Deck 14: Differential Analysis, Profitability Analysis and Capital Budgeting

Question 1

The purpose of incremental analysis is to find the alternative:

A) with the lowest fixed costs.
B) that brings in the most income.
C) with the least direct costs.
D) that contributes the most to profit.

Answer 1

D

Question 2

Petnet Corporation purchased capital equipment two years ago for $50 000. The firm is considering selling the equipment outright for $20 000 or, alternatively, trading it in on new equipment for an allowance of $24 000 The sunk cost associated with the equipment is:

A) $20 000.
B) $50 000.
C) $24 000.
D) $26 000.

Answer 2

B

Question 3

Which of these is not relevant in the evaluation of a make-or-buy decision?

A) Quality control
B) Alternative uses of the unused capacity
C) Unavoidable costs
D) Potential adverse effects on business relationships

Answer 3

C

Question 4

Sunk costs are omitted from decision analysis:

A) sometimes.
B) only if immaterial.
C) always.
D) never.

Question 5

A sunk cost is a:

A) cost that cannot be changed and is therefore not relevant to decision making.
B) fixed cost.
C) cost which may be saved by not adopting an alternative.
D) potential benefit forgone.

Question 6

A cost which differs between alternative courses of action is a:

A) relevant cost.
B) sunk cost.
C) controllable cost.
D) non-joint cost.

Question 7

List the following steps in the decision-making process in the order in which they are carried out.
I Gather information
II Evaluate the alternatives
III Define the problem
IV Choose a course of action

A) I, III, II, IV
B) III, II, I, IV
C) III, I, II, IV
D) IV, III, I, II

Question 8

The term incremental cost refers to:

A) the difference in total costs between alternatives.
B) the operating profit forgone by selecting one choice instead of another.
C) a cost that continues to be incurred even though there is no activity.
D) a cost that is directly traceable to a specific cost object.

Question 9

The point in the production process at which joint products become separate products is called the:

A) constraint point.
B) split-off point.
C) differential point.
D) acceptance point.

Question 10

Which of these is irrelevant in the evaluation of a special order?

A) Differential income
B) Differential cost
C) Average production cost
D) Idle capacity

Question 11

In relation to joint products the objective of the sell or process further decision is to:

A) maximise profit.
B) maximise production.
C) maximise joint costs.
D) minimise processing.

Question 12

A) $800.
B) $2400.
C) $4800.
D) $15 200.

Question 13

In differential analysis irrelevant costs include costs that are:

A) avoidable.
B) different among alternatives.
C) sunk.
D) opportunity costs.

Question 14

If a firm has limited production capacity in one part of a sequential production operation, it can maximise profits by producing those items having the highest:

A) selling price.
B) profit.
C) contribution margin per unit of the scarce resource.
D) gross profit.

Question 15

The decision to further process a joint product is influenced by the:

A) amount of fixed overhead which has been absorbed by the product.
B) amount of costs already incurred for the product.
C) increased costs of further processing.
D) method used to allocate joint costs.

Question 16

The decision to process a joint product further is influenced by:

A) common costs allocated to the product.
B) the costs of further processing.
C) the amount of fixed overhead which has been absorbed by the product.
D) the amount of costs already incurred for the product.

Question 17

Top managers of Arctic Cruises are alarmed at the firm's latest income statement which shows a continuing decline in profits. In approaching this situation what is the first step management should take?

A) Make key personnel changes in the marketing department.
B) Do a better job of scheduling entertainment on the ships.
C) Train the ships employees in more courteous behaviour to customers.
D) Define the problem with an emphasis on the objective to be accomplished.

Question 18

A) $21
B) $25
C) $27
D) $28.50

Question 19

In incremental analysis estimated future costs that differ between alternative courses of action are called:

A) relevant costs.
B) absorption costs.
C) variable overhead costs.
D) joint costs.

Question 20

The difference in total costs between two alternatives is referred to as the:

A) direct cost.
B) incremental cost.
C) opportunity cost.
D) sunk cost.

Question 21

Using the following information, calculate the residual profit.
Sales $500 000
Profit 40 000
Average operating assets 180 000
Shareholders' equity 50 000
Minimum required rate of return 15%

A) $13 000
B) $25 000
C) $16 000
D) $15 000

Question 22

A) $12 200
B) $12 800
C) $17 000
D) $4400

Question 23

What amount must be deposited today at 8% p.a. to grow to $1200 in three years?

A) $400.00
B) $947.28
C) $952.56
D) $981.22

Question 24

Which of these represents the number of sales dollars generated by each dollar invested in assets?

