_______________________________________________________________________________________
Multiple ch8
Student: Choice Questions
1. An analysis of what happens to the estimate of the net present value when you examine a number of
different likely situations is called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
2. An analysis of what happens to the estimate of net present value when only one variable is changed
is called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
3. An analysis which combines scenario analysis with sensitivity analysis is called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
4. An analysis of the relationship between the sales volume and various measures of profitability is
called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
5. Variable costs:
A.
B.
C.
D.
E.
change in direct relationship to the quantity of output produced.
are constant in the short-run regardless of the quantity of output produced.
are equal to the change in a variable when one more unit of output is produced.
are subtracted from fixed costs to compute the contribution margin.
form the basis that is used to determine the degree of operating leverage employed by a firm.
6. Fixed costs:
A.
B.
C.
D.
E.
change as the quantity of output produced changes.
are constant over the short-run regardless of the quantity of output produced.
reflect the change in a variable when one more unit of output is produced.
are subtracted from sales to compute the contribution margin.
can be ignored in scenario analysis since they are constant over the life of a project.
7. The sales level that results in a project's net income exactly equaling zero is called the _____ breakeven.
A.
B.
C.
D.
E.
operational
leveraged
accounting
cash
present value
8. The sales level that results in a project's net present value exactly equaling zero is called the _____
break-even.
A.
B.
C.
D.
E.
operational
leveraged
accounting
cash
present value
9. Conducting scenario analysis helps managers see the:
A.
B.
C.
D.
E.
impact of an individual variable on the outcome of a project.
potential range of outcomes from a proposed project.
changes in long-term debt over the course of a proposed project.
possible range of market prices for their firm's stock over the life of a project.
allocation distribution of funds for capital projects under conditions of hard rationing.
10. Sensitivity analysis helps you determine the:
A.
B.
C.
D.
E.
range of possible outcomes given possible ranges for every variable.
degree to which the net present value reacts to changes in a single variable.
net present value given the best and the worst possible situations.
degree to which a project is reliant upon the fixed costs.
level of variable costs in relation to the fixed costs of a project.
11. As the degree of sensitivity of a project to a single variable rises, the:
A.
B.
C.
D.
E.
lower the forecasting risk of the project.
smaller the range of possible outcomes given a pre-defined range of values for the input.
more attention management should place on accurately forecasting the future value of that variable.
lower the maximum potential value of the project.
lower the maximum potential loss of the project.
12. Sensitivity analysis is conducted by:
A. holding all variables at their base level and changing the required rate of return assigned to a project.
B. changing the value of two variables to determine their interdependency.
C. changing the value of a single variable and computing the resulting change in the current value of a
project.
D. assigning either the best or the worst possible value to every variable and comparing the results to
those achieved by the base case.
E. managers after a project has been implemented to determine how each variable relates to the level of
output realized.
13. To ascertain whether the accuracy of the variable cost estimate for a project will have much effect
on the final outcome of the project, you should probably conduct _____ analysis.
A.
B.
C.
D.
E.
leverage
scenario
break-even
sensitivity
cash flow
14. Simulation analysis is based on assigning a _____ and analyzing the results.
A.
B.
C.
D.
E.
narrow range of values to a single variable
narrow range of values to multiple variables simultaneously
wide range of values to a single variable
wide range of values to multiple variables simultaneously
single value to each of the variables
15. The type of analysis that is most dependent upon the use of a computer is _____ analysis.
A.
B.
C.
D.
E.
scenario
break-even
sensitivity
degree of operating leverage
simulation
16. Which one of the following is most likely a variable cost?
A.
B.
C.
D.
E.
office rent
property taxes
property insurance
direct labor costs
management salaries
17. Which of the following statements concerning variable costs is (are) correct?
(I) Variable costs minus fixed costs equal marginal costs.
(II) Variable costs are equal to zero when production is equal to zero.
(III) An increase in variable costs increases the operating cash flow.
A. II only
B.
C.
D.
E.
III only
I and III only
II and III only
I and II only
18. All else constant, as the variable cost per unit increases, the:
A.
B.
C.
D.
E.
contribution margin decreases.
sensitivity to fixed costs decreases.
degree of operating leverage decreases.
operating cash flow increases.
net profit increases.
19. Fixed costs:
(I) are variable over long periods of time.
(II) must be paid even if production is halted.
(III) are generally affected by the amount of fixed assets owned by a firm.
(IV) per unit remain constant over a given range of production output.
A.
B.
C.
D.
E.
I and III only
II and IV only
I, II, and III only
I, II, and IV only
I, II, III, and IV
20. All else equal, the contribution margin must increase as:
A.
B.
C.
D.
E.
both the sales price and variable cost per unit increase.
the fixed cost per unit declines.
the variable cost per unit declines.
sales price per unit declines.
the sales price minus the fixed cost per unit increases.
21. Which of the following statements are correct concerning the accounting break-even point?
(I) The net income is equal to zero at the accounting break-even point.
(II) The net present value is equal to zero at the accounting break-even point.
(III) The quantity sold at the accounting break-even point is equal to the total fixed costs plus
depreciation divided by the contribution margin.
(IV) The quantity sold at the accounting break-even point is equal to the total fixed costs divided by
the contribution margin.
A.
B.
C.
D.
E.
I and III only
I and IV only
II and III only
II and IV only
I, II, and IV only
22. All else constant, the accounting break-even level of sales will decrease when the:
A. fixed costs increase.
B.
C.
D.
E.
depreciation expense decreases.
contribution margin decreases.
variable costs per unit increase.
selling price per unit decreases.
23. The point where a project produces a rate of return equal to the required return is known as the:
A.
B.
C.
D.
E.
point of zero operating leverage.
internal break-even point.
accounting break-even point.
present value break-even point.
income break-even point.
24. Which of the following statements are correct concerning the present value break-even point of a
project?
(I) The present value of the cash inflows equals the amount of the initial investment.
(II) The payback period of the project is equal to the life of the project.
(III) The operating cash flow is at a level that produces a net present value of zero.
(IV) The project never pays back on a discounted basis.
A.
B.
C.
D.
E.
I and II only
I and III only
II and IV only
III and IV only
I, III, and IV only
25. The investment timing decision relates to:
A.
B.
C.
D.
E.
how long the cash flows last once a project is implemented.
the decision as to when a project should be started.
how frequently the cash flows of a project occur.
how frequently the interest on the debt incurred to finance a project is compounded.
the decision to either finance a project over time or pay out the initial cost in cash.
26. The timing option that gives the option to wait:
(I) may be of minimal value if the project relates to a rapidly changing technology.
(II) is partially dependent upon the discount rate applied to the project being evaluated.
(III) is defined as the situation where operations are shut down for a period of time.
(IV) has a value equal to the net present value of the project if it is started today versus the net
present value if it is started at some later date.
A.
B.
C.
D.
E.
I and III only
II and IV only
I and II only
II, III, and IV only
I, II, and IV only
27. Last month you introduced a new product to the market. Consumer demand has been
overwhelming and appears that strong demand will exist over the long-term. Given this
situation, management should consider the option to:
A.
B.
C.
D.
E.
suspend.
expand.
abandon.
contract.
withdraw.
28. Including the option to expand in your project analysis will tend to:
A.
B.
C.
D.
E.
extend the duration of a project but not affect the project's net present value.
increase the cash flows of a project but decrease the project's net present value.
increase the net present value of a project.
decrease the net present value of a project.
have no effect on either a project's cash flows or its net present value.
29. Theoretically, the NPV is the most appropriate method to determine the acceptability of a project. A
false sense of security can be overwhelm the decision-maker when the procedure is applied properly
and the positive NPV results are accepted blindly. Sensitivity and scenario analysis aid in the
process by:
A.
B.
C.
D.
E.
changing the underlying assumptions on which the decision is based.
highlights the areas where more and better data are needed.
providing a picture of how an event can affect the calculations.
All of the above.
None of the above.
30. In order to make a decision with a decision tree:
A.
B.
C.
D.
E.
one starts farthest out in time to make the first decision.
one must begin at time 0.
any path can be taken to get to the end.
any path can be taken to get back to the beginning.
