Question 1

Jackie Corp. is considering investing $10 million in a project. It expects to receive net inflows for the project as follows: $3 million each in years 1 and 2; $2 million each in years 3 and 4; and $1 million each in years 5, 6, and 7. The payback period for this project is

Accepted Answer

The payback period is the amount of time it takes for the initial investment to be recovered from the net cash inflows of the project. To find the payback period, we need to calculate the cumulative net cash inflows from the project.

Year 1: $3 million
Year 2: $3 million + $3 million = $6 million
Year 3: $6 million + $2 million = $8 million
Year 4: $8 million + $2 million = $10 million
Year 5: $10 million + $1 million = $11 million
Year 6: $11 million + $1 million = $12 million
Year 7: $12 million + $1 million = $13 million

The payback period is the point at which the cumulative net cash inflows equal the initial investment of $10 million. This occurs between year 3 and year 4, so we need to calculate the fraction of year 4 that is required to reach the payback point.

Payback period = 3 + ($10 million - $8 million) / $2 million = 4 years

Therefore, the best choice is C.

Question 2

Tony Corp. plans to invest $1 million in a project. It expects to sell the project at the end of three years, for proceeds equal to approximately $1,158,000. Which of the following is closest to the internal rate of return?

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. In this case, the formula to find the IRR for a single investment followed by a single return is: $1,000,000 * (1 + IRR)^3 = $1,158,000. Solving for IRR gives an approximate rate of 0.05 or 5%, making option B the closest choice.

Question 3

The Gregor Corp. is considering making an investment of $100 million. It expects that at the end of two years, it will sell the investment for $121 million. There will be no other inflows or outflows. The internal rate of return on this investment would be

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. In this case, the IRR is the rate $r$ that satisfies the equation $100 = \frac{121}{(1 + r)^2}$. Solving for $r$ gives an IRR of 0.1, or 10%, not the absolute dollar amounts or the simple division of profit over years.

Question 4

The Neils Corp. is considering making an investment in a project of $10,000,000. It expects to receive six payments of $2,500,000 each. Its discount rate is 6%. A table shows that the present value of an annuity of six payments of $1 each, at 6%, has a value of 4.91732. The net present value of this investment opportunity is approximately

Accepted Answer

The net present value (NPV) is calculated by subtracting the initial investment from the present value of the cash inflows. The present value of the cash inflows is found by multiplying the annuity factor (4.91732) by the annual cash inflow ($2,500,000), which equals $12,293,300. Subtracting the initial investment ($10,000,000) from this amount gives an NPV of approximately $2,293,300.

Question 5

The Gideon Corp. is considering making an investment in a project of $1,000,000. It expects to receive five payments of $300,000 each. Its discount rate is 8%. A table shows that the present value of an annuity of five payments of $1 each, at 8%, has a value of 4.1002. The net present value of this investment opportunity is approximately

Accepted Answer

The net present value (NPV) is calculated by subtracting the initial investment from the present value of the cash inflows. The present value of the cash inflows is $300,000 * 4.1002 = $1,230,060. Subtracting the initial investment of $1,000,000 from this gives an NPV of approximately $230,060.

Question 6

A likely advantage of a top-down budgetary process (compared to a participatory budget process) is

Accepted Answer

A top-down budgetary process is characterized by the centralization of budget decisions. This means that budgets are determined by upper-level management and then imposed on lower-level managers. Such a process is less participatory, and lower-level managers have little or no input into the budgeting process. As a result, they may be less likely to indulge in budgetary slack, which is the practice of building slack or cushion into the budget to protect managers from the uncertainties of the budgeting environment. Top-down budgeting may thus result in lower budgetary slack, which is an advantage of this process.

Question 7

Factors that may affect the appropriate discount rate to use for determining the net present value of a capital investment project include

Accepted Answer

All of the factors listed (i.e., the riskiness of the investment, expectations of inflation, and market rates of interest) can have an impact on the appropriate discount rate to be used for determining the net present value of a capital investment project. The riskier the investment, the higher the discount rate should be to account for the higher risk premium demanded by investors. Expectations of inflation can also impact the discount rate because investors may demand a higher rate of return to compensate for the loss of purchasing power caused by inflation. Finally, market rates of interest can also impact the discount rate, as changes in interest rates can impact the cost of capital and the required rate of return for investors.

