Deck 10: Project Analysis

Question 1

A capital budget shows a proposed list of investments.

Answer 1

True

Question 2

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

Answer 2

False

Question 3

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

Answer 3

False

Question 4

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

Question 5

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

Question 6

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

Question 7

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

Question 8

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

Question 9

If a large proportion of a firm's costs is fixed,a shortfall in sales will have a magnified effect on the firm's profits.

Question 10

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

Question 11

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

Question 12

What-if analysis is not crucial to capital budgeting.

Question 13

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 14

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

Question 15

The level of sales that produces a zero project NPV is referred to as the accounting break-even point.

Question 16

Sensitivity analysis takes into consideration the interrelationship of variables.

Question 17

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

Question 18

Operating leverage increases with fixed cost.

Question 19

A firm that employs largely agency staff is likely to have higher operating leverage than one that employs its staff on long-term contracts.

Question 20

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

Question 21

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

Question 22

Which company is likely to have high operating leverage?

A) A company with high fixed costs.
B) A company with high variable costs.
C) A company with low fixed costs.
D) A company financed largely by debt

Question 23

Which one 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 24

The purpose of sensitivity analysis is to show:

A) the optimal level of capital expenditures.
B) how price changes affect break-even volume.
C) seasonal variation in product demand.
D) how variables in a project affect profitability.

Question 25

Which one 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) It can guarantee a project's success.

Question 26

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 27

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 the proper incentives.
D) testing for interrelated variables.

Question 28

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

A) reduces a firm's taxes.
B) weeds out proposals with NPVs that have been overstated.
C) allows managers to select their favorite projects.
D) lowers the cost of capital.

Question 29

Which one of the following capital budgeting proposals is most apt to be associated with 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 30

Analysis indicates that a project's level of success is primarily dependent upon the firm controlling the variable costs.What type of analysis was conducted?

A) Sensitivity analysis
B) Break-even analysis
C) Ratio analysis
D) Real option analysis

Question 31

Which one 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 32

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

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

Question 33

Sensitivity analysis:

A) makes most sense when variables are interrelated.
B) gives an idea of the combined effect of pessimistic outcomes.
C) allows the manager to weight the various outcomes to provide a better estimate of NPV.
D) forces the manager to identify the underlying factors.

Question 34

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 35

If a 20% reduction in a project's forecast sales would still result in a positive NPV,then sensitivity analysis would suggest:

A) that there is little point in further market research.
B) that a more detailed sales forecast is required.
C) that the initial sales forecasts were inflated.
D) that more of the company's overhead costs can be allocated to this product.

Question 36

Which one of the following would not be included as a traditional capital budgeting project?

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

Question 37

What is the change in the NPV of a one-year project if fixed costs are increased from $400 to $600,assuming the firm is profitable,has a 35% tax rate,and a 12% cost of capital?

A) −$200.00
B) −$178.57
C) −$130.00
D) −$116.07

Question 38

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 39

What happens to the NPV of a two-year project if sales less costs are increased in each year from $1,000 to $1,500? Assume the firm has a 35% tax rate,and a 15% cost of capital.

A) NPV increases by $812.85.
B) NPV increases by $528.36.
C) NPV increases by $500.00.
D) NPV increases by $282.61.

Question 40

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

Question 41

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

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

Question 42

Which one 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 43

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

A) project will break even 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 44

Calculate the NPV break-even level of sales for a project requiring an investment of $3 million and providing annual cash flows equal to 15% of sales less $250,000.None of the initial investment is recoverable.Assume the project will generate these cash flows for 10 years and the discount rate is 10%.

A) $3,254,890
B) $3,504,890
C) $4,921,575
D) $1,686,667

Question 45

Assume a 5-year project has a base-case NPV of $213,000,a tax rate of 34%,and a cost of capital of 14%.What will be the worst-case NPV if the annual after-tax cash flows are reduced in that scenario by $35,000 for each of the 5 years?

A) −$92,842.17
B) −$120,157.83
C) $92,842.17
D) $120,157.83

Question 46

A firm has fixed costs of $1.2 million and depreciation of $1 million.Variable costs are 64% of sales.What is the accounting break-even level of sales?

A) $5.23 million
B) $3.44 million
C) $6.11 million
D) $4.87 million

Question 47

Which one of the following changes might 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 48

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 49

If project sales exceed the accounting break-even point,but the project has a negative EVA,then 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 but negative NPV.

Question 50

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

A) Sales
B) Depreciation
C) Labor cost
D) Food cost

Question 51

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

A) zero pretax profit.
B) zero net present value.
C) covered all opportunity costs.
D) covered the fixed and variable costs but not the depreciation.

Question 52

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

A) 40%
B) 45%
C) 55%
D) 60%

Question 53

The Corner Market has fixed costs of $1,600,depreciation of $1,200,a tax rate of 35%,and a cost of capital of 12%.Variable costs represent 67% of sales.What minimum level of sales must the market obtain to avoid a net loss on its income statement?

A) $8,484.85
B) $6,666.67
C) $7,033.33
D) $7,867.67

Question 54

A 6-year project has a zero NPV with sales of $5 million and a discount rate of 8%.The annual cash inflows are equal to 10% of sales minus $300,000.What was the initial investment in the project assuming that none of the investment is recoverable when the project ends?

A) $416,667
B) $924,576
C) $1,016,678
D) $2,311,450

Question 55

A firm with 60% of sales going to variable costs,$1.5 million fixed costs,and $500,000 depreciation and sales of $3 million.How does the current level of sales compare to the accounting break-even sales level?