None of the above.
31. In a decision tree, the NPV to make the yes/no decision is dependent on:
A.
B.
C.
D.
E.
only the cash flows from successful path.
on the path where the probabilities add up to one.
all cash flows and probabilities.
only the cash flows and probabilities of the successful path.
None of the above.
32. In a decision tree, caution should be used in analysis because:
A. early stage decisions are probably riskier and should not likely use the same discount rate.
B. if a negative NPV is actually occurring, management should opt out of the project and minimize the
firm's loss.
C. decision trees are only used for financial planning.
D. Both A and C.
E. Both A and B.
33. Sensitivity analysis evaluates the NPV with respect to:
A.
B.
C.
D.
E.
changes in the underlying assumptions.
one variable changing while holding the others constant.
different economic conditions.
All of the above.
None of the above.
34. Sensitivity analysis provides information on:
A. whether the NPV should be trusted and may provide a false sense of security if all NPVs are
positive.
B. the need for additional information as it tests each variable in isolation.
C. the degree of difficulty in changing multiple variables together.
D. Both A and B.
E. Both A and C.
35. Fixed production costs are:
A.
B.
C.
D.
E.
directly related to labor costs.
measured as cost per unit of time.
measured as cost per unit of output.
dependent on the amount of goods or services produced.
None of the above.
36. Variable costs:
A.
B.
C.
D.
E.
change as the quantity of output changes.
are zero when production is zero.
are exemplified by direct labor and raw materials.
All of the above.
None of the above.
37. An investigation of the degree to which NPV depends on assumptions made about any singular
critical variable is called a(n):
A.
B.
C.
D.
E.
operating analysis.
sensitivity analysis.
marginal benefit analysis.
decision tree analysis.
None of the above.
38. Scenario analysis is different than sensitivity analysis:
A. as no economic forecasts are changed.
B. as several variables are changed together.
C. because scenario analysis deals with actual data versus sensitivity analysis which deals with a
forecast.
D. because it is short and simple.
E. because it is a "by the seat of the pants" technique.
39. In the present-value break-even the EAC is used to:
A.
B.
C.
D.
E.
determine the opportunity cost of investment.
allocate depreciation over the life of the project.
allocate the initial investment at its opportunity cost over the life of the project.
determine the contribution margin to fixed costs.
None of the above.
40. The present value break-even point is superior to the accounting break-even point because:
A.
B.
C.
D.
present value break-even is more complicated to calculate.
present value break-even covers the economic opportunity costs of the investment.
present value break-even is the same as sensitivity analysis.
present value break-even covers the fixed costs of production, which the accounting break-even does
not.
E. present value break-even covers the variable costs of production, which the accounting break-even
does not.
41. The potential decision to abandon a project has option value because:
A.
B.
C.
D.
E.
abandonment can occur at any future point in time.
a project may be worth more dead than alive.
management is not locked into a negative outcome.
All of the above.
None of the above.
42. Which of the following are types of break-even analysis?
A.
B.
C.
D.
E.
present value break-even
accounting profit break-even
market value break-even
Both A and B.
Both A and C.
43. The approach that further attempts to model real world uncertainty by analyzing projects the way
one might analyze gambling strategies is called:
A.
B.
C.
D.
E.
gambler's approach.
blackjack approach.
Monte Carlo simulation.
scenario analysis.
sensitivity analysis.
44. Monte Carlo simulation is:
A.
B.
C.
D.
E.
the most widely used by executives.
a very simple formula.
is more complex than sensitivity or scenario analysis.
the oldest capital budgeting technique.
None of the above.
45. Which of the following are hidden options in capital budgeting?
A.
B.
C.
D.
E.
option to expand
timing option
option to abandon
All of the above.
None of the above.
The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take
10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost
estimates are considered accurate within a plus or minus 5% range. The depreciation expense is
$4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity
analysis on the expected case scenario.
46. What is the sales revenue under the optimistic case scenario?
A.
B.
C.
D.
E.
$40,000
$43,120
$44,000
$44,880
$48,400
47. What is the contribution margin under the expected case scenario?
A.
B.
C.
D.
E.
$2.67
$3.00
$7.92
$8.00
$8.72
48. What is the amount of the fixed cost per unit under the pessimistic case scenario?
A.
B.
C.
D.
E.
$4.55
$5.00
$5.83
$6.02
$6.55
49. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of
$17. Using this value, the earnings before interest and taxes will be:
A.
B.
C.
D.
E.
$4,000
$6,000
$8,500
$10,000
$18,500
50. The company conducts a sensitivity analysis using a variable cost of $9. The total variable cost
estimate will be:
A. $21,375
B.
C.
D.
E.
$22,500
$23,625
$24,125
$24,750
The Can-Do Co. is analyzing a proposed project. The company expects to sell 12,000 units, give or
take 4%. The expected variable cost per unit is $7 and the expected fixed cost is $36,000. The fixed
and variable cost estimates are considered accurate within a plus or minus 6% range. The
depreciation expense is $30,000. The tax rate is 34%. The sale price is estimated at $14 a unit, give
or take 5%. The company bases its sensitivity analysis on the expected case scenario.
51. What is the earnings before interest and taxes under the expected case scenario?
A.
B.
C.
D.
E.
$18,000
$24,000
$36,000
$48,000
$54,000
52. What is the earnings before interest and taxes under the optimistic case scenario?
A.
B.
C.
D.
E.
$22,694.40
$24,854.40
$37,497.60
$52,694.40
$67,947.60
53. What is the earnings before interest and taxes under the pessimistic case scenario?
A.
B.
C.
D.
E.
-$566.02
-$422.40
-$278.78
$3,554.50
$5,385.60
54. What is the operating cash flow for a sensitivity analysis using total fixed costs of $32,000?
A.
B.
C.
D.
E.
$14,520
$16,520
$22,000
$44,520
$52,000
55. What is the contribution margin for a sensitivity analysis using a variable cost per unit of $8?
A.
B.
C.
D.
E.
$3
$4
$5
$6
$7
56. A firm is reviewing a project with labor cost of $8.90 per unit, raw materials cost of $21.63 a unit,
and fixed costs of $8,000 a month. Sales are projected at 10,000 units over the three-month life of
the project. What are the total variable costs of the project?
A.
B.
C.
D.
E.
$216,300
$297,300
$305,300
$313,300
$329,300
57. A project has earnings before interest and taxes of $5,750, fixed costs of $50,000, a selling price of
$13 a unit, and a sales quantity of 11,500 units. Depreciation is $7,500. What is the variable cost per
unit?
A.
B.
C.
D.
E.
$6.75
$7.00
$7.25
$7.50
$7.75
58. At a production level of 5,600 units a project has total costs of $89,000. The variable cost per unit is
$11.20. What is the amount of the total fixed costs?
A.
B.
C.
D.
E.
$24,126
$26,280
$27,090
$27,820
$28,626
59. At a production level of 6,000 units a project has total costs of $120,000. The variable cost per unit
is $14.50. What is the amount of the total fixed costs?
A.
B.
C.
D.
E.
$25,165
$28,200
$30,570
$32,000
$33,000
60. Wilson's Meats has computed its fixed costs to be $.60 for every pound of meat it sells given an
average daily sales level of 500 pounds. It charges $3.89 per pound of top-grade ground beef. The
variable cost per pound is $2.99. What is the contribution margin per pound of ground beef sold?
A.
B.
C.
D.
E.
61.
$0.30
$0.60
$0.90
$2.99
$3.89
Ralph and Emma's is considering a project with total sales of $17,500, total variable costs of $9,800,
total fixed costs of $3,500, and estimated production of 400 units. The depreciation expense is
$2,400 a year. What is the contribution margin per unit?
A.
B.
C.
D.
E.
$4.50
$10.50
$14.14
$19.09
$19.25
62. You are considering a new project. The project has projected depreciation of $720, fixed costs of
$6,000, and total sales of $11,760. The variable cost per unit is $4.20. What is the accounting breakeven level of production?
A.
B.
C.
D.
E.
