Question 1

Bordeaux Company has three product lines one of which reflects the following results: $\begin{array}{lr}
\text { Sales } & \$ 215,000 \
\text { Variable expenses } & 125,000 \
\text { Contribution margin } & 90,000 \
\text { Fixed expenses } & 150,000 \
\text { Net loss } & \$(60,000)
\end{array}$ If this product line is eliminated 50% of the fixed expenses can be eliminated and the other 50% will be allocated to other product lines. If management decides to eliminate this product line the company's net income will

Accepted Answer

Eliminating the product line removes its contribution margin of $90,000 but also removes $75,000 of fixed expenses (50% of $150,000). The net effect is a decrease in overall net income by $15,000 ($90,000 - $75,000).

Question 2

Capital budgeting is the process

Accepted Answer

Capital budgeting is a process of making investment decisions in long-term assets i.e. capital expenditure decisions such as whether to invest in a new project, purchase new equipment, or expand existing operations. It involves analyzing future cash flows and determining the potential profitability and risks associated with each investment opportunity. Therefore, option C is the correct choice. Option A is incorrect because sell or process further decisions are related to deciding whether to sell a product or process it further, and not necessarily capital budgeting decisions. Option B is incorrect because determining how much capital stock to issue is a financing decision and not a capital budgeting decision. Option D is incorrect because eliminating unprofitable product lines is a strategy for improving profitability, but not necessarily a part of the capital budgeting process.

Question 3

Lawson Co. is considering purchasing a new machine which will cost $350000 but which will decrease costs each year by $100000. The useful life of the machine is 10 years. The machine would be depreciated straight-line with no residual value over its useful life at the rate of $35000/year. The cash payback period is

Accepted Answer

The cash payback period is the length of time it takes for the initial investment to be recovered through cash inflows. In this case, the initial investment is $350000 and the annual decrease in costs is $100000, so the cash inflow each year is $100000.

To find the cash payback period, we divide the initial investment by the annual cash inflow:

$350000 ÷ $100000/year = 3.5 years

Since the cash payback period is less than the useful life of the machine (10 years), and the machine will continue to provide cost savings beyond the payback period, it is a good investment. Therefore, the best choice is B.

Question 4

A company is considering purchasing factory equipment which costs $480000 and is estimated to have no salvage value at the end of its 8-year useful life. If the equipment is purchased annual revenues are expected to be $225000 and annual operating expenses exclusive of depreciation expense are expected to be $95000. The straight-line method of depreciation would be used. If the equipment is purchased the annual rate of return expected on this project is

Accepted Answer

The answer of A company is considering purchasing factory equipment...

Question 5

The following are all quantitative capital budgeting techniques except

Accepted Answer

The cost-volume-profit technique is not a quantitative capital budgeting technique but rather a managerial accounting tool used to analyze the relationships between costs, volume, and profits. The other options listed are all quantitative capital budgeting techniques.

Question 6

When using the payback method payback is expressed in terms of

Accepted Answer

The payback method expresses the length of time it takes to recover the initial investment, making the answer time. A and D do not accurately describe how the payback method is used. B could be a possible answer, as payback is expressed in dollars, but it is not the best choice as it doesn't fully capture the essence of the method.

Question 7

A company is considering purchasing factory equipment that costs $320000 and is estimated to have no salvage value at the end of its 8-year useful life. If the equipment is purchased annual revenues are expected to be $90000 and annual operating expenses exclusive of depreciation expense are expected to be $40000. The straight-line method of depreciation would be used. The cash payback period on the equipment is

Accepted Answer

The cash payback period is calculated by dividing the initial investment by the annual cash flow. The annual cash flow is the annual revenue minus the annual operating expenses, not including depreciation since it's a non-cash expense. Here, the annual cash flow is $90,000 - $40,000 = $50,000. The initial investment is $320,000. Therefore, the cash payback period is $320,000 / $50,000 = 6.4 years.

Question 8

If an asset cost $270000 and is expected to have a $60000 salvage value at the end of its twelve-year life and generates annual net cash inflows of $40000 each year the cash payback period is

Accepted Answer

The cash payback period is the amount of time required to recover the initial cost of an investment. To calculate the cash payback period, we need to determine how many years it will take for the total net cash inflows to equal the initial cost of the asset.

Initial cost = $270,000
Salvage value = $60,000
Total cash inflows per year = $40,000
Net cash inflows per year = $40,000 - ($270,000 - $60,000) / 12 = $13,000

To determine the cash payback period, we divide the initial cost by the net cash inflows per year:

Cash payback period = $270,000 / $13,000 = 20.77 years

Since the cash payback period is greater than the expected life of the asset (12 years), we need to adjust the calculation. We can determine the year in which the cumulative net cash inflows equal the initial cost of the asset:

Year 1: $13,000
Year 2: $13,000 x 2 = $26,000
Year 3: $13,000 x 3 = $39,000
Year 4: $13,000 x 4 = $52,000
Year 5: $13,000 x 5 = $65,000
Year 6: $13,000 x 6 = $78,000

We can see that the cumulative net cash inflows will equal the initial cost of the asset in year 6. Therefore, the cash payback period is 6 years and 9 months or 6.75 years. The best choice is C.

