Deck 10: Project Analysis

Question 1

A capital budget shows a proposed list of investments.

Answer 1

True

Question 2

The greater the DOL, the greater the protection against operating losses during economic downturns.

Answer 2

False

Question 3

Conflicts of interest between shareholders and managers may result in the sacrifice of attractive capital budgeting proposals.

Answer 3

True

Question 4

The clothing industry is considered to have a high degree of operating leverage.

Question 5

What-if analysis is not crucial to capital budgeting.

Question 6

"What-if" questions ask what will happen to a project in various circumstances.

Question 7

Scenario analysis allows managers to look at different and sometimes inconsistent combinations of variables.

Question 8

Sensitivity analysis takes into consideration the interrelationship of variables.

Question 9

The degree of operating leverage (DOL) shows the relationship between sales and pretax profits.

Question 10

The NPV break-even level of sales will be higher than the accounting break-even level.

Question 11

If a large proportion of a firm's costs is fixed, a shortfall in sales will have a magnified effect on the firm's profits.

Question 12

What-if analysis can help identify the inputs that are most worth refining before you commit to a project.

Question 13

Scenario analysis allows managers to look at different but consistent combinations of interrelated variables.

Question 14

The level of sales that produces a zero project NPV is referred to as the accounting break-even point.

Question 15

The strategic planning portion of the capital budgeting process is essentially a "bottom-up" process.

Question 16

While sensitivity analysis is forward-looking, scenario analysis attempts to reconstruct and analyze the past.

Question 17

The option to abandon a project becomes more valuable as the possible outcomes become more varied.

Question 18

Competitive advantage is an important element of many successful capital budgeting proposals.

Question 19

Operating leverage increases with fixed cost.

Question 20

The inputs that are most worth refining before you commit to a project are the ones that have the greatest potential to alter project NPV.

Question 21

Analysis results indicate that a project's level of success is primarily dependent upon the firm controlling the variable costs. What type of analysis was conducted?

A) Sensitivity analysis
B) Break-even analysis
C) Scenario analysis
D)Real option analysis

Question 22

Which one of the following techniques may be more appropriate to analyze projects with interrelated variables?

A) Sensitivity analysis
B) Scenario analysis
C) Break-even analysis
D)DOL analysis

Question 23

Sensitivity analysis evaluates projects by:

A) forecasting changes in interest rates that would increase financing costs.
B) recording profitability changes while changing one variable at a time.
C) ensuring that the project sponsor has the proper incentives.
D)testing for interrelated variables.

Question 24

A project that breaks even in accounting terms will surely have a negative NPV.

Question 25

Which one of the following appears to be a more likely result from using sensitivity analysis?

A) Agreement on the appropriate discount rate
B) Determination of whether to finance with debt or equity
C) Isolation of the pivotal factor in project profitability
D)Selection of the best capital budgeting project

Question 26

What is the change in the NPV of a one-year project if fixed costs are increased from $400 to $600, the firm is profitable, has a 35% tax rate, and employs a 12% cost of capital?

A) -$200.00
B) -$178.57
C) -$130.00
D)-$116.07

Question 27

Which one of the following industries has the highest level of operating leverage?

A) Steel
B) Paper
C) Hotels
D)Machinery

Question 28

The capital budget should be consistent with the firm's:

A) historical growth in sales.
B) strategic plans.
C) current level of debt.
D)dividend policy.

Question 29

Which one of the following would not be included as a traditional capital budgeting project?

A) Machine replacement proposals
B) Salary adjustment proposals
C) New product proposals
D)Plant expansion proposals

Question 30

If sensitivity analysis concludes that the largest impact on profits would come from changes in the sales level, then:

A) fixed costs should be traded for variable costs.
B) variable costs should be traded for fixed costs.
C) the project should not be undertaken.
D)additional marketing analysis may be beneficial before proceeding.

Question 31

A project that simply breaks even on an accounting basis gives you your money back but does not cover the opportunity cost of the capital tied up in the project.

Question 32

What happens to the NPV of a one-year project if fixed costs are increased from $400 to $600, the firm is not profitable, has a 35% tax rate, and employs a 12% cost of capital?

A) NPV decreases by $200.00.
B) NPV decreases by $178.57.
C) NPV decreases by $130.00.
D)NPV decreases by $113.04.

Question 33

Which one of the following statements is correct concerning sensitivity analysis?

A) It ignores interrelationships between variables.
B) Several variables are allowed to change concurrently.
C) It considers all feasible variable combinations.
D)It can guarantee a project's success.

Question 34

What level of management is responsible for originating capital budgeting proposals?

A) Senior management
B) Divisional management
C) Lower management
D)All levels of management

Question 35

If sensitivity analysis indicates none of the individual variables will cause a negative NPV under pessimistic conditions, then the:

A) project is ensured to be successful.
B) project's discount rate should be reduced.
C) economic forecasts are possibly overly optimistic.
D)interaction of the variables should be considered.

Question 36

Soft capital rationing may be beneficial to a firm if it:

A) reduces a firm's taxes.
B) weeds out proposals with weaker or biased NPVs.
C) allows managers to select their favorite projects.
D)lowers the cost of capital.