1,200 units
1,334 units
1,372 units
1,889 units
1,910 units
63. The accounting break-even production quantity for a project is 5,425 units. The fixed costs are
$31,600 and the contribution margin is $6. What is the projected depreciation expense?
A.
B.
C.
D.
E.
$700
$950
$1,025
$1,053
$1,100
64. A project has an accounting break-even point of 2,000 units. The fixed costs are $4,200 and the
depreciation expense is $400. The projected variable cost per unit is $23.10. What is the projected
sales price?
A.
B.
C.
D.
E.
$20.80
$21.00
$21.20
$25.40
$25.60
65. A proposed project has fixed costs of $3,600, depreciation expense of $1,500, and a sales quantity of
1,300 units. What is the contribution margin if the projected level of sales is the accounting breakeven point?
A.
B.
C.
D.
E.
$3.92
$4.14
$4.50
$4.80
$5.00
66. A project has a contribution margin of $5, projected fixed costs of $12,000, projected variable cost
per unit of $12, and a projected present value break-even point of 5,000 units. What is the operating
cash flow at this level of output?
A.
B.
C.
D.
E.
$1,000
$12,000
$13,000
$68,000
$73,000
67. Thompson & Son has been busy analyzing a new product. It has determined that an operating cash
flow of $16,700 will result in a zero net present value, which is a company requirement for project
acceptance. The fixed costs are $12,378 and the contribution margin is $6.20. The company feels
that it can realistically capture 10% of the 50,000 unit market for this product. Should the company
develop the new product? Why or why not?
A.
B.
C.
D.
E.
Yes; because 5,000 units of sales exceeds the quantity required for a zero net present value
Yes; because the internal break-even point is less than 5,000 units
No; because the firm can not generate sufficient sales to obtain at least a zero net present value
No; because the project has an expected internal rate of return of negative 100%
No; because the project will not pay back on a discounted basis
68. Kurt Neal and Son is considering a project with a discounted payback just equal to the project's life.
The projections include a sales price of $11, variable cost per unit of $8.50, and fixed costs of
$4,500. The operating cash flow is $6,200. What is the breakeven quantity?
A.
B.
C.
D.
E.
1,800 units
2,480 units
3,057 units
3,750 units
4,280 units
69. At stage 2 of the decision tree it shows that if a project is successful, the payoff will be $53,000 with
a 2/3 chance of occurrence. There is also the 1/3 chance of a $-24,000 payoff. The cost of getting to
stage 2 (1 year out) is $44,000. The cost of capital is 15%. What is the NPV of the project at stage
1?
A.
B.
C.
D.
E.
$-13,275
$-20,232
$ 2,087
$ 7,536
Can not be calculated without the exact timing of future cash flows.
The Quick-Start Company has the following pattern of potential cash flows with its planned
investment in a new cold weather starting system for fuel injected cars.
70.
If the company has a discount rate of 17%, what is the value closest to time 1 net present value?
A. $ 48.6 million
B. $ 80.9 million
C. $108.2 million
D. $181.4 million
E. None of the above.
71. If the company has a discount rate of 17%, should it decide to invest?
A.
B.
C.
D.
E.
yes, NPV = $2.2 million
yes, NPV = $21.6 million
no, NPV = -$1.9 million
yes, NPV = $ 8.6 million
No, since more than one branch is NPV = 0 or negative, the firm must reject.
72. The Mini-Max Company has the following cost information on its new prospective project.
Calculate the accounting break-even point.
Initial investment: $700
Fixed costs: $200 per year
Variable costs: $3 per unit
Depreciation: $140 per year
Price: $8 per unit
Discount rate: 12%
Project life: 5 years
Tax rate: 34%
A.
B.
C.
D.
E.
25 units per year
68 units per year
103 units per year
113 units per year
None of the above.
73. The Mini-Max Company has the following cost information on its new prospective project.
Calculate the present value break-even point.
Initial investment: $700
Fixed costs are $ 200 per year
Variable costs: $ 3 per unit
Depreciation: $ 140 per year
Price: $8 per unit
Discount rate: 12%
Project life: 3 years
Tax rate: 34%
A.
B.
C.
D.
E.
68 units per year
75 units per year
84 units per year
114 units per year
None of the above.
74.
From the information below, calculate the accounting break-even point.
Initial investment: $2,000
Fixed costs are $2,000 per year
Variable costs: $6 per unit
Depreciation: $250 per year
Price: $20 per unit
Discount rate: 10%
Project life: 4 years
Tax rate: 34%
A.
B.
C.
D.
E.
88 units per year
100 units per year
143 units per year
161 units per year
None of the above.
75. Given the following information, calculate the present value break-even point.
Initial investment: $2,000
Fixed costs: $2,000 per year
Variable costs: $6 per unit
Depreciation: $250 per year
Price: $20 per unit
Discount rate: 10%
Project life: 4 years
Tax rate: 34%
A.
B.
C.
D.
E.
100 units per year
143 units per year
202 units per year
286 units per year
None of the above.
76. You are considering a project which has been assigned a discount rate of 8%. If you start the project
today, you will incur an initial cost of $480 and will receive cash inflows of $350 a year for three
years. If you wait one year to start the project, the initial cost will rise to $520 and the cash flows
will increase to $385 a year for three years. What is the value of the option to wait?
A.
B.
C.
D.
E.
$15.23
$17.08
$18.67
$20.20
$50.20
77. Wilson's Antiques is considering a project that has an initial cost today of $10,000. The project has a
two-year life with cash inflows of $6,500 a year. Should Wilson's decide to wait one year to
commence this project, the initial cost will increase by 5% and the cash inflows will increase to
$7,500 a year. What is the value of the option to wait if the applicable discount rate is 10%?
A.
B.
C.
D.
E.
$1,006.76
$1,235.54
$1,509.28
$1,606.76
$1,735.54
78.
Your firm is considering a project with a five-year life and an initial cost of $120,000.The discount
rate for the project is 12%. The firm expects to sell 2,100 units a year. The cash flow per unit is $20.
The firm will have the option to abandon this project after three years at which time it expects it
could sell the project for $50,000. At what level of sales should the firm be willing to abandon this
project?
A.
B.
C.
D.
E.
420 units
1,041 units
1,479 units
1,618 units
2,500 units
79. Your firm is considering a project with a five-year life and an initial cost of $120,000.The discount
rate for the project is 12%. The firm expects to sell 2,100 units a year. The cash flow per unit is $20.
The firm will have the option to abandon this project after three years at which time it expects it
could sell the project for $50,000. You are interested in knowing how the project will perform if the
sales forecast for years four and five of the project are revised such that there is a 50% chance that
the sales will be either 1,400 or 2,500 units a year. What is the net present value of this project given
your sales forecasts?
A.
B.
C.
D.
E.
$23,617
$23,719
$25,002
$26,877
$28,746
80. Margerit is reviewing a project with projected sales of 1,500 units a year, a cash flow of $40 a unit
and a three-year project life. The initial cost of the project is $95,000. The relevant discount rate is
15%. Margerit has the option to abandon the project after one year at which time she feels she could
sell the project for $60,000. At what level of sales should she be willing to abandon the project?
A.
B.
C.
D.
E.
899 units
923 units
967 units
1,199 units
1,206 units
Essay Questions
81. What is the benefit of scenario analysis if it does not produce an accept or reject decision for a
proposed project?
82. Consider the following statement by a project analyst: "I analyzed my project using scenarios for the
base case, best case, and worst case. I computed break-evens and degrees of operating leverage. I did
sensitivity analysis and simulation analysis. I computed NPV, IRR, payback, AAR, and PI. In the
end, I have over a hundred different estimates and am more confused than ever. I would have been
better off just sticking with my first estimate and going by my gut reaction." Critique this statement.
83. The Marx Brewing Company recently installed a new bottling machine. The machine's initial cost is
$2,000, and can be depreciated on a straight line basis to a zero salvage in 5 years. The machine's
per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is
$1.50. Marx's tax rate is 34%, and it uses a 16% discount rate. Calculate the accounting break-even
point on the new machine, as well as the present value break-even point on the new machine.