Question 9

A company is considering purchasing factory equipment that costs $320000 and is estimated to have no salvage value at the end of its 8-year useful life. If the equipment is purchased annual revenues are expected to be $90000 and annual operating expenses exclusive of depreciation expense are expected to be $40000. The straight-line method of depreciation would be used. If the equipment is purchased the annual rate of return expected on this equipment is

Accepted Answer

The answer of A company is considering purchasing factory equipment...

Question 10

A segment has the following data: $$\begin{array} { l r } 
\text { Sales } & \$ 350,000 \
\text { Variable expenses } & 150,000 \
\text { Fixed expenses } & 285,000
\end{array}$$ What will be the incremental effect on net income if this segment is eliminated assuming the fixed expenses will be allocated to profitable segments?

Accepted Answer

If the segment is eliminated, the company will lose the contribution margin of $200,000 (Sales $350,000 - Variable expenses $150,000), leading to a decrease in net income by $200,000. Fixed expenses will still be incurred as they are allocated to other segments.

Question 11

How is annual cash inflow determined?

Accepted Answer

Depreciation is a non-cash expense that reduces net income but does not involve an outflow of cash. Therefore, it is added back to net income to arrive at the annual cash inflow.

Question 12

The higher the rate of return for a given risk the

Accepted Answer

The higher the rate of return for a given risk, the more attractive the investment becomes. This is because investors are always looking to maximize their return while taking on an acceptable level of risk. A higher rate of return provides a better reward for the amount of risk taken on, making the investment more appealing.

Question 13

If the payback period for a project is greater than its economic life the

Accepted Answer

If the payback period for a project is greater than its economic life, it means that the project will not generate enough cash flows to recover the initial investment before it reaches the end of its economic life. This indicates that the entire initial investment will never be recovered. Therefore, choice B is the correct answer. Choices A, C, and D are incorrect because they do not represent a plausible scenario for a project with a payback period greater than its economic life.

Question 14

The annual rate of return method is based on

Accepted Answer

The annual rate of return method is based on accounting data, as it typically uses figures such as net income and investment cost derived from financial statements to calculate the return on investment over a specific period.

Question 15

A company projects an increase in net income of $180000 each year for the next five years if it invests $900000 in new equipment. The equipment has a five-year life and an estimated salvage value of $300000. What is the annual rate of return on this investment?

Accepted Answer

The annual rate of return is calculated as (Net income - Depreciation) / Initial investment. The net income is $180,000 per year, the depreciation is ($900,000 - $300,000) / 5 = $120,000 per year, and the initial investment is $900,000. Therefore, the annual rate of return is ($180,000 - $120,000) / $900,000 = 30%.

Question 16

A company is considering eliminating a product line. The fixed costs currently allocated to the product line will be allocated to other product lines upon discontinuance. If the product line is discontinued

Accepted Answer

The contribution margin of the product line (revenue minus variable costs) will indicate the net income increase or decrease upon discontinuance. If the product line's contribution margin is positive, discontinuing it would reduce net income by that amount, as the fixed costs will still be incurred and allocated to other product lines.

Question 17

What will most likely occur if a company eliminates an unprofitable segment when a portion of fixed costs are unavoidable?

Accepted Answer

Eliminating an unprofitable segment will not remove all expenses, especially if some fixed costs are unavoidable and cannot be eliminated. These fixed costs will be redistributed among the remaining segments, potentially lowering the overall net income if the eliminated segment was contributing to covering a portion of those fixed costs.

Question 18

The rate that management expects to pay on borrowed or equity funds is known as

Accepted Answer

The cost of capital is the rate that management expects to pay on borrowed or equity funds. The other options, hurdle rate and cutoff rate, are similar terms that can also be used to refer to the cost of capital, but the most commonly used term in finance is the cost of capital. Therefore, only option B is the correct answer.

Question 19

A company's cost of capital refers to the

Accepted Answer

A company's cost of capital refers to the rate management expects to pay on all borrowed and equity funds. It is the cost of funds used for financing business operations and investments.

Question 20

Which of the following is not a common method of capital budgeting?

Accepted Answer

The gross profit method is not a common method of capital budgeting. The common methods are the payback method, discounted cash flow method, and annual rate of return method.

Quiz 26: Incremental Analysis and Capital Budgeting