A) Current sales are $2 million below the break-even level.
B) Current sales are $333,333 below the break-even level.
C) Current sales are $800,000 below the break-even level.
D) Current sales exceed the break-even level by $360,000.

Question 56

Weston's has variable costs that average 68% of sales.If fixed costs increase by $1,what will be the increase in the break-even level of revenues?

A) An increase of $0.68
B) An increase of $1.00
C) An increase of $1.471
D) An increase of $3.125

Question 57

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) sales are equal to the sum of fixed costs, variable costs, and depreciation.

Question 58

Which statement is not correct?

A) project proposers tend to be overconfident about the likely success of the project.
B) project proposers often exaggerate the likely profitability in order to gain acceptance.
C) overconfidence and enthusiasm can result in increased effort.
D) most project proposals are based on very conservative forecasts.

Question 59

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

A) negative NPV.
B) positive NPV.
C) high degree of operating leverage.
D) downturn in the business cycle.

Question 60

Calculate the accounting break-even level of sales assuming $865,000 of fixed costs,$400,000 depreciation expense,and a variable costs-to-sales ratio of 65%.

A) $2,769,230.77
B) $3,614,285.71
C) $4,237,769.23
D) $1,946.153.85

Question 61

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

A) consideration of the opportunity cost of capital.
B) consideration of interest expense.
C) allowance of the sales level to vary in response to changes in demand.
D) inclusion of income taxes.

Question 62

Fixed costs including depreciation have increased at Leverage Inc.,from $4 million to $5.3 million.Suppose that the company now breaks even on an accounting basis with sales of $20 million.What must be the break-even variable cost as a percentage of sales?

A) 69.2%
B) 65.8%
C) 73.5%
D) 76.7%

Question 63

Decision trees:

A) are an alternative to NPV analysis.
B) recognize that managers may need to react to unexpected future events.
C) are a way to adjust the discount rate to allow for uncertainty.
D) lay out the different steps in preparing the capital budget.

Question 64

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

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

Question 65

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

A) future production will be profitable.
B) the outlook for the business is very assured.
C) the future is very uncertain.
D) today's production costs are lower than in the future.

Question 66

A project offers a 30% probability of a payoff after one year of $2 million and a 70% chance of a payoff of $1 million.What is the maximum you would invest in this project today if the discount rate is 10%?

A) $818,181.82
B) $1,181,818.18
C) $1,300,000.00
D) $1,430,000.00

Question 67

If MacCaugh's pilot project is successful,it will be able to build a plant with an NPV of $2 million in 1 year's time.Otherwise the pilot investment will be valueless.If the discount rate is 20% and the chances of success are 50%,how much can MacCaugh afford to spend on the pilot project?

A) $1 million.
B) $2 million.
C) $1.667 million.
D) $833,333.

Question 68

A project that has zero economic value added:

A) has a positive NPV.
B) has an NPV of zero.
C) has a negative NPV.
D) is at the accounting break-even point.

Question 69

If the firm's degree of operating leverage is 4.5,what percentage change in sales will result in a 3% rise in profits?

A) 0.33%
B) 0.67%
C) 3.03%
D) 1.50%

Question 70

Fixed costs:

A) are a constant percentage of sales revenues.
B) vary with the level of depreciation expense.
C) are constant regardless of the level of output.
D) are inversely related to the level of output.

Question 71

Which one of these projects would you always reject?

A) High operating leverage, sales projected at the accounting break-even level, and no option to abandon or expand.
B) High operating leverage, sales projected at the NPV break-even level, and an option to abandon or expand.
C) Low operating leverage, sales projected at the accounting break-even level, and an option to abandon or expand.
D) Low operating leverage, sales projected at the NPV break-even level, and an option to abandon or expand.

Question 72

If a firm's DOL is 3.6 with a profit of $2,000,000 and depreciation of $500,000,what are its other fixed costs?

A) $5,250,000
B) $4,700,000
C) $5,520,000
D) $5,800,000

Question 73

The branches on a decision tree

A) illustrate possible combinations of fixed and variable costs.
B) are a convenient way to illustrate the results of a sensitivity analysis.
C) show possible project break-even points.
D) show possible management decisions and possible uncertain consequences.

Question 74

A firm with $800,000 of fixed costs including $200,000 of 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

Question 75

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

A) increase pretax profits by 3.5%.
B) decrease pretax profits by 3.5%.
C) increase pretax profits by 21.0%.
D) increase pretax profits by 1.71%.

Question 76

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 particularly well when sales are high.

Question 77

If the proportion of fixed costs increases:

A) DOL falls.
B) DOL rises.
C) the NPVbreakeven level of sales declines.
D) the NPV of the cash flows declines.

Question 78

A firm with a DOL of 4.5 generates pretax profits of $1 million.If depreciation expense is $600,000,what are its other fixed costs?

A) $1.1 million
B) $2.1 million
C) $2.9 million
D) $3.9 million

Question 79

If a firm doubled its level of fixed costs but maintained its operating leverage,then one explanation may be that:

A) depreciation expense increased to offset the increase.
B) sales revenue also doubled and the proportion of variable costs did not change.
C) sales revenues declined and the proportion of variable costs doubled.
D) pretax profits decreased.

Question 80

If the firm's degree of operating leverage is 3.8,what percentage change in sales will result in a 13.8% fall in profits?

A) 0.28%
B) −2.75%
C) −3.63%
D) 10.00%