Question 1

Tucker's Trucking is considering a project with a discounted payback period just equal to the project's life.The projections include a sales price of $38, variable cost per unit of $18.50, and fixed costs of $32,000.The operating cash flow is $19,700.What is the break-even quantity?

Accepted Answer

Q_{financial break-even} = ($32,000 + $19,700)/($38 - $18.50) = 2,651 units

Question 2

A project has the following estimated data: price = $74 per unit; variable costs = $39.22 per unit; fixed costs = $6,500; required return = 8 percent; initial investment = $8,000; life = 4 years.Ignore the effect of taxes.What is the degree of operating leverage at the financial break-even level of output?

Accepted Answer

DOL = 1 + (6,500/$2,415.37) = 3.691

Question 3

McGilla Golf has decided to sell a new line of golf clubs.The clubs will sell for $500 per set and have a variable cost of $200 per set.The company spent $113,000 for a marketing study that determined the company will sell 58,000 sets per year for 7 years.The marketing study also determined that the company will lose sales of 15,000 sets of its high-priced clubs.The high-priced clubs sell at $700 and have variable costs of $300.The company will also increase sales of its cheap clubs by 9,000 sets.The cheap clubs sell for $200 and have variable costs of $100 per set.The fixed costs each year will be $7,559,000.The company has also spent $1,133,000 on research and development for the new clubs.The plant and equipment required will cost $21,000,000 and will be depreciated on a straight-line basis over the life of the project.The new clubs will also require an increase in net working capital of $1,053,000 that will be returned at the end of the project.The tax rate is 40 percent, and the cost of capital is 8 percent.What is the IRR?

Accepted Answer

Sales = ($500 × 58,000) + ($700 × (-15,000)) + $200 × 9,000) = $20,300,000Variable costs = (-$200 × 58,000) + (-$300 × (-15,000)) + (-$100 × 9,000) = -$8,000,000Depreciation = $21,000,000/7 = $3,000,000

Question 4

You are considering a new product launch.The project will cost $630,000, have a 5-year life, and have no salvage value; depreciation is straight-line to zero.Sales are projected at 160 units per year, price per unit will be $24,000, variable cost per unit will be $12,000, and fixed costs will be $283,000 per year.The required return is 12 percent and the relevant tax rate is 34 percent.Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within ±9 percent.What is the worst case NPV?

Accepted Answer

We can calculate the base case NPV using the given data:

CF0 = -$630,000 
CF1-5 = [160(1±0.09)($24,000-$12,000) - $283,000](1-0.34) = $104,640 - $69,505.6 = $35,134.4 
r = 12%

NPV = -$630,000 + $35,134.4(PVIFA12%,5) = -$630,000 + $144,182.6 = $-485,817.4

To calculate the worst case NPV, we need to adjust the sales, variable costs, and fixed costs projections by -9%.

Worst case NPV = -$630,000 + [$24,000(0.91) - $12,000(0.91) - $283,000](1-0.34)PVIFA12%,5 
= -$630,000 + $26,479.6(PVIFA12%,5) 
= -$630,000 + $112,734.5 
= $-517,265.5

Therefore, the worst case NPV is $-517,265.5.

Based on the worst case scenario, the project should not be pursued as it has a negative NPV. However, since the base case NPV is negative as well, the project should not be pursued regardless of the best or worst case scenario.

Question 5

A project has a unit price of $5,000, a variable cost per unit of $3,750, fixed costs of $17,000,000, and depreciation expense of $6,970,000.What is the accounting break-even quantity?

Accepted Answer

Q_{Accounting break-even} = ($17,000,000 + $6,970,000)/($5,000 - $3,750) = 19,176 units

Question 6

Cool Shades, Inc.(CSI) manufactures biotech sunglasses.The variable materials cost is $1.69 per unit, and the variable labor cost is $3.04 per unit.Suppose the firm incurs fixed costs of $750,000 during a year in which total production is 450,000 units and the selling price is $11.50 per unit.What is the cash break-even point?

Accepted Answer

To find the cash break-even point, we need to use the formula:
Total Revenue = Total cost (fixed cost + variable cost per unit)

Total Revenue = Selling price per unit x Number of units sold = $11.50 x Q
Total cost = Fixed cost + Variable cost per unit x Number of units sold = $750,000 + ($1.69 + $3.04) x Q = $750,000 + $4.73Q

Setting these two equal to each other:
$11.50Q = $750,000 + $4.73Q
$6.77Q = $750,000
Q = 110,783 units

Therefore, the cash break-even point is 110,783 units, option C.

