 3

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected.
Details of the proposals


-
Calculate the relevant annual cash flow for Project A

A)£190,000.
B)£243,000.
C)£137,000.
D)£84,000.

Answer 3

£137,000.

Question 4

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected.
Details of the proposals


-Calculate the Net Present Value of the cash flows for Project A

A)£24,050.
B)£24,000.
C)£25,000.
D)£31,000

Question 5

Calculate the NPV for the replacement decision if the selling price per unit decreases by 0.76%

A)£11,000.
B)£0.
C)£200.
D)£100.

Question 6

The calculation of the net present value of an investment project requires that the depreciation tax shield be included at

A)the amount of the depreciation with no adjustment for taxes.
B)the amount of the depreciation times one minus the tax rate.
C)the amount of the depreciation times the tax rate.
D)zero, since depreciation is not relevant to the calculation of net present value.

Question 7

What is the expected value of the probability distribution for the following product
$\begin{array}{|c|c|}\hline \text { Profit}& \text { Estimated probability of Product A } \\\hline £ 300 & 0.1 \\\hline £ 400 & 0.1 \\\hline £ 600 & 0.2 \\\hline £ 600 & 0.2 \\\hline £ 700 & 0.2 \\\hline £ 800 & 0.1 \\\hline£ 900&.01\\ \hline\end{array}$

A)£700.
B)£800.
C)£900.
D)£600.

Question 8

The payback capital budgeting technique considers

$\begin{array}{cc} \text {Cash flows over entire life of project}& \text {Time value of money}\\\end{array}$
A. $\begin{array}{cc} &&&&&&\text { No } &&&&&&&&&&&& \text {No } &\\\end{array}$
B. $\begin{array}{cc}&&&&&&\text { No} &&&&&&&&&&&&\text { Yes } &\\\end{array}$
C. $\begin{array}{cc}&&&&&&\text { Yes } &&&&&&&&&&& \text { Yes }\\\end{array}$
D. $\begin{array}{cc} &&&&&&\text { Yes}&&&&&&&&&&&\text { No } \\\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Question 9

(Appendix 14D) The release of working capital at the termination of an investment project is not a taxable cash inflow

Question 10

The present value of a given sum decreases as the number of years over which it is to be discounted also decreases

Question 11

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected.
Details of the proposals


-
Calculate the Net Present Value of the cash flows for Project A

A)£13,200.
B)£25,200.
C)£28,942.
D)£18,942.

Question 12

Which of the following capital budgeting techniques implicitly assumes that the cash flows are reinvested at the company's minimum required rate of return?

$\begin{array}{lrr} \text {Net Present Value}& \text { Internal Rate of Return}\\\end{array}$

A. $\begin{array}{lrr} &&\text { Yes } &&&&&&&& \text { Yes } &\\\end{array}$

B. $\begin{array}{lrr}&& \text { Yes } &&&&&&&& \text { No} &\\\end{array}$

C. $\begin{array}{lrr} && \text { No} &&&&&&&& \text { No } &\\\end{array}$

D. $\begin{array}{lrr} && \text { No } &&&&&&&& \text { Yes } &\\\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Question 13

If an investment has cash outflows of Q pounds at the end of each year for three years, then the present value of these cash outflows under a 10% rate of return will be

A)greater than under a 12% rate of return.
B)less than under a 12% rate of return.
C)equal to that under a 12% rate of return.
D)unknown because it depends on the size of Q.

Question 14

The required rate of return is the maximum rate of return that an investment project can yield in order to be acceptable

Question 15

(Ignore income taxes in this problem.) Allen College has a telephone system that is in poor condition. The system can be either overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:
Allen College uses a 12% discount rate and the total cost approach to capital budgeting analysis. Both alternatives are expected to have a useful life of eight years. The net present value of the new system alternative is

A)£(233,300).
B)£(283,300).
C)£(263,100).
D)£(273,100).

Question 16

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected.
Details of the proposals


-Calculate the Present Value of the cash flows for Project A

A)£725,098.
B)£774,050.
C)£151,000.
D)£495,000.

Question 17

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected.
Details of the proposals


-Calculate the Present Value of the cash flows for Project B

A)£788,942.
B)£768,942.
C)£535,000
D)£825,000.