A) Assets invested
B) Profit margin
C) Number of sales
D) Asset turnover

Question 25

Using the following information, calculate the return on investment.
Sales $100 000
Operating profit $6000
Profit margin 8%
Equity $25 000
Minimum required rate of return 10%
Turnover of assets 1.5 times p.a.

A) 10%
B) 22%
C) 8%
D) 12%

Question 26

A) $0.75
B) $0.91
C) $1.00
D) $1.06

Question 27

Discounting calculates which value of an amount to be received?

A) Present
B) Future
C) Payback
D) Historical

Question 28

What amount must be deposited today at 6% to grow to $900 in three years?

A) $405.70
B) $755.64
C) $817.22
D) $456.79

Question 29

A) $8000
B) $4400
C) $5000
D) $4000

Question 30

Capital investment proposals should be ranked in decreasing order of:

A) rate of return.
B) dollar amount required.
C) salvage value.
D) residual value expected.

Question 31

If $100 is invested at 6%, which calculation will provide the answer to how much will it grow to at the end of three years?

A) $100 x 0.9434 x 3
B) ($100 / 2.6730) x 3
C) $100 / 0.8396
D) $100 x 2.6730

Question 32

A) product b, since it has the highest contribution margin per unit.
B) product b, since it has the highest price.
C) product a, since it has the highest contribution margin per labour hour.
D) product B, since it has the lowest costs.

Question 33

Using the information provided by Tasco Sales, calculate the return on investment.
Sales $1 900 000
Operating profit 30 000
Average operating assets 600 000
Shareholders' equity 50 000
Minimum required rate of return 10%

A) 4%
B) 9%
C) 5%
D) 6%

Question 34

Which of these is not a capital investment decision?

A) Replace old equipment
B) Acquire a new company
C) Downsize the workforce
D) Add a new product line

Question 35

The time value of money concept is given consideration in long-range investment decisions by:

A) investing only in short term projects.
B) assigning greater value to more immediate cash flows.
C) assuming equal annual cash flow patterns.
D) using the payback method and at least one other method to make an evaluation.

Question 36

A manager can improve return on assets by how many of the following actions?
$\bullet$ Increasing sales
$\bullet$ Decreasing costs
$\bullet$ Decreasing assets

A) 0
B) 1
C) 2
D) 3

Question 37

Milam Company requires a 12% return on all investments. How much will the company be willing to pay for machine A if the machine will pay $8000 per year for 10 years?

A) $2576
B) $8000
C) $45 202
D) $80 000

Question 38

Which of these is not a reason why capital budgeting decisions must be carefully considered?

A) They involve large sums of money.
B) Resources are committed for long periods.
C) Cash flows must be discounted.
D) Because they are long-term there is greater risk that external conditions may alter.

Question 39

Return on investment equals:

A) profit margin x return on equity.
B) asset turnover x residual profit.
C) selling price x cost of investment.
D) profit margin x asset turnover.

Question 40

A) 12%
B) 18%
C) 25%
D) 41%

Question 41

Anton Wine Company is considering a project with annual after-tax cash flows of $4000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

A) $16 316
B) $14 556
C) $17 318
D) $13 434

Question 42

Which of the following is not a component of the cost of capital?

A) Preference shares
B) Retained earnings
C) Debt
D) Cost of sales

Question 43

An increase in the discount rate:

A) will increase present values.
B) will have no effect on net present value.
C) may either increase or decrease present values, depending on the state of the economy.
D) will reduce present values.

Question 44

Always Rite Corporation is considering a project with annual after-tax cash flows of $8000 per year for 5 years. The company's cost of capital is 5%. Using the net present value method, what is the maximum amount that the company should invest?

A) $22 985
B) $27 472
C) $34 636
D) $33 908

Question 45

Darwin Limited is considering purchasing a new asset with an initial cost of $75 000 and an estimated annual income of $20 000. Cash operating expenses are expected to be $11 500 per year. Straight-line depreciation will be used over the five-year life of the asset and salvage value of $15 000 is to be considered in computing depreciation. Assuming that the income tax rate is 30%, what is the amount of annual tax savings from depreciation? (Assume the straight-line depreciation method is used for both accounting and tax purposes.)

A) $3600
B) $4500
C) $9150
D) $12 750

Question 46

Rank these investments in order of profitability, showing the best project first.
$\bullet$ Investment A - NPV, $114 561
$\bullet$ Investment B - NPV, $145 000
$\bullet$ Investment C - NPV, $72 634
$\bullet$ Investment D - NPV, $0

A) D, C, A, B
B) D, A, B, C
C) B, A, C, D
D) B, C, A, D

Question 47

A) $1039
B) $2892
C) $4417
D) $4745

Question 48

Which of these is not an advantage of the payback method of capital budgeting?

