Deck 12: Evaluating Project Economics and Capital Rationing

Question 1

The cash flow degree of operating leverage will change for different levels of revenue.

Answer 1

True

Question 2

Depreciation and amortisation can be handled as a fixed cost of the company, for accounting break-even purposes.

Answer 2

True

Question 3

If Leaning Marcus' had an increase in EBIT of 24 per cent with an accounting degree of operating leverage of 1.2, then the company must have had a 20 per cent increase in revenue if no other changes were involved.

Answer 3

True

Question 4

The per-unit contribution margin is defined as the sales price of an item less its total variable cost.

Question 5

Operating leverage is a measure of the sensitivity of profit to changes in revenue.

Question 6

Distinguishing between fixed and variable costs will enable one to calculate the sensitivity of EBITDA to changes in revenue.

Question 7

If a project fails to break even from a pretax operating cash flow perspective, then the company is going to have to put more cash into the project to keep it going.

Question 8

If there is no uncertainty about costs, volatility in pretax operating cash flows and accounting profits will be driven entirely by changes in revenue and operating leverage.

Question 9

Tax do not enter into the equation for the cash flow degree of operating leverage because both fixed costs and pretax operating cash flows are measured on a pretax basis.

Question 10

An increase in the proportion of a project's costs that are fixed will increase the degree of operating leverage for the project.

Question 11

Operating profits and operating cash flow describe the same item.

Question 12

Total variable costs for a company do not vary directly with the number of units sold.

Question 13

EBITDA is more sensitive to changes in revenue than EBIT.

Question 14

A synonym for pretax operating cash flow is EBIT.

Question 15

A company that has zero fixed costs will have a cash flow degree of operating leverage equal to one.

Question 16

If a company's accounting degree of operating leverage is 1.12, then a 10 per cent increase in revenue should result in a 12 per cent increase in EBIT.

Question 17

If The Tower of Pizza has a cash flow degree of operating leverage equal to 1.15, then a 20 per cent increase in revenue should drive a 35 per cent increase in pretax operating cash flow.

Question 18

The pretax operating cash flow (EBITDA) break-even point is determined by how many units will have to be sold in order to cover the companies fixed cash expenses.

Question 19

Break-even analysis tells us how many sales dollars must occur in order for a project to break even on a cash flow or an accounting basis.

Question 20

A project with a higher proportion of fixed costs will have cash flows and accounting profits that are more sensitive to changes in revenues than an otherwise identical project with a lower proportion of fixed costs.

Question 21

Depreciation and amortisation are treated like fixed costs

A) in the calculation of the degree of pretax cash flow operating leverage.
B) in the calculation of the degree of accounting operating leverage.
C) for cash flow purposes.
D) none of the above.

Question 22

Gilligan's Boat Tours finds that if it were to increase its price by 10 per cent, it would have a 6 per cent reduction in the NPV of its new 3-Hour Tour. Gilligan's analysis could be described as

A) a Monte Carlo simulation.
B) scenario analysis.
C) sensitivity analysis.
D) none of the above.

Question 23

Under simulation analysis, the company will use a computer program to calculate probabilities of a range of estimates such as on the value of sales,

Question 24

The degree of pretax cash flow operating leverage provides us with

A) a measure of how sensitive pretax operating cash flows are to changes in revenue.
B) a measure of how sensitive accounting operating profits are to changes in revenue.
C) a measure of how sensitive NOPAT is to changes in revenue.
D) none of the above.

Question 25

___________ is a measure of the sensitivity of EBITDA or EBIT to changes in revenue.

A) Total leverage
B) Financial leverage
C) Operating leverage
D) None of the above

Question 26

An analysis in which a company would like to know the effect of a price change on the NPV of a project, holding all other variables and forecasts constant, is one type of sensitivity analysis.

Question 27

The accounting operating profit (EBIT) break-even point tells us how many units must be sold to avoid an accounting operating loss.

Question 28

If a company is about to operate in an environment in which there will be a great deal of variability in the level of revenues, then the company

A) should structure its cost structure to have high fixed costs and higher total variable costs.
B) should structure its cost structure to have high fixed costs and consequently lower per unit variable costs.
C) should structure its cost structure to have low fixed costs and consequently higher per unit variable costs.
D) None of the above.

