Question 1

Depreciation and amortisation are treated like fixed costs

Accepted Answer

Depreciation and amortization are non-cash expenses and are treated like fixed costs in the calculation of the degree of pretax cash flow operating leverage because they do not vary with the level of production or sales.

Question 2

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

Accepted Answer

Gilligan's analysis involves changing one specific variable (the price) to see how it affects the NPV. This is an example of sensitivity analysis, which examines how changes in one variable impact outcomes. Monte Carlo simulation involves creating multiple scenarios with different variables, and scenario analysis involves examining specific combinations of variables. Therefore, neither A nor B are the best choices for this situation.

Question 3

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,

Accepted Answer

Simulation analysis is a computer-based method of estimating the probabilities of different outcomes based on a range of potential inputs or scenarios. In business, simulation analysis can be used to evaluate the potential outcomes of different business strategies, transactions, or investments, and can help companies make more informed decisions by providing a clearer understanding of the risks and uncertainties surrounding different options. As part of this process, a computer program can be used to simulate the potential outcomes of different scenarios, including estimates of sales values, revenue, costs, profits, and other performance metrics.

Question 4

The degree of pretax cash flow operating leverage provides us with

Accepted Answer

The degree of pretax cash flow operating leverage measures the sensitivity of pretax operating cash flows to changes in revenue, indicating how much a company's cash flow will increase or decrease given a change in revenue. Therefore, the correct answer is A.

Question 5

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

Accepted Answer

Operating leverage is the measure of how much fixed costs a business has. The higher the fixed costs, the higher the operating leverage. When a business has a high operating leverage, it means that a small increase in revenue can lead to a much larger increase in EBITDA or EBIT. On the other hand, a small decrease in revenue can lead to a much larger decrease in EBITDA or EBIT. This makes operating leverage an important measure for businesses to consider as they plan their operations and financial strategies.

Question 6

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.

Accepted Answer

A sensitivity analysis is a tool used to determine how changes in one variable will affect the outcome of a project or investment decision. In this case, the company is interested in determining the effect of a price change on the NPV of the project, while holding all other variables and forecasts constant. This is a common type of sensitivity analysis that can help companies make better-informed decisions about pricing strategies and the potential profitability of their projects.

Question 7

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

Accepted Answer

The EBIT break-even point represents the level of sales necessary to cover all fixed and variable costs and to generate a profit of zero, or to avoid an accounting operating loss.

Question 8

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

Accepted Answer

When operating in an environment with high variability in revenue, it is important to have a cost structure with low fixed costs and higher per unit variable costs. This allows the company to adjust costs more easily according to changes in revenue. Having high fixed costs would make it harder for the company to adapt to changes in revenue and could lead to financial difficulties if revenue decreases. Therefore, option C is the best choice.

Question 9

Revenue minus variable and fixed costs best describes

Accepted Answer

The answer of Revenue minus variable and fixed costs best...

Question 10

Another name for EBITDA is

Accepted Answer

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is a measure of a company's operating performance and cash flow before accounting for financing and accounting decisions. Therefore, it is equivalent to pretax operating cash flow.

Question 11

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

Accepted Answer

The crossover level of unit sales is calculated to compare two alternatives, focusing on their fixed and variable costs, not specifically on their operating leverage. Operating leverage can influence the analysis, but the key is comparing fixed and variable costs to find where the total costs of both alternatives are equal.

Question 12

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.

Accepted Answer

This statement describes the concept of the cross-over point, which is where two production cost options have equal operating cash flows. Beyond this point, the option with the lower costs will generate higher cash flows.

Question 13

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.

Accepted Answer

The accounting operating profit break-even point includes only the fixed costs and variable costs, while ignoring any non-cash expenses such as depreciation. On the other hand, the pretax operating cash flow break-even point takes into account all cash flows, including non-cash expenses. Therefore, the pretax operating cash flow break-even point is generally smaller than the accounting operating profit break-even point.

Question 14

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.

Accepted Answer

Scenario analysis takes into consideration multiple variables and evaluates how they might change based on different scenarios, while sensitivity analysis only examines the impact of changes in one variable at a time. Therefore, if a price change will affect multiple variables, scenario analysis would be more appropriate.

Question 15

A company with a higher proportion of fixed costs will create

Accepted Answer

A higher proportion of fixed costs means that a larger portion of the company's expenses are not affected by changes in revenue. This, in turn, creates a higher degree of sensitivity of EBITDA (earnings before interest, taxes, depreciation, and amortization) to a change in revenues. In other words, small changes in revenue can have a significant impact on EBITDA because the fixed costs remain the same.

Question 16

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.

Accepted Answer

In a capital rationing situation, the company has limited resources and needs to prioritize investments that generate the highest returns for shareholders. Identifying the combination of positive-NPV projects that adds the most value to the company is essential in maximizing shareholder wealth.

Question 17

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

Accepted Answer

The degree of accounting leverage measures the sensitivity of a company's earnings before interest and taxes (EBIT) to changes in revenue. A degree of accounting leverage of 1.3 means that for every 1% increase in revenue, EBIT should increase by 1.3%.

Therefore, a 10% increase in revenue should drive a 13% increase in EBIT (10% x 1.3). Therefore, option B is the correct choice.

Question 18

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.

Accepted Answer

The process described is actually capital budgeting, not capital asset pricing. Capital asset pricing is a financial model used to determine the expected return of an investment based on market risk and the risk-free rate of return.

Question 19

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

Accepted Answer

Sensitivity analysis is a technique used to examine the potential impact of changes in one variable on the outcomes of a model or decision. In this case, the company wants to know how a change in a single input affects the net present value of a project. Sensitivity analysis can provide insights into how sensitive the project's net present value is to changes in that input variable. Monte Carlo simulation and scenario analysis are more appropriate when examining the impact of changes in multiple variables, rather than a single input change.

Question 20

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

Accepted Answer

Simulation analysis provides a range of possible outcomes and their probabilities, but it does not give a pinpoint accurate forecast of a project's NPV. The accuracy of the forecast depends on the accuracy of the input assumptions and models used in the simulation.

Quiz 12: Evaluating Project Economics and Capital Rationing