A) It can be used to separate investments when other methods show similar returns.
B) The sooner cash is recovered the sooner it can be reinvested.
C) It looks at returns over the whole life of the investment.
D) A quick payback period reduces the risk of the investment.

Question 49

The cost of capital is the:

A) cost of borrowing from a bank.
B) cost involved in issuing new shares.
C) rate of interest on government bonds.
D) weighted average of the cost of obtaining funds in the form of debt and/or equity.

Question 50

Hot Rocks Corporation estimates that it can save $2800 a year in cash operating costs for the next ten years if it buys a special purpose machine at a cost of $11 000. No residual value is expected. The firm's minimum desired rate of return is 12%. Compute the net present value.

A) $6289.66
B) $4314.00
C) $2850.29
D) $4820.56

Question 51

The method of project selection that brings the time value of money into capital investment analysis is the:

A) accounting rate of return method.
B) net present value method.
C) payback method.
D) return on average investment method.

Question 52

The net present value method of evaluating proposed investments:

A) measures a project's time adjusted rate of return.
B) ignores cash flows beyond the payback period.
C) applies to only mutually exclusive investment proposals.
D) discounts cash flows at the minimum rate of return.

Question 53

Select the incorrect statement concerning the return on average investment method of capital budgeting.

A) It measures profit in the same way as the income statement.
B) It is easy to use.
C) It distinguishes between investments requiring an immediate payment of cash and those where payment is in the future.
D) It considers profits over the useful life of the investment.

Question 54

Lamb Ltd is evaluating an investment proposal using the payback method. Cash inflows are expected to be $3000 in year 1, $3500 in year 2, $5000 in year 3, and $4500 in year 4. The initial investment required is $7000. Assuming even cash inflows within each year what is the payback period?

A) 1.8 years
B) 2.1 years
C) 2.3 years
D) 3.1 years

Question 55

An investment will return net after-tax cash inflows of $5000 per year for 5 years. The desired rate of return is 10%. What is the total present value of the future cash flows?

A) $12 622
B) $10 891
C) $18 954
D) $13 923

Question 56

Ignoring tax effects which item is not relevant to capital investment?

A) Cost savings
B) Net income
C) Disposal value
D) Depreciation

Question 57

Which of the following is irrelevant to capital investment analysis?

A) Residual value
B) Carrying value
C) Net cash flows
D) Investment cost

Question 58

Rank these investments in order payback period showing the best project first.
$\bullet$ Investment A - 4.7 years
$\bullet$ Investment B - 3.8 years
$\bullet$ Investment C - 4 years
$\bullet$ Investment D - 3.2 years

A) D, C, A, B
B) D, B, C, A
C) B, A, C, D
D) A, C, B, D

Question 59

Which item is a non-cash expense?

A) Depreciation
B) Salaries
C) Rates
D) Income taxes

Question 60

How does depreciation affect net cash flows?

A) Increases taxation payable
B) Reduces taxation payable
C) Reduces cash inflows
D) Increases cash outflows

Question 61

A piece of equipment costing $108 000 is expected to generate $16 000 annually in cash inflows during its life of 6 years. The payback in years is:

A) 6.25 years.
B) 6.75 years.
C) 9.60 years.
D) 2.34 years.

Question 62

Which statement concerning the internal rate of return method of capital budgeting is true?

A) The interest rate that will discount future cash flows so that their present value is exactly equal to the cost of the investment is the cost of capital.
B) When the internal rate of return method is employed a direct relationship will exist between the interest rate chosen and the present value of future cash flows.
C) When the net present value is equal to zero, the cost of capital (discount rate) and the internal rate of return are equal.
D) The internal rate of return is the discount rate that will produce a positive net present value for the investment.

Question 63

Which of these is not true for the payback method of investment analysis?

A) It does not consider the time value of money.
B) It does not consider project profitability.
C) It is relatively simple to calculate.
D) The longer the payback period the better.

Question 64

Equipment A costing $80 000 is expected to generate $12 000 annually in cash inflows during its life of 8 years. Equipment B costing $120 000 is expected to generate $17 000 annually in cash inflows during its life of 8 years. Equipment C costing $60 000 is expected to generate $8000 annually in cash inflows during its life of 9 years. Rank the three investments in terms of payback period.

A) A1, B2, C3
B) B1, A2, C3
C) A1, B2, C3
D) C1, A2, B3

Question 65

Aston Advertising is considering the purchase of a special purpose machine for $22 000. It is expected to have a useful life of ten years with no salvage value. The firm's accountant estimates savings in cash operating costs of $5000 per year. Compute the pay-back period.

A) 4.6 years
B) 4.4 years
C) 6.2 years
D) 5.6 years