Question 8

The payback period method of evaluating capital investments explicitly considers the time value of money.

Accepted Answer

The payback period method focuses on how quickly an investment can be recouped through cash inflows and does not take into account the time value of money.

Question 9

In general, when fixed operating costs become a larger percentage of a company's operating costs, operating leverage increases.

Accepted Answer

This is because a higher percentage of fixed costs means that any increase in sales or revenue will result in a larger increase in profits, due to the fact that the fixed costs remain the same. This creates higher operating leverage, which can amplify the effect of changes in sales volume on a company's profits.

Question 10

One implication of cost-volume-profit analysis is that companies with higher per-unit contribution margins will have higher break-even points.

Accepted Answer

Companies with higher per-unit contribution margins will have lower break-even points. This is because a higher contribution margin means that more revenue is available to cover fixed costs, resulting in a lower level of sales required to break even.

Question 11

One implication of cost-volume-profit analysis is that companies with lower fixed costs have lower break-even points.

Accepted Answer

Cost-volume-profit analysis shows the relationship between a company's fixed costs, variable costs, selling price, and sales volume. The break-even point is the point at which total revenue equals total costs (fixed costs plus variable costs). The lower the fixed costs, the lower the break-even point, as the company does not need to sell as much in order to cover its fixed costs.

Question 12

One implication of cost-volume-profit analysis is that, when companies have significant fixed costs, total profits will always change proportionately with levels of output.

Accepted Answer

While cost-volume-profit analysis does consider fixed costs and their impact on profits, it does not necessarily mean that total profits will always change proportionately with levels of output. Other factors such as changes in sales price and variable costs can also affect profits.

Question 13

One assumption of "cost-volume-profit" analysis is that costs are either fixed or proportional within some relevant range of production.

Accepted Answer

Cost-volume-profit analysis assumes that costs can be categorized as either fixed or variable, and that within a certain range of production, variable costs are directly proportional to the level of production.

Question 14

The level of production at which costs exactly equal revenues is called the "break-even point."

Accepted Answer

The statement is correct. The break-even point is the level of production at which a company's costs (fixed and variable) are equal to its revenue.

Question 15

If the Henry Corp. produced 4,000,000 units this year, at a variable cost of $4 per unit and with fixed costs of $1,000,000, and sold all 4,000,000 items at $5 each, its total contribution margin for the year would equal $3,000,000.

Accepted Answer

The calculation for total contribution margin is incorrect. The contribution margin per unit would be $1 ($5 selling price - $4 variable cost) and the total contribution margin would be 4,000,000 units x $1 = $4,000,000. To calculate the net income, the fixed costs ($1,000,000) would need to be subtracted from the total contribution margin, resulting in a net income of $3,000,000.

Question 16

If the Gu Corp. produced 3,000,000 units this year, at a variable cost of $3 per unit and with fixed costs of $1,000,000, and sold all 3,000,000 items at $5 each, its total contribution margin for the year would equal $6,000,000.

Accepted Answer

Contribution Margin = Sales - Variable Costs. 
Sales = 3,000,000 x $5 = $15,000,000 
Variable Costs = 3,000,000 x $3 = $9,000,000 
Contribution Margin = $15,000,000 - $9,000,000 = $6,000,000

Question 17

The "unit contribution margin" equals the selling price per unit minus the per-unit variable costs.

Accepted Answer

This is a correct definition of the unit contribution margin.

Question 18

The high-low estimation method of determining costs works well, even if the low production day was one that was affected by non-typical events.

Accepted Answer

The high-low estimation method assumes a linear relationship between cost and activity levels, and using data from a non-typical day can distort the analysis, leading to inaccurate cost estimations.

Question 19

One potential problem in using regression analysis to find the relation between inputs and costs is that extreme observations can produce misleading regression results.

Accepted Answer

Extreme observations, also known as outliers, can have a disproportionate effect on the regression line and produce inaccurate results. Therefore, it is important to identify and address outliers in the data before conducting regression analysis.

Question 20

In general, when a company has high operating leverage, and its sales increase, profits increase proportionally faster than sales.

Accepted Answer

This is because high operating leverage means that a large portion of the company's expenses are fixed costs. As sales increase, the same amount of fixed costs are spread over a larger revenue base, resulting in higher profits.

Quiz 5: Accounting for Inventory