Question 1

The following are disadvantages of using EVA as a performance measure EXCEPT:
A)EVA does not measure present values.
B)EVA rewards the choice of projects with quick paybacks and penalizes projects with longer payback periods.
C)EVA reduces explicit monitoring by top management.
D)EVA is difficult to apply to start-up ventures.

Accepted Answer

This statement is incorrect because EVA actually increases explicit monitoring by top management through the use of a standardized performance measure. The other three statements are disadvantages of using EVA as a performance measure.

Question 2

The term economic value added (EVA)is copyrighted by:
A)Brealey-Myers.
B)Brealey-Myers-Allen.
C)Ross-Westerfield.
D)Stern-Stewart.

Accepted Answer

The term Economic Value Added (EVA) was developed by the consulting firm Stern Steward & Co. in the early 1990s, and is therefore copyrighted by Stern-Stewart.

Question 3

The following are advantages of using EVA as a performance measure EXCEPT:
A)EVA can substitute for explicit monitoring by top management.
B)EVA makes the cost of capital visible to operating management,thereby reducing capital employed.
C)EVA does not measure present values.
D)EVA highlights business units that are underperforming their peers.

Accepted Answer

The other three choices are valid advantages of using EVA, but option C is incorrect because EVA does measure present values. EVA (Economic Value Added) is a financial performance metric that calculates the residual income generated by a company after deducting its cost of capital from its operating profit. Present values are taken into account when calculating the cost of capital that is subtracted from operating profit to get EVA.

Question 4

Which of the following actions-all else equal-will increase a firm's EVA?
A)The firm raises its prices,but ships the same amount of product.
B)The firm increases its inventory.
C)The firm increases its borrowing to repurchase some of its shares.
D)The firm increases its accounts receivable.

Accepted Answer

Increasing prices while maintaining the same level of product shipments will increase a firm's revenue and therefore, all else equal, increase its EVA. B, C, and D would not necessarily increase EVA. Increasing inventory may indicate poor management of working capital, increasing borrowing to repurchase shares may not necessarily improve the firm's profitability, and increasing accounts receivable may indicate poor collection practices, which would lower cash flow and decrease EVA.

Question 5

A firm has an average investment of $10,000 during the year.During the same period,the firm generates after-tax income of $1,000.
If the cost of capital is 15%,what is the net return on the investment?
A)15%
B)-5%
C)10%
D)5%

Accepted Answer

The net return on investment is calculated as (After-tax income - Cost of capital) / Average investment. Here, the cost of capital is 15% of $10,000, which is $1,500. The after-tax income is $1,000. So, the net return is ($1,000 - $1,500) / $10,000 = -5%.

Question 6

According to the survey of senior managers by Graham,Harvey,and Rajgopal,senior managers admitted to the following:
I.adjusting their firms' operations and investments in order to manage earnings;
II.decreasing discretionary spending in R&D,advertising,or maintenance to meet earnings targets;
III.deferring or rejecting investment projects with positive NPVs in order to meet earnings targets
A)I only
B)II only
C)I and II only
D)I,II,and III

Accepted Answer

The survey of senior managers by Graham, Harvey, and Rajgopal revealed that senior managers admitted to all three practices - adjusting operations and investments to manage earnings, decreasing discretionary spending in R&D, advertising, or maintenance to meet earnings targets, and deferring or rejecting investment projects with positive NPVs to meet earnings targets. Therefore, the best choice is D, which includes all three practices.

Question 7

EVA is used for:
i.measuring performance within the firm; II)rewarding performance within the firm; III)improving performance within the firm
A)I only
B)II only
C)I and II only
D)I,II,and III

Accepted Answer

EVA (Economic Value Added) is a financial performance metric that is used to measure, reward, and improve performance within a firm by assessing the value created beyond the required return of the company's shareholders.