84. Discuss two shortcomings in the standard decision tree analysis that a financial manager should be
cognizant of?
85. Sensitivity analysis is a method which allows for evaluation of the NPV given a series of changes to
the underlying assumptions. Discuss why and how scenario analysis is used in addition to sensitivity
analysis.
86. The market value of an investment project should be viewed as the sum of the standard NPV and the
value of managerial options. Explain three different real or managerial options that management
may have, what they are, and how they would influence market value.
ch8 KEY
Multiple Choice Questions
1. An analysis of what happens to the estimate of the net present value when you examine a number of
different likely situations is called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
Difficulty level: Easy
Ross - Chapter 08 #1
Topic: SCENARIO ANALYSIS
2. An analysis of what happens to the estimate of net present value when only one variable is changed
is called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
Difficulty level: Easy
Ross - Chapter 08 #2
Topic: SENSITIVITY ANALYSIS
3. An analysis which combines scenario analysis with sensitivity analysis is called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
Difficulty level: Easy
Ross - Chapter 08 #3
Topic: SIMULATION ANALYSIS
4. An analysis of the relationship between the sales volume and various measures of profitability is
called _____ analysis.
A.
B.
C.
D.
E.
forecasting
scenario
sensitivity
simulation
break-even
Difficulty level: Easy
Ross - Chapter 08 #4
Topic: BREAK-EVEN ANALYSIS
5. Variable costs:
A.
B.
C.
D.
E.
change in direct relationship to the quantity of output produced.
are constant in the short-run regardless of the quantity of output produced.
are equal to the change in a variable when one more unit of output is produced.
are subtracted from fixed costs to compute the contribution margin.
form the basis that is used to determine the degree of operating leverage employed by a firm.
Difficulty level: Easy
Ross - Chapter 08 #5
Topic: VARIABLE COSTS
6. Fixed costs:
A.
B.
C.
D.
E.
change as the quantity of output produced changes.
are constant over the short-run regardless of the quantity of output produced.
reflect the change in a variable when one more unit of output is produced.
are subtracted from sales to compute the contribution margin.
can be ignored in scenario analysis since they are constant over the life of a project.
Difficulty level: Easy
Ross - Chapter 08 #6
Topic: FIXED COSTS
7. The sales level that results in a project's net income exactly equaling zero is called the _____ breakeven.
A.
B.
C.
D.
E.
operational
leveraged
accounting
cash
present value
Difficulty level: Easy
Ross - Chapter 08 #7
Topic: ACCOUNTING BREAK-EVEN
8. The sales level that results in a project's net present value exactly equaling zero is called the _____
break-even.
A.
B.
C.
D.
E.
operational
leveraged
accounting
cash
present value
Difficulty level: Easy
Ross - Chapter 08 #8
Topic: PRESENT VALUE BREAK-EVEN
9. Conducting scenario analysis helps managers see the:
A.
B.
C.
D.
E.
impact of an individual variable on the outcome of a project.
potential range of outcomes from a proposed project.
changes in long-term debt over the course of a proposed project.
possible range of market prices for their firm's stock over the life of a project.
allocation distribution of funds for capital projects under conditions of hard rationing.
Difficulty level: Easy
Ross - Chapter 08 #9
Topic: SCENARIO ANALYSIS
10. Sensitivity analysis helps you determine the:
A.
B.
C.
D.
E.
range of possible outcomes given possible ranges for every variable.
degree to which the net present value reacts to changes in a single variable.
net present value given the best and the worst possible situations.
degree to which a project is reliant upon the fixed costs.
level of variable costs in relation to the fixed costs of a project.
Difficulty level: Easy
Ross - Chapter 08 #10
Topic: SENSITIVITY ANALYSIS
11. As the degree of sensitivity of a project to a single variable rises, the:
A.
B.
C.
D.
E.
lower the forecasting risk of the project.
smaller the range of possible outcomes given a pre-defined range of values for the input.
more attention management should place on accurately forecasting the future value of that variable.
lower the maximum potential value of the project.
lower the maximum potential loss of the project.
Difficulty level: Medium
Ross - Chapter 08 #11
Topic: SENSITIVITY ANALYSIS
12. Sensitivity analysis is conducted by:
A. holding all variables at their base level and changing the required rate of return assigned to a project.
B. changing the value of two variables to determine their interdependency.
C. changing the value of a single variable and computing the resulting change in the current value of a
project.
D. assigning either the best or the worst possible value to every variable and comparing the results to
those achieved by the base case.
E. managers after a project has been implemented to determine how each variable relates to the level of
output realized.
Difficulty level: Medium
Ross - Chapter 08 #12
Topic: SENSITIVITY ANALYSIS
13. To ascertain whether the accuracy of the variable cost estimate for a project will have much effect
on the final outcome of the project, you should probably conduct _____ analysis.
A.
B.
C.
D.
E.
leverage
scenario
break-even
sensitivity
cash flow
Difficulty level: Easy
Ross - Chapter 08 #13
Topic: SENSITIVITY ANALYSIS
14. Simulation analysis is based on assigning a _____ and analyzing the results.
A.
B.
C.
D.
E.
narrow range of values to a single variable
narrow range of values to multiple variables simultaneously
wide range of values to a single variable
wide range of values to multiple variables simultaneously
single value to each of the variables
Difficulty level: Medium
Ross Chapter - 08 #14
Topic: SIMULATION
15. The type of analysis that is most dependent upon the use of a computer is _____ analysis.
A.
B.
C.
D.
E.
scenario
break-even
sensitivity
degree of operating leverage
simulation
Difficulty level: Easy
Ross - Chapter 08 #15
Topic: SIMULATION
16. Which one of the following is most likely a variable cost?
A.
B.
C.
D.
E.
office rent
property taxes
property insurance
direct labor costs
management salaries
Difficulty level: Easy
Ross - Chapter 08 #16
Topic: VARIABLE COSTS
17. Which of the following statements concerning variable costs is (are) correct?
(I) Variable costs minus fixed costs equal marginal costs.
(II) Variable costs are equal to zero when production is equal to zero.
(III) An increase in variable costs increases the operating cash flow.
A.
B.
C.
D.
E.
II only
III only
I and III only
II and III only
I and II only
Difficulty level: Medium
Ross - Chapter 08 #17
Topic: VARIABLE COSTS
18. All else constant, as the variable cost per unit increases, the:
A.
B.
C.
D.
E.
contribution margin decreases.
sensitivity to fixed costs decreases.
degree of operating leverage decreases.
operating cash flow increases.
net profit increases.
Difficulty level: Medium
Ross - Chapter 08 #18
Topic: VARIABLE COSTS
19. Fixed costs:
(I) are variable over long periods of time.
(II) must be paid even if production is halted.
(III) are generally affected by the amount of fixed assets owned by a firm.
(IV) per unit remain constant over a given range of production output.
A.
B.
C.
D.
E.
I and III only
II and IV only
I, II, and III only
I, II, and IV only
I, II, III, and IV
Difficulty level: Medium
Ross - Chapter 08 #19
Topic: FIXED COSTS
20. All else equal, the contribution margin must increase as:
A.
B.
C.
D.
E.
both the sales price and variable cost per unit increase.
the fixed cost per unit declines.
the variable cost per unit declines.
sales price per unit declines.
the sales price minus the fixed cost per unit increases.
Difficulty level: Medium
Ross - Chapter 08 #20
Topic: CONTRIBUTION MARGIN
21. Which of the following statements are correct concerning the accounting break-even point?
(I) The net income is equal to zero at the accounting break-even point.
(II) The net present value is equal to zero at the accounting break-even point.
(III) The quantity sold at the accounting break-even point is equal to the total fixed costs plus
depreciation divided by the contribution margin.
(IV) The quantity sold at the accounting break-even point is equal to the total fixed costs divided by
the contribution margin.
A.
B.
C.
D.
E.
I and III only
I and IV only
II and III only
II and IV only
I, II, and IV only
Difficulty level: Medium
Ross - Chapter 08 #21
Topic: ACCOUNTING BREAK-EVEN
22. All else constant, the accounting break-even level of sales will decrease when the:
A.