Question 18

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected.
Details of the proposals


-Calculate the relevant annual cash flow for Project B

A)£187,567.
B)£236,096.
C)£136,096
D)£36,096.

Question 19

(Ignore income taxes in this problem.) Allen College has a telephone system that is in poor condition. The system can be either overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:
Allen College uses a 12% discount rate and the total cost approach to capital budgeting analysis. Both alternatives are expected to have a useful life of eight years. The net present value of the overhaul alternative is

A)£(238,232).
B)£(108,000).
C)£(228,232).
D)£(232,272).

Question 20

If the internal rate of return is used as the discount rate in computing net present value, the net present value will be

A)positive.
B)negative.
C)zero.
D)unknown.

Question 21

If two projects require the same amount of investment, then the preference ranking computed using either the profitability index or the net present value would be the same

Question 22

The Deta Company is analyzing projects X, Y, and Z as possible investment opportunities. Each of these projects has a useful life of six years. The following information has been obtained: $\begin{array}{lrr}&\text { Project X} &\text { Project Y} &\text { Project Z} \\\\ \text { Initial investment needed. } &£ 260,000 & £ 180,000 & £ 340,000\\ \text { Present value of future cash inflows.} &£ 295,000 & £ 220,000 & £ 390,000 \\ \text { Internal rate of return.} &20 \% & 16 \% & 18 \%\\\end{array}$


-
Which of the following statements is correct

A)Project X is preferred over Project Y according to the profitability index.
B)Project Y is preferred over Project Z according to an internal rate of return ranking.
C)Project Z is preferred over Project X according to a net present value ranking.
D)Project X is preferred over Project Z according to the profitability index.

Question 23

If the internal rate of return exceeds the required rate of return for a project, then the net present value of that project is positive

Question 24

(Ignore income taxes in this problem.) The Yates Company purchased a piece of equipment that is expected to have a useful life of 7 years with no salvage value at the end of the 7-year period. This equipment is expected to generate a cash inflow of £32,000 each year of its useful life. If this investment has an internal rate of return of 14%, then the initial cost of the equipment is

A)£150,000.
B)£137,216.
C)£12,800.
D)£343,360.

Question 25

The length of time required to recover the initial cash outlay for a project is determined by using the

A)discounted cash flow method.
B)the payback method.
C)the net present value method.
D)the simple rate of return methoD.

Question 26

The Deta Company is analyzing projects X, Y, and Z as possible investment opportunities. Each of these projects has a useful life of six years. The following information has been obtained: $\begin{array}{lrr}&\text { Project X} &\text { Project Y} &\text { Project Z} \\\\ \text { Initial investment needed. } &£ 260,000 & £ 180,000 & £ 340,000\\ \text { Present value of future cash inflows.} &£ 295,000 & £ 220,000 & £ 390,000 \\ \text { Internal rate of return.} &20 \% & 16 \% & 18 \%\\\end{array}$


-
Which project has the highest ranking according to the net present value and the profitability index criteria
$\begin{array}{lrr} \text {Net Present Value } &\text { Protitability Index } \\\end{array}$

A. $\begin{array}{lrr}&&& \text { Z } &&&&&&&\text { Z} &\\\end{array}$

B. $\begin{array}{lrr} &&& \text { Y } &&&&&&&\text { X } &\\\end{array}$


C. $\begin{array}{lrr} &&& \text {X } &&&&&&&\text {Y } &\\\end{array}$


D. $\begin{array}{lrr} &&& \text {Z } &&&&&&&\text { Y} &\\\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Question 27

The simple rate of return method places its focus on cash flows instead of on accounting net operating income

Question 28

Bringing future sums to their present value is known as

A)interpolating.
B)compounding.
C)annualising.
D)discounting.

Question 29

Calculate the contribution per unit for the new machine

A)£1.77.
B)£1.75
C)£1.57
D)£1.39.

Question 30

An investment project for which the net present value is £300 would result in which of the following conclusions

A)The net present value is too small; the project should be rejected.
B)The investment project promises slightly more than the required rate of return.
C)The net present value method is not suitable for evaluating this project; the internal rate of return method should be used.
D)The investment project should only be accepted if net present value is zero; a positive net present value indicates an error(s) in the estimates associated with the analysis of this investment.

