Question 1

Evaluate the following statement: If a project fails to break even from a pretax operating cash flow perspective, then the firm is going to put more cash into the project to keep it going.

Accepted Answer

True

Question 2

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

Accepted Answer

False

Question 3

EBITDA is more sensitive to changes in revenue than EBIT.

Accepted Answer

EBITDA is less sensitive to changes in revenue than EBIT because it excludes depreciation and amortization, which are non-cash expenses that can vary significantly with changes in revenue.

Question 4

Evaluate the following statement: If The Tower of Pizza has a cash flow degree of operating leverage equal to 1.15, then a 20 percent increase in revenue should drive a 35 percent increase in pretax operating cash flow.

Accepted Answer

A cash flow degree of operating leverage (DOL) of 1.15 means that a 1% increase in revenue would lead to a 1.15% increase in operating cash flow. Therefore, a 20% increase in revenue would result in a 23% (20% * 1.15) increase in pretax operating cash flow, not 35%.

Question 5

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

Accepted Answer

Since both fixed costs and pretax operating cash flows are measured on a pretax basis, taxes do not enter into the equation of operating leverage's degree of cash flow. Therefore, the statement is true.

Question 6

Depreciation and amortization can be considered a fixed cost of the firm for accounting break-even purposes.

Accepted Answer

Depreciation and amortization are non-cash expenses that represent the allocation of the cost of an asset over its useful life. Since these expenses do not vary with changes in sales volume, they can be considered fixed costs for accounting break-even purposes.

Question 7

The pretax operating cash flow (EBITDA) break-even point is the number of units that have to be sold in order to cover fixed cash expenses.

Accepted Answer

The pretax operating cash flow (EBITDA) break-even point is indeed the number of units that must be sold to cover fixed cash expenses, making statement A true.

Question 8

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.

Accepted Answer

A project with a higher proportion of fixed costs will have a higher breakeven point, meaning it will require a higher level of revenue to cover the fixed costs and start generating profits. Therefore, any increase or decrease in revenue will have a greater impact on the project's cash flows and accounting profits compared to a project with lower fixed costs.

Question 9

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

Accepted Answer

Operating leverage is the degree to which a company uses fixed costs in its cost structure. So, if a project's costs become more fixed, the company's fixed costs will be higher and therefore, the degree of operating leverage will increase. This means that a small change in sales can result in a large change in profits.

Question 10

A synonym for pretax operating cash flow is EBIT.

Accepted Answer

Pretax operating cash flow refers to the cash generated by a company's operations before taxes, while EBIT (Earnings Before Interest and Taxes) is a measure of a firm's profit that includes all expenses except interest and income tax expenses. EBIT does not directly measure cash flow.

Question 11

Evaluate the following statement: A firm that has zero fixed costs will have a degree of cash flow operating leverage equal to one.

Accepted Answer

A firm with zero fixed costs will have its cash flow operating leverage equal to one because operating leverage is a measure of how revenue growth translates into growth in operating income, and without fixed costs, any change in sales directly changes operating income at the same rate.

Question 12

Evaluate the following statement: Operating profits and operating cash flow describe the same item.

Accepted Answer

Operating profits and operating cash flow are not the same item. Operating profits refer to the profit generated by a company's operations, while operating cash flow refers to the cash generated or used by a company's operations. While they may be related, they are two distinct measures used to assess a company's financial performance.

Question 13

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

Accepted Answer

Total variable costs are costs that vary with the level of output, meaning they do vary directly with the number of units sold. Therefore, the statement is false.

Question 14

Evaluate the following statement: If there is no uncertainty regarding costs, volatility in pretax operating cash flows and accounting operating profits will be driven entirely by changes in revenue and operating leverage.

Accepted Answer

If there is no uncertainty regarding costs, the costs will remain constant and will not contribute to changes in the pretax operating cash flows and accounting operating profits. Therefore, any changes in revenue and operating leverage would be the only factors driving volatility in these measures.

Question 15

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

Accepted Answer

By understanding which costs are fixed and which are variable, one can calculate the contribution margin (revenue minus variable costs) and determine the breakeven point. This allows one to analyze the impact of changes in revenue on EBITDA (earnings before interest, taxes, depreciation, and amortization) and overall profitability.

Question 16

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

Accepted Answer

The answer of The per-unit contribution margin is defined as...

Question 17

If a firm's degree of accounting operating leverage is 1.12, then a 10 percent increase in revenue should result in a 12.0 percent increase in EBIT.

Accepted Answer

The degree of operating leverage (DOL) measures the percentage change in EBIT (earnings before interest and taxes) for a given percentage change in sales. If the DOL is 1.12, a 10 percent increase in sales would result in a 1.12 * 10% = 11.2% increase in EBIT, not 12.0%.

Question 18

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

Accepted Answer

The degree of pretax cash flow operating leverage is a measure of how much operating cash flow changes with a change in revenue. As revenue increases, fixed costs remain constant, and operating leverage increases, which means the degree of pretax cash flow operating leverage will change for different levels of revenue. Therefore, option A is correct.

Question 19

Evaluate the following statement: Break-even analysis tells us how many units must be sold in order for a project to break even on a cash flow or an accounting basis.

Accepted Answer

Break-even analysis is a financial tool that helps to determine the minimum level of sales required to cover all the costs of a project, including both fixed and variable costs. It also indicates how many units must be sold to achieve the break-even point. Therefore, the given statement is true, as break-even analysis provides information on the number of units required to break even on both a cash flow and accounting basis.

Question 20

Evaluate the following statement: Tunemony Craft has a degree of accounting operating leverage of 1.2. If EBIT increases 24 percent, then the firm must have had a 20 percent increase in revenue if no other changes were involved.

Accepted Answer

The degree of accounting operating leverage (DOL) is calculated as the percentage change in EBIT divided by the percentage change in revenue. If DOL is 1.2 and EBIT increases by 24%, then the percentage change in revenue is 24% / 1.2 = 20%.

Quiz 12: Evaluating Project Economics