Question 7

You are in charge of a project that has a degree of operating leverage of 2.64.What will happen to the operating cash flows if the number of units you sell increase by 4 percent?

Accepted Answer

Percentage change in OCF = 2.64 × 0.04 = 10.56 percent increase

Question 8

A proposed project has fixed costs of $36,000 per year.The operating cash flow at 18,000 units is $58,000.What will be the new degree of operating leverage if the number of units sold rises to 18,500?

Accepted Answer

DOL = 1 + ($36,000/$58,000) = 1.62068966Percentage change in Q = (18,500 - 18,000)/18,000 = 2.7778 percentAt 18,500 units, percentage change in OCF = 1.62068966 × .027778 = 4.501916 percentNew OCF = $58,000 × (1 + 0.04501916) = $60,611.11At 18,500 units, DOL = 1 + ($36,000/$60,611.11) = 1.59

Question 9

Consider a 6-year project with the following information: initial fixed asset investment = $460,000; straight-line depreciation to zero over the 6-year life; zero salvage value; price = $34; variable costs = $19; fixed costs = $188,600; quantity sold = 90,528 units; tax rate = 32 percent.What is the sensitivity of OCF to changes in quantity sold?

Accepted Answer

OCF = [($34 - $19) × 90,528 - 188,600][1 - 0.32] + [($460,000/6) × 0.32] = $819,670.93Using 91,528 units: (You can use any amount as the second level of quantity sold as the sensitivity will be the same.)OCF = [($34 - $19) × 91,528 - 188,600][1 - 0.32] + [($460,000/6) × 0.32] = $829,870.93Sensitivity = ($829,870.93 - $819,670.93)/(91,528 - 90,528) = $10.20

Question 10

You are the manager of a project that has a 2.8 degree of operating leverage and a required return of 14 percent.Due to the current state of the economy, you expect sales to decrease by 7 percent next year.What change should you expect in the operating cash flows next year given your sales prediction?

Accepted Answer

Percentage change in OCF = 2.8 × (-0.07) = -0.196 = 19.60 percent decrease

Question 11

Steele Insulators is analyzing a new type of insulation for interior walls.Management has compiled the following information to determine whether or not this new insulation should be manufactured.The insulation project has an initial fixed asset requirement of $1.3 million, which would be depreciated straight-line to zero over the 12-year life of the project.Projected fixed costs are $769,000 and the anticipated annual operating cash flow is $241,000.What is the degree of operating leverage for this project?

Accepted Answer

Degree of Operating Leverage (DOL) = Contribution Margin / Operating Income

Contribution Margin = Sales - Variable Costs

Since the problem does not provide sales or variable cost projections, we cannot calculate DOL directly from this information.

However, we can use the following formula to approximate DOL:

DOL = % change in Operating Income / % change in Sales

Assuming that the $241,000 operating cash flow projection represents operating income, we can calculate DOL as follows:

DOL = (241,000 - 769,000) / (241,000 + 769,000) = -528,000 / 1,010,000 = -0.522

Since DOL is negative, we cannot interpret the result in terms of operating leverage. However, we can say that the project is not expected to generate enough operating income to cover fixed costs based on the information provided.

Question 12

The Motor Works is considering an expansion project with estimated annual fixed costs of $71,000, depreciation of $38,500, variable costs per unit of $17.90 and an estimated sales price of $26.50 per unit.How many units must the firm sell to break-even on a cash basis?

Accepted Answer

Q_{cash break-even} = $71,000/($26.50 - $17.90) = 8,256

Question 13

The accounting manager of Gateway Inns has noted that every time the inn's average occupancy rate increases by 2 percent, the operating cash flow increases by 5.3 percent.What is the degree of operating leverage if the contribution margin per unit is $47?

Accepted Answer

DOL = 0.053/0.02 = 2.65

Question 14

We are evaluating a project that costs $854,000, has a 15-year life, and has no salvage value.Assume that depreciation is straight-line to zero over the life of the project.Sales are projected at 154,000 units per year.Price per unit is $41, variable cost per unit is $20, and fixed costs are $865,102 per year.The tax rate is 33 percent, and we require a 14 percent return on this project.Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±14 percent.What is the worst-case NPV?