Question 8

The economic rate of return on an asset is defined as: A)[(C₁ + PV₁ - PV₀)]/(PV₀) B)[(C₁ - (PV₁ - PV₀)]/(PV₀) C)[(C₁ + PV₁)]/(PV₀) D)[(C₁ + PV₀)]/(PV₁)

Accepted Answer

The economic rate of return formula is [(Cash savings from investment + Present value of cash inflows – Present value of cash outflows)] / Present value of cash outflows. Option A is the only one that follows this formula.

Question 9

A firm has an average investment of $10,000 during the year.During the same time,the firm generates after-tax income of $2,000.
If the cost of capital is 15%,what is the net return on the investment?
A)5%
B)20%
C)15%
D)10%

Accepted Answer

The net return on the investment is the after-tax income divided by the average investment, minus the cost of capital. In this case, the net return on the investment is (2,000 / 10,000) - 0.15 = 0.05, or 5%.

Question 10

Which of the following actions-all else equal-will decrease a firm's EVA?
A)The firm raises its prices,but ships the same amount of product.
B)The firm reduces its inventory.
C)The firm increases its borrowing to repurchase some of its shares.
D)The firm increases its accounts receivable.

Accepted Answer

The answer of Which of the following actions-all else equal-will...

Question 11

Which type of situation best represents "gambling for redemption"?
A)A manager decides to invest in a single new product instead of three different products.
B)A firm risks its reputation on the introduction of a revolutionary product.
C)The firm's treasurer invests all of its cash in a single money market mutual fund.
D)A firm on the verge of bankruptcy invests all available funds in a high-risk,low-NPV project in order to attempt to save itself.

Accepted Answer

Gambling for redemption refers to taking a high-risk action in an attempt to save oneself from a dire situation or to redeem oneself from a previous failure. Option D describes a situation where a firm on the verge of bankruptcy is investing in a high-risk, low-NPV project in hopes of saving themselves. This scenario represents gambling for redemption as the firm is taking a desperate risk in an attempt to turn their situation around. The other options do not involve a high level of risk or desperation.

Question 12

A firm has an average investment of $10,000 during the year.During the same time,the firm generates after-tax income of $2,000.
Calculate the economic value added (EVA)for the firm.(The cost of capital is 15%.)
A)$500
B)$1,500
C)$2,000
D)$1,000

Accepted Answer

Economic Value Added (EVA) is calculated as Net Operating Profit After Taxes (NOPAT) minus the product of the cost of capital and the average investment. Here, EVA = $2,000 - (15% of $10,000) = $2,000 - $1,500 = $500.

Question 13

Which of the following is NOT an advantage to calculating and reporting economic depreciation?
A)Most firms can easily calculate economic depreciation.
B)Economic depreciation is generally more realistic than accounting depreciation.
C)Economic depreciation enables a firm to understand the true value of its assets.
D)All of the options are advantages to calculating and reporting economic depreciation.

Accepted Answer

Option A is incorrect because not all firms may be able to easily calculate economic depreciation due to lack of knowledge or expertise in economics. The other three options are advantages of calculating and reporting economic depreciation.

Question 14

One calculates economic profit (EP)as follows:
A)EP = (ROI - r)× (capital invested),where r = cost of capital
B)EP = (ROI + r)× (capital invested),where r = cost of capital
C)EP = (ROI)× (capital invested)
D)EP = (ROI)/(capital invested)

Accepted Answer

Economic profit is the difference between the return on investment (ROI) and the cost of capital. Therefore, Option A is the correct calculation for economic profit.

Question 15

A firm has an average investment of $100,000 during the year.During the same period,the firm generates an after-tax income of $16,000.If the cost of capital is 15%,what is the economic profit?
A)+$16,000
B)+$15,000
C)+$1,000
D)-$1,000

Accepted Answer

Economic profit = After-tax income - (Average investment * Cost of capital)= $16,000 - ($100,000 * 0.15)= $16,000 - $15,000= $1,000

Question 16

One calculates economic value added (EVA)as follows:
A)EVA = income earned - (cost of debt)× (investment)
B)EVA = income earned - (cost of equity)× (investment)
C)EVA = income earned - (cost of capital)× (investment)
D)EVA = income earned - (investment)× (cost of capital)

Accepted Answer

EVA is calculated by subtracting the cost of capital from the income earned, multiplied by the amount of investment. This measures the true economic profit generated by a company after accounting for the cost of capital.