Question 29

Revenue minus variable and fixed costs best describes

A) EBIT.
B) EBITDA.
C) NOPAT.
D) none of the above.

Question 30

Another name for EBITDA is

A) pretax operating cash flow.
B) operating cash flow.
C) profit before tax.
D) profit.

Question 31

The cross-over level of unit sales can be calculated for any two alternatives that have the same level of operating leverage.

Question 32

The cross-over level of unit sales is the level at which one fixed/variable cost combination of production will begin to generate higher levels of operating cash flows than another fixed/variable cost combination of production.

Question 33

The accounting operating profit break-even points are smaller than the corresponding pretax operating cash flow break-even points for a project with positive costs.

Question 34

If a company knows that a price change will have an effect on a number of other forecast variables, such as the sales forecast, then the company might require scenario analysis rather than sensitivity analysis.

Question 35

A company with a higher proportion of fixed costs will create

A) a higher degree of sensitivity of EBITDA to a change in revenues.
B) a lower degree of sensitivity of EBITDA to a change in revenues.
C) no discernible difference of a change in sensitivity of EBITDA to a change in revenues.
D) a company with a much more stable profit stream as a function of revenues.

Question 36

If the company is in a capital rationing situation, then it becomes necessary for the company to identify the bundle or combination of positive-NPV projects that creates the greatest total value for shareholders.

Question 37

If the degree of accounting leverage is 1.3 for a company, then a 10 per cent increase in revenue should drive a

A) 13% increase in pretax operating cash flows.
B) 13% increase in EBIT.
C) 30% increase in EBIT.
D) none of the above.

Question 38

The process of identifying the bundle of projects that creates the greatest total value and allocates the available capital to these projects is called capital asset pricing.

Question 39

If a company were interested in knowing the effect of a single input change on the net present value of a project, then the company would most likely want to perform

A) a Monte Carlo simulation.
B) scenario analysis.
C) sensitivity analysis.
D) none of the above.

Question 40

Simulation analysis has the benefit of providing a pinpoint accurate forecast of a project's NPV.

Question 41

Calculating operating leverage. Coach K Sneakers Ltd had EBIT of $1,850 last year with fixed costs equal to $500 (depreciation and amortisation not included) and depreciation and amortisation equal to $150. What was Coach K's degree of accounting operating leverage?

A) 1.25
B) 1.35
C) 1.38
D) 1.40

Question 42

Rouf-Mart has analysed a new type of all-in-one retail centre where the NPV of the project has an expected value with a distribution that yields a standard deviation of $25 million. Rouf-Mart came to this conclusion by analysing the individual input distributions for the project. This analysis is called.

A) a sensitivity analysis.
B) a scenario analysis.
C) a simulation analysis.
D) none of the above.

Question 43

The profitability index is useful in a capital rationing situation because

A) it helps identify projects by the amount of value created per dollar invested.
B) if followed, then it is only necessary to take the projects with the highest PI first.
C) it will rank the best project to be taken in an absolute manner.
D) none of the above.

Question 44

Variable costs, fixed costs, and project risk. Solutions Bank Textbooks had sales and operating expenses of $1 million last year. If the company had fixed costs of $300,000 on sales of 35,000 books, then what is the company's per-unit contribution?

A) $28.57
B) $20.00
C) $8.57
D) None of the above

Question 45

Calculating operating leverage. SunBucks Tea Supplies had EBITDA of $3,000 and EBIT of $2,750, with fixed cash expenses of $600 last year. What was SunBucks degree of accounting operating leverage?

A) 1.20
B) 1.25
C) 1.28
D) 1.31

Question 46

Scenario analysis can help a company to

A) understand the degree of uncertainty that a different set of project-affecting circumstances may hold.
B) eliminate all of the uncertainty that a different set of project-affecting circumstances may hold.
C) transform a risky project into a risk-free project.
D) none of the above.