B.
C.
D.
fixed costs increase.
depreciation expense decreases.
contribution margin decreases.
variable costs per unit increase.
E. selling price per unit decreases.
Difficulty level: Medium
Ross - Chapter 08 #22
Topic: PRESENT VALUE BREAK-EVEN
23. The point where a project produces a rate of return equal to the required return is known as the:
A.
B.
C.
D.
E.
point of zero operating leverage.
internal break-even point.
accounting break-even point.
present value break-even point.
income break-even point.
Difficulty level: Easy
Ross - Chapter 08 #23
Topic: ACCOUNTING BREAK-EVEN
24. Which of the following statements are correct concerning the present value break-even point of a
project?
(I) The present value of the cash inflows equals the amount of the initial investment.
(II) The payback period of the project is equal to the life of the project.
(III) The operating cash flow is at a level that produces a net present value of zero.
(IV) The project never pays back on a discounted basis.
A.
B.
C.
D.
E.
I and II only
I and III only
II and IV only
III and IV only
I, III, and IV only
Difficulty level: Medium
Ross - Chapter 08 #24
Topic: PRESENT VALUE BREAK-EVEN
25. The investment timing decision relates to:
A.
B.
C.
D.
E.
how long the cash flows last once a project is implemented.
the decision as to when a project should be started.
how frequently the cash flows of a project occur.
how frequently the interest on the debt incurred to finance a project is compounded.
the decision to either finance a project over time or pay out the initial cost in cash.
Difficulty level: Medium
Ross - Chapter 08 #25
Topic: INVESTMENT TIMING DECISION
26. The timing option that gives the option to wait:
(I) may be of minimal value if the project relates to a rapidly changing technology.
(II) is partially dependent upon the discount rate applied to the project being evaluated.
(III) is defined as the situation where operations are shut down for a period of time.
(IV) has a value equal to the net present value of the project if it is started today versus the net
present value if it is started at some later date.
A. I and III only
B. II and IV only
C. I and II only
D. II, III, and IV only
E. I, II, and IV only
Difficulty level: Challenge
Ross - Chapter 08 #26
Topic: OPTION TO WAIT
27. Last month you introduced a new product to the market. Consumer demand has been
overwhelming and appears that strong demand will exist over the long-term. Given this
situation, management should consider the option to:
A.
B.
C.
D.
E.
suspend.
expand.
abandon.
contract.
withdraw.
Difficulty level: Easy
Ross - Chapter 08 #27
Topic: OPTION TO EXPAND
28. Including the option to expand in your project analysis will tend to:
A.
B.
C.
D.
E.
extend the duration of a project but not affect the project's net present value.
increase the cash flows of a project but decrease the project's net present value.
increase the net present value of a project.
decrease the net present value of a project.
have no effect on either a project's cash flows or its net present value.
Difficulty level: Medium
Ross - Chapter 08 #28
Topic: OPTION TO EXPAND
29. Theoretically, the NPV is the most appropriate method to determine the acceptability of a project. A
false sense of security can be overwhelm the decision-maker when the procedure is applied properly
and the positive NPV results are accepted blindly. Sensitivity and scenario analysis aid in the
process by:
A.
B.
C.
D.
E.
changing the underlying assumptions on which the decision is based.
highlights the areas where more and better data are needed.
providing a picture of how an event can affect the calculations.
All of the above.
None of the above.
Difficulty level: Medium
Ross - Chapter 08 #29
Topic: SENSITIVITY AND SENARIO ANALYSIS
30. In order to make a decision with a decision tree:
A.
B.
C.
D.
E.
one starts farthest out in time to make the first decision.
one must begin at time 0.
any path can be taken to get to the end.
any path can be taken to get back to the beginning.
None of the above.
Difficulty level: Medium
Ross - Chapter 08 #30
Topic: DECSION TREE
31. In a decision tree, the NPV to make the yes/no decision is dependent on:
A.
B.
C.
D.
E.
only the cash flows from successful path.
on the path where the probabilities add up to one.
all cash flows and probabilities.
only the cash flows and probabilities of the successful path.
None of the above.
Difficulty level: Medium
Ross - Chapter 08 #31
Topic: DECISION TREE
32. In a decision tree, caution should be used in analysis because:
A. early stage decisions are probably riskier and should not likely use the same discount rate.
B. if a negative NPV is actually occurring, management should opt out of the project and minimize the
firm's loss.
C. decision trees are only used for financial planning.
D. Both A and C.
E. Both A and B.
Difficulty level: Medium
Ross - Chapter 08 #32
Topic: DECISION TREE
33. Sensitivity analysis evaluates the NPV with respect to:
A.
B.
C.
D.
E.
changes in the underlying assumptions.
one variable changing while holding the others constant.
different economic conditions.
All of the above.
None of the above.
Difficulty level: Medium
Ross - Chapter 08 #33
Topic: SENSITIVITY ANALYSIS
34. Sensitivity analysis provides information on:
A. whether the NPV should be trusted and may provide a false sense of security if all NPVs are
positive.
B. the need for additional information as it tests each variable in isolation.
C. the degree of difficulty in changing multiple variables together.
D. Both A and B.
E. Both A and C.
Difficulty level: Medium
Ross - Chapter 08 #34
Topic: SENSITIVITY ANALYSIS
35. Fixed production costs are:
A. directly related to labor costs.
B.
C.
D.
E.
measured as cost per unit of time.
measured as cost per unit of output.
dependent on the amount of goods or services produced.
None of the above.
Difficulty level: Medium
Ross - Chapter 08 #35
Topic: FIXED COSTS
36. Variable costs:
A.
B.
C.
D.
E.
change as the quantity of output changes.
are zero when production is zero.
are exemplified by direct labor and raw materials.
All of the above.
None of the above.
Difficulty level: Easy
Ross - Chapter 08 #36
Topic: VARIABLE COSTS
37. An investigation of the degree to which NPV depends on assumptions made about any singular
critical variable is called a(n):
A.
B.
C.
D.
E.
operating analysis.
sensitivity analysis.
marginal benefit analysis.
decision tree analysis.
None of the above.
Difficulty level: Easy
Ross - Chapter 08 #37
Topic: SENSITIVITY ANALYSIS
38. Scenario analysis is different than sensitivity analysis:
A. as no economic forecasts are changed.
B. as several variables are changed together.
C. because scenario analysis deals with actual data versus sensitivity analysis which deals with a
forecast.
D. because it is short and simple.
E. because it is a "by the seat of the pants" technique.
Difficulty level: Medium
Ross - Chapter 08 #38
Topic: SENSITIVITY AND SCENARIOS ANALYSIS
39. In the present-value break-even the EAC is used to:
A.
B.
C.
D.
E.
determine the opportunity cost of investment.
allocate depreciation over the life of the project.
allocate the initial investment at its opportunity cost over the life of the project.
determine the contribution margin to fixed costs.
None of the above.
Difficulty level: Medium
Ross - Chapter 08 #39
Topic: EQUIVALENT ANNUAL COST
40. The present value break-even point is superior to the accounting break-even point because:
A.
B.
C.
D.
present value break-even is more complicated to calculate.
present value break-even covers the economic opportunity costs of the investment.
present value break-even is the same as sensitivity analysis.
present value break-even covers the fixed costs of production, which the accounting break-even does
not.
E. present value break-even covers the variable costs of production, which the accounting break-even
does not.
Difficulty level: Easy
Ross - Chapter 08 #40
Topic: BREAK-EVEN
41. The potential decision to abandon a project has option value because:
A.
B.
C.
D.
E.
abandonment can occur at any future point in time.
a project may be worth more dead than alive.
management is not locked into a negative outcome.
All of the above.
None of the above.
Difficulty level: Easy
Ross - Chapter 08 #41
Topic: ABANDONMENT
42. Which of the following are types of break-even analysis?
A.
B.
C.
D.
E.
present value break-even
accounting profit break-even
market value break-even
Both A and B.
Both A and C.