Question 17

A firm has an average investment of $10,000 during the year.During the same period,the firm generates after-tax income of $1,000.
Calculate the economic value added (EVA)for the firm.(The cost of capital is 15%.)
A)-$500
B)$1,500
C)$1,200
D)$1,000

Accepted Answer

Economic Value Added (EVA) is calculated as Net Operating Profit After Taxes (NOPAT) minus the product of the cost of capital and the average investment. Here, EVA = $1,000 - (15% of $10,000) = $1,000 - $1,500 = -$500.

Question 18

Which of the following is the most likely example of bias in a firm's accounting profitability measures?
A)A manufacturing firm increases its cash holdings.
B)A pharmaceutical firm increases its holdings of finished goods inventory.
C)A bank increases its holding of marketable securities.
D)A consulting firm launches a new policy to pay for MBA education for its midlevel managers.

Accepted Answer

The consulting firm launching a new policy to pay for MBA education for its midlevel managers (D) is the most likely example of bias in accounting profitability measures. This is because the expense of education could be capitalized and amortized over several years, rather than being expensed immediately. This accounting treatment could artificially inflate the firm's short-term profitability by deferring the expense recognition.

Question 19

A factory manager can improve EVA by:
i.increasing earnings; II)increasing capital employed; III)reducing earnings; IV)reducing capital employed
A)I and II only
B)II and III only
C)III and IV only
D)I and IV only

Accepted Answer

EVA (Economic Value Added) can be improved by increasing earnings (I) and reducing capital employed (IV), as this increases the value created over the cost of capital.

Question 20

Generally,firms with high levels of intangible assets tend to report (all else equal):
A)lower than actual ROI on their financial statements.
B)higher than actual ROI on their financial statements.
C)same as the actual ROI on their financial statements.
D)no general relation exists.

Accepted Answer

Intangible assets are often not fully recognized on financial statements, leading to an understatement of assets and thus a lower reported ROI compared to the actual ROI.

Quiz 12: Agency Problems, Compensation, and Performance Measurement

The following are disadvantages of using EVA as a performance measure EXCEPT:

The term economic value added (EVA) is copyrighted by:

The following are advantages of using EVA as a performance measure EXCEPT:

Which of the following actions-all else equal-will increase a firm's EVA?

A firm has an average investment of $10,000 during the year.During the same period,the firm generates after-tax income of $1,000. If the cost of capital is 15%,what is the net return on the investment?

EVA is used for: i.measuring performance within the firm; II) rewarding performance within the firm; III) improving performance within the firm

The economic rate of return on an asset is defined as:

A firm has an average investment of $10,000 during the year.During the same time,the firm generates after-tax income of $2,000. If the cost of capital is 15%,what is the net return on the investment?

Which of the following actions-all else equal-will decrease a firm's EVA?

Which type of situation best represents "gambling for redemption"?

A firm has an average investment of $10,000 during the year.During the same time,the firm generates after-tax income of $2,000. Calculate the economic value added (EVA) for the firm.(The cost of capital is 15%.)

Which of the following is NOT an advantage to calculating and reporting economic depreciation?

One calculates economic profit (EP) as follows:

A firm has an average investment of $100,000 during the year.During the same period,the firm generates an after-tax income of $16,000.If the cost of capital is 15%,what is the economic profit?

One calculates economic value added (EVA) as follows:

A firm has an average investment of $10,000 during the year.During the same period,the firm generates after-tax income of $1,000. Calculate the economic value added (EVA) for the firm.(The cost of capital is 15%.)

Which of the following is the most likely example of bias in a firm's accounting profitability measures?

A factory manager can improve EVA by: i.increasing earnings; II) increasing capital employed; III) reducing earnings; IV) reducing capital employed

Generally,firms with high levels of intangible assets tend to report (all else equal) :