Question 47

Capital constraints can occur due to

A) difficulties in accurately assessing the risks and returns associated with a company's projects.
B) the capital market's inability to fund all of a company's projects due to a lack of funds.
C) the capital market's policy of not funding all of a company's projects.
D) none of the above.

Question 48

If a project holds an 80 per cent probability of high demand and a 20 per cent probability of low demand, then the expected value of the net present value of the two different demand assumptions would give us a weighted average net present value for the project. Such an analysis is called

A) a sensitivity analysis.
B) a scenario analysis.
C) a simulation analysis.
D) none of the above.

Question 49

An analysis in which each of the inputs and assumptions for a project takes on a separate assumed distribution whereby a computer draws on each of those input and assumption distributions to create a distribution for the NPV of the entire project is called

A) a sensitivity analysis.
B) a scenario analysis.
C) a simulation analysis.
D) none of the above.

Question 50

A company is considering two distinct set of circumstances that assume high inflation and low inflation. In the high inflationary set of circumstances, the price per unit will be affected as well as the variable and fixed costs. If the low-inflation set of circumstances is considered the baseline, then the analysis concerning the high inflationary circumstances could be considered

A) a sensitivity analysis.
B) a scenario analysis.
C) a Monte Carlo simulation.
D) none of the above.

Question 51

Which of the following project risk analyses is best able to analyse the effect of a single set of circumstances, with correlated inputs, on the NPV of a project?

A) sensitivity analysis
B) scenario analysis
C) simulation analysis
D) none of the above

Question 52

The capital market may not be able to fund all of a company's positive NPV project because

A) the capital market will always speculate that it is not going to get a fair return.
B) even the capital market has a constraint for the amount of capital that it can supply a company.
C) it can be difficult for outside investors to accurately assess the risks and returns associated with the company's projects.
D) none of the above.

Question 53

Calculating operating leverage. Marvellous Company has a degree of cash flow operating leverage equal to 1.25. If the company's EBITDA was $1,000 last year while its depreciation and amortisation expense was $50 in the same year, then what was the company's degree of accounting operating leverage?

A) 1.26
B) 1.30
C) 1.32
D) 1.35

Question 54

If a company is interested in the distribution of the NPV for a project that it is considering, then the company should be most interested in

A) a sensitivity analysis.
B) a scenario analysis.
C) a simulation analysis.
D) none of the above.

Question 55

The process of identifying the bundle of projects that creates the greatest total value and allocating the available capital to the projects is known as

A) risk analysis.
B) budgeting.
C) rationing.
D) capital rationing.

Question 56

A change in sales price of a product sold by a company will probably involve a reduction in the number of units sold, as well as the possibility of a change in the cost structure of the company's product in question. If a company were interested in the entire price change effect on the NPV of a project, then it would be interested in

A) sensitivity analysis.
B) scenario analysis.
C) simulation analysis.
D) none of the above.

Question 57

At times, when a company is considering an alternative such that a set of variables affecting a project are interrelated, then analysis that considers this interrelation could be performed. This is called

A) a sensitivity analysis.
B) a scenario analysis.
C) a Monte Carlo simulation.
D) none of the above.

Question 58

If a company wanted to find the effect of a change in the variable cost per unit of production on the net present value of a project, then the company might perform

A) a sensitivity analysis.
B) a scenario analysis.
C) a Monte Carlo simulation.
D) none of the above.

Question 59

Calculating operating leverage. Potter Company has a degree of cash flow operating leverage equal to 1.266. If the company's EBITDA was $1,500 last year while its depreciation and amortisation expense was $100 in the same year, then what was the company's degree of accounting operating leverage?

A) 1.29
B) 1.33
C) 1.36
D) 1.39

Question 60

Which of the following project risk analyses is best able to analyse the effect of a single input, uncorrelated with other inputs, on the NPV of a project?

A) sensitivity analysis.
B) scenario analysis.
C) simulation analysis.
D) none of the above.