Difficulty level: Easy
Ross - Chapter 08 #42
Topic: TYPES OF BREAK-EVEN ANALYSIS
43. The approach that further attempts to model real world uncertainty by analyzing projects the way
one might analyze gambling strategies is called:
A.
B.
C.
D.
E.
gambler's approach.
blackjack approach.
Monte Carlo simulation.
scenario analysis.
sensitivity analysis.
Difficulty level: Medium
Ross - Chapter 08 #43
Topic: MONTE CARLO SIMULATION
44. Monte Carlo simulation is:
A. the most widely used by executives.
B.
C.
D.
E.
a very simple formula.
is more complex than sensitivity or scenario analysis.
the oldest capital budgeting technique.
None of the above.
Difficulty level: Easy
Ross - Chapter 08 #44
Topic: MONTE CARLO SIMULATION
45. Which of the following are hidden options in capital budgeting?
A.
B.
C.
D.
E.
option to expand
timing option
option to abandon
All of the above.
None of the above.
Difficulty level: Easy
Ross - Chapter 08 #45
Topic: OPTIONS IN CAPITAL BUDGETING
The Adept Co. is analyzing a proposed project. The company expects to sell 2,500 units, give or take
10%. The expected variable cost per unit is $8 and the expected fixed costs are $12,500. Cost
estimates are considered accurate within a plus or minus 5% range. The depreciation expense is
$4,000. The sale price is estimated at $16 a unit, give or take 2%. The company bases its sensitivity
analysis on the expected case scenario.
Ross - Chapter 08
46. What is the sales revenue under the optimistic case scenario?
A.
B.
C.
D.
E.
$40,000
$43,120
$44,000
$44,880
$48,400
Sales revenue for the best case = 2,500 x 1.1 x $16 x 1.02 = $44,880
Difficulty level: Medium
Ross - Chapter 08 #46
Topic: SCENARIO ANALYSIS
47. What is the contribution margin under the expected case scenario?
A.
B.
C.
D.
E.
$2.67
$3.00
$7.92
$8.00
$8.72
Contribution margin for the base case = $16 - $8 = $8
Difficulty level: Medium
Ross - Chapter 08 #47
Topic: SCENARIO ANALYSIS
48. What is the amount of the fixed cost per unit under the pessimistic case scenario?
A.
B.
C.
D.
E.
$4.55
$5.00
$5.83
$6.02
$6.55
Fixed cost per unit for the worst case = ($12,500 x 1.05)
(2,500 x .9) = $5.83
Difficulty level: Medium
Ross - Chapter 08 #48
Topic: SCENARIO ANALYSIS
49. The company is conducting a sensitivity analysis on the sales price using a sales price estimate of
$17. Using this value, the earnings before interest and taxes will be:
A.
B.
C.
D.
E.
$4,000
$6,000
$8,500
$10,000
$18,500
EBIT = [($17 - $8) x 2,500] - $12,500 - $4,000 = $6,000
Difficulty level: Medium
Ross - Chapter 08 #49
Topic: SENSITIVITY ANALYSIS
50. The company conducts a sensitivity analysis using a variable cost of $9. The total variable cost
estimate will be:
A.
B.
C.
D.
E.
$21,375
$22,500
$23,625
$24,125
$24,750
Total variable cost = $9 x 2,500 = $22,500
Difficulty level: Medium
Ross - Chapter 08 #50
Topic: SENSITIVITY ANALYSIS
The Can-Do Co. is analyzing a proposed project. The company expects to sell 12,000 units, give or
take 4%. The expected variable cost per unit is $7 and the expected fixed cost is $36,000. The fixed
and variable cost estimates are considered accurate within a plus or minus 6% range. The
depreciation expense is $30,000. The tax rate is 34%. The sale price is estimated at $14 a unit, give
or take 5%. The company bases its sensitivity analysis on the expected case scenario.
Ross - Chapter 08
51. What is the earnings before interest and taxes under the expected case scenario?
A. $18,000
B.
C.
D.
E.
$24,000
$36,000
$48,000
$54,000
Difficulty level: Medium
Ross - Chapter 08 #51
Topic: SCENARIO ANALYSIS
52. What is the earnings before interest and taxes under the optimistic case scenario?
A.
B.
C.
D.
E.
$22,694.40
$24,854.40
$37,497.60
$52,694.40
$67,947.60
EBIT for best case = (12,000 x 1.04) x [($14 x 1.05) - ($7 x .94)] ($36,000 x .94) - $30,000 =
$37,497.60
Difficulty level: Challenge
Ross - Chapter 08 #52
Topic: SCENARIO ANALYSIS
53. What is the earnings before interest and taxes under the pessimistic case scenario?
A.
B.
C.
D.
E.
-$566.02
-$422.40
-$278.78
$3,554.50
$5,385.60
Difficulty level: Challenge
Ross - Chapter 08 #53
Topic: SCENARIO ANALYSIS
54. What is the operating cash flow for a sensitivity analysis using total fixed costs of $32,000?
A.
B.
C.
D.
E.
$14,520
$16,520
$22,000
$44,520
$52,000
Difficulty level: Medium
Ross - Chapter 08 #54
Topic: SENSITIVITY ANALYSIS
55. What is the contribution margin for a sensitivity analysis using a variable cost per unit of $8?
A.
B.
C.
D.
E.
$3
$4
$5
$6
$7
Contribution margin = $14 - $8 = $6
Difficulty level: Medium
Ross - Chapter 08 #55
Topic: SENSITIVITY ANALYSIS
56. A firm is reviewing a project with labor cost of $8.90 per unit, raw materials cost of $21.63 a unit,
and fixed costs of $8,000 a month. Sales are projected at 10,000 units over the three-month life of
the project. What are the total variable costs of the project?
A.
B.
C.
D.
E.
$216,300
$297,300
$305,300
$313,300
$329,300
Total variable costs = ($8.90 + $21.63) x 10,000 = $305,300
Difficulty level: Medium
Ross - Chapter 08 #56
Topic: VARIABLE COST
57. A project has earnings before interest and taxes of $5,750, fixed costs of $50,000, a selling price of
$13 a unit, and a sales quantity of 11,500 units. Depreciation is $7,500. What is the variable cost per
unit?
A.
B.
C.
D.
E.
$6.75
$7.00
$7.25
$7.50
$7.75
[11,500 x ($13.00 v)] - $50,000 - $7,500 = $5,750; v = $7.50
Difficulty level: Medium
Ross - Chapter 08 #57
Topic: VARIABLE COST
58. At a production level of 5,600 units a project has total costs of $89,000. The variable cost per unit is
$11.20. What is the amount of the total fixed costs?
A.
B.
C.
D.
E.
$24,126
$26,280
$27,090
$27,820
$28,626
Total fixed cost = $89,000 (5,600 x $11.20) = $26,280
Difficulty level: Medium
Ross - Chapter 08 #58
Topic: FIXED COST
59.
At a production level of 6,000 units a project has total costs of $120,000. The variable cost per unit
is $14.50. What is the amount of the total fixed costs?
A.
B.
C.
D.
E.
$25,165
$28,200
$30,570
$32,000
$33,000
Total fixed cost = $120,000 (6,000 x $14.50) = $33,000
Difficulty level: Medium
Ross - Chapter 08 #59
Topic: FIXED COST
60. Wilson's Meats has computed its fixed costs to be $.60 for every pound of meat it sells given an
average daily sales level of 500 pounds. It charges $3.89 per pound of top-grade ground beef. The
variable cost per pound is $2.99. What is the contribution margin per pound of ground beef sold?
A.
B.
C.
D.
E.
$0.30
$0.60
$0.90
$2.99
$3.89
Contribution margin = $3.89 - $2.99 = $.90
Difficulty level: Medium
Ross - Chapter 08 #60
Topic: CONTRIBUTION MARGIN
61. Ralph and Emma's is considering a project with total sales of $17,500, total variable costs of $9,800,
total fixed costs of $3,500, and estimated production of 400 units. The depreciation expense is
$2,400 a year. What is the contribution margin per unit?
A.
B.
C.
D.
E.