Question 31

(Ignore income taxes in this problem.) An investment of P pounds now will yield cash inflows of £3,000 at the end of the first year and £2,000 at the end of the fourth year. If the internal rate of return for this investment is 20%, then the value of P is

A)£3,463.
B)£2,499.
C)£964.
D)£4,185.

Question 32

Calculate the relevant cash flows for year 0

A)-£245,000.
B)-£240,000.
C)-£250,000.
D)-£330,000

Question 33

(Ignore income taxes in this problem.) Two years ago Leroy paid £8,000 for 100 shares of common stock in the Uptown Company. He obtained a cash dividend of £300 at the end of each year for the next two years. At the end of the second year he sold the stock for £9,000 in cash. Using a discount rate of 12%, what is the net present value of Leroy's investment

A)£(320)
B)£(827)
C)£4,243
D)£8,745

Question 34

Preference decisions attempt to determine which of many alternative investment projects would be the best for the company to accept

Question 35

The capital budgeting method that recognises the time value of money by discounting cash flows over the life of the project, using the company's required rate of return as the discount rate is called the

A)simple rate of return method.
B)the net present value method.
C)the internal rate of return method.
D)the payback methoD.

Question 36

(Ignore income taxes in this problem.) Cause Company is planning to invest in a machine with a useful life of five years and no salvage value. The machine is expected to produce cash flow from operations of £20,000 in each of the five years. Cause's required rate of return is 10%. The maximum price that the company would pay for the machine would be

A)£32,220.
B)£62,100.
C)£75,820.
D)£122,100.

Question 37

(Ignore income taxes in this problem.) A piece of new equipment will cost £70,000. The equipment will provide a cost savings of £15,000 per year for ten years, after which it will have a £3,000 salvage value. If the required rate of return is 14%, the equipment's net present value is

A)£8,240.
B)£(8,240).
C)£23,888.
D)£9,050.

Question 38

(Ignore income taxes in this problem.) Murdock Company has a chance to make and sell a new plastic five-gallon container. The company estimates that the net cash flows (sales less cash operating expenses) arising from manufacture and sale of the new container would be as follows (numbers in parentheses indicate an outflow): $\begin{array}{lrr} \text {Years 1-10 } &£ 85,000\\ \text {Years 11 } &£(20,000)\\ \text { Years 12} &£ 95,000\\\end{array}$


-
Murdock would need to purchase production equipment costing £200,000 now to use in the manufacture of the new containers. This equipment would have a 12-year life and a £20,000 salvage value. Murdock Company's required rate of return is 12%. The net present value of all cash flows associated with this investment (rounded to the nearest thousand pounds) is

A)£304,000.
B)£380,000.
C)£318,000.
D)£298,000.

Question 39

The basic premise of the payback method is that the longer it takes the cost of an investment to be recovered, the less desirable is the investment

Question 40

In a capital budgeting decision, the required rate of return (discount rate) does not need to be specified in advance for which of the following
$\begin{array}{lrr} \text {Net Present Value}& \text { Internal Rate of Return}\\\end{array}$

A. $\begin{array}{lrr} &&\text { Yes } &&&&&&&& \text { Yes } &\\\end{array}$

B. $\begin{array}{lrr}&& \text { Yes } &&&&&&&& \text { No} &\\\end{array}$

C. $\begin{array}{lrr} && \text { No} &&&&&&&& \text { No } &\\\end{array}$

D. $\begin{array}{lrr} && \text { No } &&&&&&&& \text { Yes } &\\\end{array}$

A)Option A
B)Option B
C)Option C
D)Option D

Question 41

In preference decisions, the profitability index and internal rate of return methods may produce conflicting rankings of projects

Question 42

(Ignore income taxes in this problem.) Chow Company has gathered the following data on a proposed investment project: $\begin{array}{lr} \text {Investment required in equipment. } &£ 142,500\\ \text {Annual cash inflows. } &£ 30,000\\ \text {Salvage value. } &£ 0 \\ \text { Life of the investment. } & \text { 8 years}\\ \text { Required rate of return. } &10 \%\\\end{array}$


-
The simple rate of return on the investment is closest to

A)8.55%.
B)10.00%.
C)21.05%.
D)33.55%.