Question 61

Break-even analysis. Poisson Calculators has found that it is indifferent between purchasing a high-capacity vacuum component assembly machine or a lower capacity machine as long as sales are above 1,900 units per month. The price of each calculator is $70. The high-capacity machine has cash expenses of $100,000 per month and depreciation and amortisation expenses of $30,000 per month, while the alternative has cash expenses of $30,000 per month and depreciation and amortisation expenses of $5,000 per month. Under the low-capacity alternative, variable costs per unit are $60. If the company bases its decisions on the Accounting Operating Profit Break-even, then what is the variable cost per unit under the high-capacity alternative?

A) $10
B) $47
C) $60
D) $70

Question 62

Calculating operating leverage. Swan's Bicycle Boats had a degree of accounting operating leverage equal to 1.50 during the most recent period. If the company's EBITDA was $5,000 and its fixed costs were equal to $1,750, then what was Swan's depreciation and amortisation expense during the same period?

A) $500
B) $1,000
C) $1,500
D) $2,833

Question 63

Capital rationing. You are considering a project that has an initial cost of $1,200,000. If you take the project, it will produce net cash flows of $300,000 per year for the next six years. If the appropriate discount rate for the project is 10 per cent, what is the profitability index of the project?

A) 0.09
B) 1.09
C) 2.09
D) 2.18

Question 64

Capital rationing. TuleTime Comics is considering a new show that will generate annual cash flows of $100,000 into the infinite future. If the initial outlay for such a production is $1,500,000 and the appropriate discount rate is 6 per cent for the cash flows, then what is the profitability index for the project?

A) 0.11
B) 0.90
C) 1.11
D) 1.90

Question 65

Break-even analysis. Binders-For-School Ltd is in the process of determining whether to purchase a high-capacity machine to make textbooks for the upcoming school year. The high-capacity machine will generate fixed costs of $10,000 per year versus the $2,000 fixed costs of using a low-capacity machine. The variable costs per unit when using the high-capacity machine will be $30. The company will charge $60 for each textbook and has determined that the high-capacity machine will be more economically beneficial if sales are greater than 800 books. What is the variable cost per unit under the low-capacity machine scenario?

A) $20
B) $40
C) $60
D) $80

Question 66

Break-even analysis. Bright Light Auto Lamps has found that it is indifferent between purchasing a high-capacity vacuum sealing machine or a lower capacity machine as long as sales are above 200 units per month. The price of each sealed beam light is $50. The high-capacity machine has cash expenses of $10,000 per month, while the alternative has cash expenses of $5,000 per month and depreciation and amortisation expenses of $2,000 per month. Under high capacity, the variable costs per unit are $10; and they are $40 for the other alternative. If the company bases its decisions on the Accounting Operating Profit Break-even, then what are the depreciation expenses under the high-capacity alternative?

A) $3,000
B) $4,000
C) $9,000
D) none of the above

Question 67

Break-even analysis. TimeKeepers is about to introduce a new LED clock and has determined that it will charge $30 per clock. The company must decide whether or not to purchase a high-capacity clock-making machine. If the high-capacity machine is selected, then the fixed costs for the company will be $5,000 per year, with variable costs of $5 per clock. Otherwise the fixed costs will be $1,000, with variable costs of $15 per clock. Above what level of expected sales should TimeKeepers choose the high fixed cost alternative?

A) 400 units
B) 500 units
C) 4,000 units
D) 5,000 units

Question 68

Break-even analysis. Markovian Caviar Sales has discovered that the extent of the demand for its caviar harvest is 20,000 tins per year. If the fixed costs for the new product are $2,300,000 and the variable harvest cost per tin is $35, then what price can Markovian charge per tin if the company needs to break even on a pretax operating cash flow basis?

A) $135.00
B) $150.00
C) $185.00
D) None of the above

Question 69

Calculating operating leverage. TurkeyJerkey Dried Meats Ltd had a degree of accounting operating leverage equal to 1.714 during the most recent period. If the company's EBITDA was $4,000 and depreciation and amortisation was equal to $500, then what were TurkeyJerkey's fixed cash expenses during the same period?