$4.50
$10.50
$14.14
$19.09
$19.25
Contribution margin = ($17,500 - $9,800)
400 = $19.25
Difficulty level: Medium
Ross - Chapter 08 #61
Topic: CONTRIBUTION MARGIN
62. You are considering a new project. The project has projected depreciation of $720, fixed costs of
$6,000, and total sales of $11,760. The variable cost per unit is $4.20. What is the accounting breakeven level of production?
A. 1,200 units
B. 1,334 units
C. 1,372 units
D. 1,889 units
E. 1,910 units
Difficulty level: Medium
Ross - Chapter 08 #62
Topic: ACCOUNTING BREAK-EVEN
63. The accounting break-even production quantity for a project is 5,425 units. The fixed costs are
$31,600 and the contribution margin is $6. What is the projected depreciation expense?
A.
B.
C.
D.
E.
$700
$950
$1,025
$1,053
$1,100
Depreciation at the accounting break-even = (5,425 x $6) - $31,600 = $950
Difficulty level: Medium
Ross - Chapter 08 #63
Topic: ACCOUNTING BREAK-EVEN
64. A project has an accounting break-even point of 2,000 units. The fixed costs are $4,200 and the
depreciation expense is $400. The projected variable cost per unit is $23.10. What is the projected
sales price?
A.
B.
C.
D.
E.
$20.80
$21.00
$21.20
$25.40
$25.60
Accounting break-even Q = 2,000 = ($4,200 + $400)
(P - $23.10); P = $25.40
Difficulty level: Medium
Ross - Chapter 08 #64
Topic: ACCOUNTING BREAK-EVEN
65. A proposed project has fixed costs of $3,600, depreciation expense of $1,500, and a sales quantity of
1,300 units. What is the contribution margin if the projected level of sales is the accounting breakeven point?
A.
B.
C.
D.
E.
$3.92
$4.14
$4.50
$4.80
$5.00
Contribution margin = ($3,600 + $1,500)
1,300 = $3.92
Difficulty level: Medium
Ross - Chapter 08 #65
Topic: ACCOUNTING BREAK-EVEN
66. A project has a contribution margin of $5, projected fixed costs of $12,000, projected variable cost
per unit of $12, and a projected present value break-even point of 5,000 units. What is the operating
cash flow at this level of output?
A.
B.
C.
D.
E.
$1,000
$12,000
$13,000
$68,000
$73,000
Operating cash flow at the financial break-even point = (5,000 x $5) - $12,000 = $13,000
Difficulty level: Medium
Ross - Chapter 08 #66
Topic: PRESENT VALUE BREAK-EVEN
67. Thompson & Son has been busy analyzing a new product. It has determined that an operating cash
flow of $16,700 will result in a zero net present value, which is a company requirement for project
acceptance. The fixed costs are $12,378 and the contribution margin is $6.20. The company feels
that it can realistically capture 10% of the 50,000 unit market for this product. Should the company
develop the new product? Why or why not?
A.
B.
C.
D.
E.
Yes; because 5,000 units of sales exceeds the quantity required for a zero net present value
Yes; because the internal break-even point is less than 5,000 units
No; because the firm can not generate sufficient sales to obtain at least a zero net present value
No; because the project has an expected internal rate of return of negative 100%
No; because the project will not pay back on a discounted basis
Financial break-even point = ($12,378 + $16,700) $6.20 = 4,690; The product should be accepted
because the expected level of sales exceeds the financial break-even point.
Difficulty level: Challenge
Ross - Chapter 08 #67
Topic: PRESENT VALUE BREAK-EVEN
68. Kurt Neal and Son is considering a project with a discounted payback just equal to the project's life.
The projections include a sales price of $11, variable cost per unit of $8.50, and fixed costs of
$4,500. The operating cash flow is $6,200. What is the breakeven quantity?
A.
B.
C.
D.
E.
1,800 units
2,480 units
3,057 units
3,750 units
4,280 units
Financial break-even point = ($4,500 + $6,200)
($11 - $8.50) = 4,280
Difficulty level: Medium
Ross - Chapter 08 #68
Topic: PRESENT VALUE BREAK-EVEN
69.
At stage 2 of the decision tree it shows that if a project is successful, the payoff will be $53,000 with
a 2/3 chance of occurrence. There is also the 1/3 chance of a $-24,000 payoff. The cost of getting to
stage 2 (1 year out) is $44,000. The cost of capital is 15%. What is the NPV of the project at stage
1?
A.
B.
C.
D.
E.
$-13,275
$-20,232
$ 2,087
$ 7,536
Can not be calculated without the exact timing of future cash flows.
Feedback: $-44,000 + [((2/3($53,000)) + (1/3($-24,000))) / 1.15] = $-20,232
Difficulty level: Medium
Ross - Chapter 08 #69
Topic: DECISION TREE NET PRESENT VALUE
The Quick-Start Company has the following pattern of potential cash flows with its planned
investment in a new cold weather starting system for fuel injected cars.
Ross - Chapter 08
70.
If the company has a discount rate of 17%, what is the value closest to time 1 net present value?
A.
B.
C.
D.
E.
$ 48.6 million
$ 80.9 million
$108.2 million
$181.4 million
None of the above.
Difficulty level: Challenge
Ross - Chapter 08 #70
Topic: DECISION TREE
71. If the company has a discount rate of 17%, should it decide to invest?
A.
B.
C.
D.
E.
yes, NPV = $2.2 million
yes, NPV = $21.6 million
no, NPV = -$1.9 million
yes, NPV = $ 8.6 million
No, since more than one branch is NPV = 0 or negative, the firm must reject.
Difficulty level: Challenge
Ross - Chapter 08 #71
Topic: DECISION TREE
72.
The Mini-Max Company has the following cost information on its new prospective project.
Calculate the accounting break-even point.
Initial investment: $700
Fixed costs: $200 per year
Variable costs: $3 per unit
Depreciation: $140 per year
Price: $8 per unit
Discount rate: 12%
Project life: 5 years
Tax rate: 34%
A.
B.
C.
D.
E.
25 units per year
68 units per year
103 units per year
113 units per year
None of the above.
Feedback: Contribution Margin = ($8 - $3) (1 0.34) = $3.30
Difficulty level: Challenge
Ross - Chapter 08 #72
Topic: ACCOUNTING BREAK-EVEN
73. The Mini-Max Company has the following cost information on its new prospective project.
Calculate the present value break-even point.
Initial investment: $700
Fixed costs are $ 200 per year
Variable costs: $ 3 per unit
Depreciation: $ 140 per year
Price: $8 per unit
Discount rate: 12%
Project life: 3 years
Tax rate: 34%
A.
B.
C.
D.
E.
68 units per year
75 units per year
84 units per year
114 units per year
None of the above.
Difficulty level: Challenge
Ross - Chapter 08 #73
Topic: PRESENT VALUE BREAK-EVEN
74. From the information below, calculate the accounting break-even point.
Initial investment: $2,000
Fixed costs are $2,000 per year
Variable costs: $6 per unit
Depreciation: $250 per year
Price: $20 per unit
Discount rate: 10%
Project life: 4 years
Tax rate: 34%
A.
B.
C.
D.
E.
88 units per year
100 units per year
143 units per year
161 units per year
None of the above.
Contribution Margin = ($20 - $6) (10.34) = $9.24
Difficulty level: Challenge
Ross - Chapter 08 #74
Topic: ACCOUNTING BREAK-EVEN
75. Given the following information, calculate the present value break-even point.
Initial investment: $2,000
Fixed costs: $2,000 per year
Variable costs: $6 per unit
Depreciation: $250 per year
Price: $20 per unit
Discount rate: 10%
Project life: 4 years
Tax rate: 34%
A.
B.
C.
D.
E.
100 units per year
143 units per year
202 units per year
286 units per year
None of the above.
Difficulty level: Challenge
Ross - Chapter 08 #75
Topic: PRESENT VALUE BREAK-EVEN
76. You are considering a project which has been assigned a discount rate of 8%. If you start the project
today, you will incur an initial cost of $480 and will receive cash inflows of $350 a year for three
years. If you wait one year to start the project, the initial cost will rise to $520 and the cash flows
will increase to $385 a year for three years. What is the value of the option to wait?