Question 43

The cost of capital involves a blending of costs of all sources of capital funds, both debt and equity

Question 44

A decrease in the discount rate

A)will increase present values of future cash flows.
B)is one way to compensate for greater risk in a project.
C)will reduce present values of future cash flows.
D)responses A and B are both correct.

Question 45

Spring Company has invested £20,000 in a project. Spring's discount rate is 12% and the profitability index on the project is 1.00. Which of the following statements would be true
I) The present value of the project's net cash flows is £20,000.
II) The project's internal rate of return is equal to 12%.

A)Only I.
B)Only II.
C)Both I and II.
D)Neither I nor II.

Question 46

The profitability index is used to compare the internal rates of return of two companies with different investment amounts

Question 47

The simple rate of return focuses on accounting net operating income rather than on cash flows

Question 48

Calculate the relevant cash flow in Year 5 for the scrap value

A)£15,000.
B)£14,900
C)£100.
D)£15,100.

Question 49

If a company has computed the profitability index of an investment project as 1.15, then

A)the project's internal rate of return is less than the discount rate.
B)the project's internal rate of return is greater than the discount rate.
C)the project's internal rate of return is equal to the discount rate.
D)the relationship of the rate of return and the discount rate is impossible to determine from the data given.

Question 50

Calculate the relevant fixed costs for this decision

A)£20,000.
B)£15,000.
C)£35,000
D)£25,000.

Question 51

Calculate the relevant cash flows for year 1

A)£63,200.
B)£55,200.
C)£83,200.
D)£68,200.

Question 52

The after-tax cost of a deductible cash expense is

A)The amount of the cash expense.
B)The amount of the cash expense times the tax rate.
C)The amount of the cash expense times the 1 minus the tax rate.
D)None of the above is true.

Question 53

(Ignore income taxes in this problem.) Chow Company has gathered the following data on a proposed investment project: $\begin{array}{lr} \text {Investment required in equipment. } &£ 142,500\\ \text {Annual cash inflows. } &£ 30,000\\ \text {Salvage value. } &£ 0 \\ \text { Life of the investment. } & \text { 8 years}\\ \text { Required rate of return. } &10 \%\\\end{array}$


-
The internal rate of return on the investment is closest to

A)13%.
B)15%.
C)14%.
D)12%.

Question 54

Calculate the contribution per unit for the existing machine

A)£1.00.
B)£1.32
C)£1.12.
D)£1.62.

Question 55

(Ignore income taxes in this problem.) Mercredi, Inc., is considering investing in automated equipment with a ten-year useful life. Managers at Highpoint have estimated the cash flows associated with the tangible costs and benefits of automation, but have been unable to estimate the cash flows associated with the intangible benefits. Using the company's 14% required rate of return, the net present value of the cash flows associated with just the tangible costs and benefits is a negative £182,560. How large would the annual net cash inflows from the intangible benefits have to be to make this a financially acceptable investment

A)£18,256.
B)£26,667.
C)£35,000.
D)£38,000.

Question 56

(Ignore income taxes in this problem.) Chow Company has gathered the following data on a proposed investment project: $\begin{array}{lr} \text {Investment required in equipment. } &£ 142,500\\ \text {Annual cash inflows. } &£ 30,000\\ \text {Salvage value. } &£ 0 \\ \text { Life of the investment. } & \text { 8 years}\\ \text { Required rate of return. } &10 \%\\\end{array}$


-
The net present value on this investment is closest to

A)£30,000.
B)£76,024.
C)£58,800.
D)£17,550.

Question 57

(Ignore income taxes in this problem.) Beaver Company is investigating the purchase of a new threading machine that costs £18,000. The machine would save about £4,000 per year over the present method of threading component parts, and would have a salvage value of about £3,000 in 6 years when the machine would be replaced. The company's required rate of return is 12%. The machine's net present value is

A)£1,556.
B)(£35).
C)£11,000.
D)£8,000.