A) $1,499
B) $1,999
C) $5,499
D) $5,999

Question 70

Break-even analysis. A cement contractor has determined that he is better off buying a large cement truck if he is able to sell more than 500 yards of cement per month. The price of a yard of cement is $60, and the variable costs for a large truck are $20 per yard. The variable costs for a small truck are $40 per yard, and the fixed costs for the small truck are $10,000. What are the fixed costs associated with the large truck?

A) $0
B) $10,000
C) $20,000
D) $30,000

Question 71

Break-even analysis. IronVerks Ribshack has total fixed costs of $8,500 per month. It sells rib plates for $15 each, and the variable cost of providing each plate is $10. What is the pretax operating cash flow break-even point for IronVerks?

A) 567 plates
B) 1,700 plates
C) 8,500 plates
D) None of the above

Question 72

Break-even analysis. Yoo Computers is introducing a new game system that promises to never become outdated. Yoo will sell the systems for $200, and it will accrue $130 in variable costs to produce. If cash fixed expenses are $35 million per year and the depreciation and amortisation expenses are $7 million per year, then what is the Accounting Operating Profit Break-Even point for Yoo?

A) 210,000 units
B) 323,077 units
C) 500,000 units
D) 600,000 units

Question 73

Break-even analysis. Max's Brakes is introducing a new revolutionary brake-pad for vehicles that will never wear out. Max's will sell the pads for $100 a pair and they will cost $80 in variable costs to produce. If cash fixed expenses are $1,500 per year and the depreciation and amortisation expenses are $600 per year, then what is the Accounting Operating Profit Break-Even point for Max's?

A) 8 pairs
B) 21 pairs
C) 75 pairs
D) 105 pairs

Question 74

Break-even analysis. Binders-For-School Ltd is in the process of determining whether to purchase a high-capacity machine to make textbooks for the upcoming school year. The high-capacity machine will generate fixed costs of $10,000 per year versus the $2,000 fixed costs of using a low-capacity machine. The variable costs per unit when using the high-capacity machine will be $30. The company will charge $60 for each textbook and has determined that the high-capacity machine will be more economically beneficial if sales are greater than 800 books. What is the contribution margin under the low-capacity machine scenario?

A) $10
B) $20
C) $30
D) $40

Question 75

Break-even analysis. ClockWatchers is about to introduce a new employee monitoring tool and has determined that it will charge $100 per unit. The company must decide whether or not to purchase a high-capacity manufacturing machine. If the high-capacity machine is selected, then the cash fixed costs will be $5,000 per year, with variable costs of $50 per unit and depreciation and amortisation expenses of $2,000. Otherwise the fixed costs will be $2,000, with variable costs of $75 per unit and depreciation and amortisation expenses of $500. If EBIT Break-even is how the company evaluates its projects, then above what level of expected sales should ClockWatchers choose the high fixed cost alternative?

A) 60 units
B) 90 units
C) 120 units
D) 180 units

Question 76

Capital rationing. Mick's Pub's is considering expanding the number of restaurants it owns. If it decides on the expansion, it will invest $2,300,000, and the NPV of the project is $900,000. What is the profitability index of the project?

A) 0.39
B) 1.00
C) 1.39
D) 2.39

Question 77

When a company is in a capital rationing situation, it may be helpful for the company to use the profitability index to prioritise which projects to take. Briefly describe how the profitability index may fail the company in that situation.

Question 78

Briefly explain the difference between the degree of pretax cash flow operating leverage and the degree of accounting operating leverage. Also explain why a corporate decision-maker might be more interested in the cash-flow metric. .

Question 79

Break-even analysis. Monochrome Sun Glasses has found that its pretax operating cash flow basis break-even number of glasses sold is 770,000 pairs. If each pair is sold for $25 and the variable cost per unit is $15, then what is the amount of Monochrome's fixed costs?

A) $77,000
B) $1,155,000
C) $7,700,000
D) $11,550,000

Question 80

Capital rationing. The profitability index for a project is 1.18. If the project will produce cash inflows of $60,000 for the next 12 years, what is the initial outlay for the project if the appropriate discount rate is 5 per cent? (Round to the nearest $10.)

A) $450,670
B) $627,520
C) $1,016,950
D) none of the above