Accepted Answer

OCF_Worst = {[($41 × 0.86) - ($20 × 1.14)][154,000 × 0.86] - ($865,102 × 1.14)}{1 - 0.33) + ($854,000/15)(0.33) = $463,658.70

Question 15

Hybrid cars are touted as a "green" alternative; however, the financial aspects of hybrid ownership are not as clear.Consider a hybrid model that has a list price of $5,500 (including tax consequences) more than a comparable car with a traditional gasoline engine.Additionally, the annual ownership costs (other than fuel) for the hybrid were expected to be $420 more than the traditional model.The EPA mileage estimate is 23 mpg for the traditional model and 25 mpg for the hybrid model.Assume the appropriate interest rate is 10 percent, all cash flows occur at the end of the year, you drive 15,900 miles per year, and keep either car for 6 years.What price per gallon would make the decision to buy they hybrid worthwhile?

Accepted Answer

The answer of Hybrid cars are touted as a "green"...

Question 16

Cantor's has been busy analyzing a new product.Thus far, management has determined that an OCF of $218,200 will result in a zero net present value for the project, which is the minimum requirement for project acceptance.The fixed costs are $329,000 and the contribution margin per unit is $211.The company feels that it can realistically capture 2.5 percent of the 110,000 unit market for this product.The tax rate is 34 percent and the required rate of return is 11 percent.Should the company develop the new product? Why or why not?

Accepted Answer

Financial break-even point = ($329,000 + $218,200)/$211 = 2,593.36 unitsExpected sales = 110,000 × 0.025 = 2,750 units.The project should be accepted because the expected level of sales is greater than the financial break-even quantity.

Question 17

Mountain Gear can manufacture mountain climbing shoes for $15.25 per pair in variable raw material costs and $18.46 per paid in variable labor costs.The shoes sell for $135 per pair.Last year, production was 170,000 pairs and fixed costs were $830,000.What is the minimum acceptable total revenue the company should accept for a one-time order for an extra 10,000 pairs?

Accepted Answer

To calculate the minimum acceptable total revenue, we need to first calculate the total variable cost per pair of shoes:

Total variable cost = variable raw material costs + variable labor costs
Total variable cost = $15.25 + $18.46
Total variable cost = $33.71 per pair

Next, we can calculate the total fixed costs:

Total fixed costs = $830,000

To calculate the total cost of producing the extra 10,000 pairs of shoes, we can use the formula:

Total cost = (total variable cost per pair x number of pairs) + total fixed costs

Total cost = ($33.71 x 10,000) + $830,000
Total cost = $337,100

Therefore, the minimum acceptable total revenue the company should accept for a one-time order for an extra 10,000 pairs is $337,100. The only choice that matches this answer is C.

Question 18

Consider a project with the following data: accounting break-even quantity = 29,000 units; cash break-even quantity = 16,250 units; life = 10 years; fixed costs = $203,000; variable costs = $24 per unit; required return = 14 percent; depreciation = straight line.Ignoring the effect of taxes, what is the financial break-even quantity?

Accepted Answer

16,250 = $203,000/(P - $24); P = $36.492307729,000 = ($203,000 + D)/($36.4923077 - $24); D = $159,276.923Initial investment = 10 × $159,276.923 = $1,592,769.23 Q_F = ($203,000 + $305,355.43)/($36.4923077 - $24) = 40,693.47 units

Question 19

A proposed project has a contribution margin per unit of $13.10, fixed costs of $74,000, depreciation of $12,500, variable costs per unit of $22, and a financial break-even point of 11,360 units.What is the operating cash flow at this level of output?

Accepted Answer

OCF_{financial break-even} = (11,360 × $13.10) - $74,000 = $74,816

Question 20

At an output level of 50,000 units, you calculate that the degree of operating leverage is 1.8.What will be the percentage change in operating cash flow if the new output level is 54,500 units?

Accepted Answer

DOL = 1.8 = Percentage change in OCF/[54,500 - 50,000)/50,000]; %ΔOCF = 16.20 percent

Quiz 11: Some Lessons From Recent Capital Market History