Question 58

(Ignore income taxes in this problem.) Murdock Company has a chance to make and sell a new plastic five-gallon container. The company estimates that the net cash flows (sales less cash operating expenses) arising from manufacture and sale of the new container would be as follows (numbers in parentheses indicate an outflow): $\begin{array}{lrr} \text {Years 1-10 } &£ 85,000\\ \text {Years 11 } &£(20,000)\\ \text { Years 12} &£ 95,000\\\end{array}$


-Murdock would need to purchase production equipment costing £200,000 now to use in the manufacture of the new containers. This equipment would have a 12-year life and a £20,000 salvage value. Murdock Company's required rate of return is 12%. The payback period on this investment is (rounded to the nearest tenth of a year)

A)2.0 years.
B)2.4 years.
C)3.0 years.
D)3.4 years.

Question 59

A very useful guide for making investment decisions is: The shorter the payback period, the more profitable the project

Question 60

One criticism of the payback method is that it ignores cash flows that occur after the payback point has been reached

Question 61

(Ignore income taxes in this problem.) Welch Company purchased a piece of equipment with the following data: $\begin{array}{lr} \text { Useful life. } & \text { 6 years } \\ \text { Yearly net cash inflow. } &£ 45,000\\ \text { Salvage value.} &£ 0\\ \text { Internal rate of return } & 18 \%\\ \text { Required rate of return } & 14 \%\\\end{array}$

The initial cost of the equipment was

A)£157,410.
B)£175,005.
C)£235,890.
D)impossible to determine from the information given.

Question 62

What is the expected value of the probability distribution for the following product? $$\begin{array} { | l | c | } \hline N P V & \text { Estimated probability of Product Alpha } \\\hline £ 4,500 & 0.1 \\\hline £ 6,000 & 0.1 \\\hline £ 7,500 & 0.2 \\\hline £ 9,000 & 0.2 \\\hline £ 10,500 & 0.2 \\\hline £ 12,000 & 0.1 \\\hline £ 13,500 & 0.1 \\\hline\end{array}$$

Question 63

(Ignore income taxes in this problem.) Hamilton Company invested in a two-year project having an internal rate of return of 12%. The project is expected to produce cash flow from operations of £60,000 in the first year and £70,000 in the second year. The cost of the project is closest to

A)£103,600.
B)£109,400.
C)£116,100.
D)£122,500.

Question 64

Under the internal rate of return capital budgeting technique, it is assumed that cash flows are reinvested at the

A)company's cost of capital.
B)hurdle rate of return.
C)internal rate of return.
D)discount rate.

Question 65

Discuss the advantages and disadvantages of the various DCF and non-DCF methods.

Question 66

(Ignore income taxes in this problem.) Given the following data: $\begin{array}{lrr} \text { Present investment required. } &£ 10,000\\ \text {Net present value. } &£ 1,300\\ \text {Annual cost savings. } &£?\\ \text { Dis count rate. } &14 \%\\ \text {Life of the project. } &\text { 8 years } \\\end{array}$

Based on the data given, the annual cost savings would be (rounded)

A)£4,024.
B)£2,436.
C)£1,875.
D)£3,704.

Question 67

Greenwich plc has £1million to invest in new products and has to decide between two alternatives. Both projects have an estimated life of 4 years. The annual sales for Project X have been forecast at 50,000 units and for Project Y only 4,000 units.
Recent experience suggests that any new products will face severe competition and it is becoming increasingly difficult for managers to prepare reliable forecasts. Senior managers are therefore very concerned about the sensitivity of revenues and costs for the projects.
Details of the proposals
$$\begin{array} { | l | l | l | } \hline & \text { Project } & \text { P roject Y } \\\hline & \text { Unit £} & \text { Unit £ } \\\hline \text { Selling price } & 290 & 890 \\\hline \text { Costs: } & & \\ \hline \text { Labour } & 200 & 40 \\\hline \text { Material } & 25 & 320 \\\hline \text { Variable Overhead } & 25 & 41 \\\hline\end{array}$$
The cost of capital for the group is 10%
Total fixed costs for project X are forecast at £1,500,000 and this includes £500,000 of head office charges. A residual value has been estimated at £100,000.
Total fixed costs for project Y are forecast at £1,250,000 and this includes £300,000 of head office charges. There will be no residual value.
Calculate how sensitive Project Y and Project X is to increases in variable overhead costs.

Question 68

Discuss how uncertainty and risk may be considered in investment decisions.

Question 69

Explain why it is important to allow for inflation in a capital budgeting question.