A.
B.
C.
D.
E.
$15.23
$17.08
$18.67
$20.20
$50.20
Difficulty level: Challenge
Ross - Chapter 08 #76
Topic: TIMING OPTIONS
77. Wilson's Antiques is considering a project that has an initial cost today of $10,000. The project has a
two-year life with cash inflows of $6,500 a year. Should Wilson's decide to wait one year to
commence this project, the initial cost will increase by 5% and the cash inflows will increase to
$7,500 a year. What is the value of the option to wait if the applicable discount rate is 10%?
A.
B.
C.
D.
E.
$1,006.76
$1,235.54
$1,509.28
$1,606.76
$1,735.54
Difficulty level: Challenge
Ross - Chapter 08 #77
Topic: TIMING OPTIONS
78. Your firm is considering a project with a five-year life and an initial cost of $120,000.The discount
rate for the project is 12%. The firm expects to sell 2,100 units a year. The cash flow per unit is $20.
The firm will have the option to abandon this project after three years at which time it expects it
could sell the project for $50,000. At what level of sales should the firm be willing to abandon this
project?
A.
B.
C.
D.
E.
420 units
1,041 units
1,479 units
1,618 units
2,500 units
Difficulty level: Challenge
Ross - Chapter 08 #78
Topic: OPTION TO ABANDON
79. Your firm is considering a project with a five-year life and an initial cost of $120,000.The discount
rate for the project is 12%. The firm expects to sell 2,100 units a year. The cash flow per unit is $20.
The firm will have the option to abandon this project after three years at which time it expects it
could sell the project for $50,000. You are interested in knowing how the project will perform if the
sales forecast for years four and five of the project are revised such that there is a 50% chance that
the sales will be either 1,400 or 2,500 units a year. What is the net present value of this project given
your sales forecasts?
A.
B.
C.
D.
E.
$23,617
$23,719
$25,002
$26,877
$28,746
Difficulty level: Challenge
Ross - Chapter 08 #79
Topic: OPTION TO ABANDON
80. Margerit is reviewing a project with projected sales of 1,500 units a year, a cash flow of $40 a unit
and a three-year project life. The initial cost of the project is $95,000. The relevant discount rate is
15%. Margerit has the option to abandon the project after one year at which time she feels she could
sell the project for $60,000. At what level of sales should she be willing to abandon the project?
A.
B.
C.
D.
E.
899 units
923 units
967 units
1,199 units
1,206 units
Difficulty level: Challenge
Ross - Chapter 08 #80
Topic: OPTION TO ABANDON
Essay Questions
81. What is the benefit of scenario analysis if it does not produce an accept or reject decision for a
proposed project?
Scenario analysis provides management with a look at potential outcomes given various assumptions
and helps measure the potential for project failure. This information provides a basis upon which
management can apply their wisdom and knowledge to make the accept or reject decision. However, the
final decision does require human judgment.
Ross - Chapter 08 #81
Topic: SCENARIO ANALYSIS
82. Consider the following statement by a project analyst: "I analyzed my project using scenarios for the
base case, best case, and worst case. I computed break-evens and degrees of operating leverage. I did
sensitivity analysis and simulation analysis. I computed NPV, IRR, payback, AAR, and PI. In the
end, I have over a hundred different estimates and am more confused than ever. I would have been
better off just sticking with my first estimate and going by my gut reaction." Critique this statement.
The goal of evaluating an NPV estimate or other decision criteria is to determine the reasonableness of
it. If done properly, the added analysis will heighten either the degree of comfort or the degree of
discomfort about a project. Ultimately, this type of analysis reveals both the weaknesses and the
strengths of a project. Furthermore, it helps isolate potential trouble areas and sharpens the focus on
which variables are most crucial for forecasting. The very nature of the process still leaves a great deal
of uncertainty even after all of the analysis is complete. However, in the end, the analyst should be better
informed and more comfortable in making a decision, not less so.
Ross - Chapter 08 #82
Topic: EVALUATION
83. The Marx Brewing Company recently installed a new bottling machine. The machine's initial cost is
$2,000, and can be depreciated on a straight line basis to a zero salvage in 5 years. The machine's
per year fixed cost is $1,800, and its variable cost is $0.50 per unit. The selling price per unit is
$1.50. Marx's tax rate is 34%, and it uses a 16% discount rate. Calculate the accounting break-even
point on the new machine, as well as the present value break-even point on the new machine.
Accounting break-even is:
$1,800 + ($400)(1 0.34) / ($1.50 - $0.5)(1-.34) = 2,200 units
Present value break-even is:
EAC = $2,000/(PVIFA.16,5) = $2,000/3.2743 = $610.81
PV BEP = [EAC + FC(1-Tc)-Dep(Tc)]/(CM(1-Tc))
= [$610.81 + $1,800(1-.34) - $400(.34)] / ($1.50 - $0.50)(1-.34) = 2,519 units
Ross - Chapter 08 #83
Topic: PRESENT VALUE BREAK-EVEN
84. Discuss two shortcomings in the standard decision tree analysis that a financial manager should be
cognizant of?
First, there is differential risk at various stages of the tree should imply the use of different discount
rates. Second, the firm has different options than following a negative NPV path and may alter the total
outcome under poor future stages.
Ross - Chapter 08 #84
Topic: DECISION TREE
85. Sensitivity analysis is a method which allows for evaluation of the NPV given a series of changes to
the underlying assumptions. Discuss why and how scenario analysis is used in addition to sensitivity
analysis.
Sensitivity analysis:
measures input of changing one input at a time.
variables may change simultaneously in reality.
estimates may be overly optimistic or pessimistic.
Scenario analysis:
a variant of sensitivity analysis.
allows for multiple factor influences.
examines a number of different scenarios.
minimizes the false sense of security that may come from sensitivity analysis.
Ross - Chapter 08 #85
Topic: SENSITIVITY AND SENARIOS ANALYSIS
86. The market value of an investment project should be viewed as the sum of the standard NPV and the
value of managerial options. Explain three different real or managerial options that management
may have, what they are, and how they would influence market value.
To expand project favorable market reaction
Contract business under conditions of poor demand, etc.
Abandonment, equipment replacement, opening and closing facilities.
Ross - Chapter 08 #86
Topic: OPTIONS IN CAPITAL BUDGETING
ch8 Summary
Category
# of Questions
Difficulty level: Challenge
Difficulty level: Easy
Difficulty level: Medium
15
22
43
Ross - Chapter 08
89
Topic: ABANDONMENT
1
Topic: ACCOUNTING BREAK-EVEN
9
Topic: BREAK-EVEN
1
Topic: BREAK-EVEN ANALYSIS
Topic: CONTRIBUTION MARGIN
Topic: DECISION TREE
Topic: DECISION TREE NET PRESENT VALUE
Topic: DECSION TREE
Topic: EQUIVALENT ANNUAL COST
Topic: EVALUATION
Topic: FIXED COST
Topic: FIXED COSTS
Topic: INVESTMENT TIMING DECISION
Topic: MONTE CARLO SIMULATION
Topic: OPTION TO ABANDON
Topic: OPTION TO EXPAND
Topic: OPTION TO WAIT
Topic: OPTIONS IN CAPITAL BUDGETING
Topic: PRESENT VALUE BREAK-EVEN
Topic: SCENARIO ANALYSIS
Topic: SENSITIVITY ANALYSIS
Topic: SENSITIVITY AND SCENARIOS ANALYSIS
Topic: SENSITIVITY AND SENARIO ANALYSIS
Topic: SENSITIVITY AND SENARIOS ANALYSIS
Topic: SIMULATION
Topic: SIMULATION ANALYSIS
Topic: TIMING OPTIONS
Topic: TYPES OF BREAK-EVEN ANALYSIS
Topic: VARIABLE COST
Topic: VARIABLE COSTS
1
3
5
1
1
1
1
2
3
1
2
3
2
1
2
9
9
12
1
1
1
2
1
2
1
2
5