Question 37

Which one of the following capital budgeting proposals is most apt to be associated with a conflict of interests?

A) The proposal with the highest NPV
B) The proposal with the longest payback period
C) The proposal with the highest IRR and quickest payback
D)The proposal to solve pollution problems cited by the EPA

Question 38

Managers that accept projects that only break even on an accounting basis are helping their shareholders.

Question 39

If a 20% reduction in forecast sales would not extinguish a project's profitability, then sensitivity analysis would suggest:

A) deemphasizing that variable as a critical factor.
B) requiring a more detailed sales forecast.
C) that the initial sales forecasts were inflated.
D)reallocating fixed costs to this product.

Question 40

The purpose of sensitivity analysis is to show:

A) the optimal level of capital expenditures.
B) how price changes affect break-even volume.
C) seasonal variation in product demand.
D)how variables in a project affect profitability.

Question 41

Break-even revenues on an accounting basis typically indicate a:

A) negative NPV for the firm.
B) positive NPV for the firm.
C) high degree of operating leverage.
D)downturn in the business cycle.

Question 42

Calculate the ratio of variable costs to sales for a firm with a $3 million accounting break-even revenue point, $1.2 million fixed costs, and $450,000 depreciation.

A) 40%
B) 45%
C) 55%
D)60%

Question 43

Using a computer model to repeatedly vary the combination of project variables in order to compare vast numbers of potential NPVs is called:

A) scenario analysis.
B) sensitivity analysis.
C) NPV break-even analysis.
D)simulation analysis.

Question 44

The accounting break-even level of revenues represents the point at which the firm has:

A) zero pretax profit.
B) zero net present value.
C) covered all opportunity costs.
D)covered the fixed and variable costs but not the depreciation.

Question 45

A firm has fixed costs of $1.2 million and depreciation of $1 million. At a sales level of $3.6 million, the variable costs of $2.304 million. What is the accounting break-even level of sales?

A) $5.23 million
B) $3.44 million
C) $6.11 million
D)$4.87 million

Question 46

What is the maximum percentage of variable costs to sales that a firm could have and still break even with $5 million in revenues, $1 million in fixed costs, and $500,000 of depreciation?

A) 30%
B) 70%
C) 80%
D)90%

Question 47

If forecasted sales exceed the accounting break-even level but are less than the economic break-even level, the project has a:

A) positive NPV but earns less than the discount rate.
B) negative NPV but earns more than the discount rate.
C) net loss on the income statement.
D)net profit on the income statement.

Question 48

Which one of the following changes, if of a sufficient magnitude, could turn a negative NPV project into a positive NPV project?

A) A decrease in the estimated annual sales
B) An increase in the discount rate
C) An increase in the initial investment
D)A decrease in the fixed costs

Question 49

What effect will a reduction in the cost of capital have on the accounting break-even level of revenues?

A) It raises the break-even level.
B) It reduces the break-even level.
C) It has no effect on the break-even level.
D)This cannot be determined without knowing the length of the investment horizon.

Question 50

If the level of sales is less than that calculated as the economic break-even level, then the:

A) project will break even in accounting terms.
B) project's EVA will be greater than zero but less than the opportunity cost of capital.
C) project will have a negative EVA.
D)discount rate should be reduced.

Question 51

Calculate the economic break-even level of sales for a project requiring an investment of $3 million and providing annual cash flows equal to 15% of sales less $250,000. None of the initial investment is recoverable. Assume the project will generate these cash flows for 10 years and the discount rate is 10%.

A) $3,254,890
B) $3,504,890
C) $4,921,575
D)$1,686,667

Question 52

A firm with 60% of sales going to variable costs, $1.5 million fixed costs, and $500,000 depreciation and sales of $3 million. How does the current level of sales compare to the accounting break-even sales level?

A) Current sales are $2 million below the break-even level.
B) Current sales are $333,333 below the break-even level.
C) Current sales are $800,000 below the break-even level.
D)Current sales exceed the break-even level by $360,000.

Question 53

A 6-year project has an economic break-even level of sales of $5 million and a discount rate of 8%. The annual cash inflows are equal to 10% of sales minus $300,000. What was the initial investment in the project assuming that none of the investment is recoverable when the project ends?

A) $416,667
B) $924,576
C) $1,016,678
D)$2,311,450

Question 54

The Corner Market has fixed costs of $1,600, depreciation of $1,200, a tax rate of 35%, and a cost of capital of 12%. Variable costs represent 67% of sales. What minimum level of sales must the market obtain to avoid a net loss on its income statement?

A) $8,484.85
B) $6,666.67
C) $7,033.33
D)$7,867.67

Question 55

Calculate the accounting break-even level of sales assuming $865,000 of fixed costs, $400,000 depreciation expense, and a variable costs-to-sales ratio of 65%.

A) $2,769,230.77
B) $3,614,285.71
C) $4,237,769.23
D)$1,946.153.85

Question 56

The accounting break-even level of sales represents the point where:

A) fixed costs are covered.
B) variable costs are covered.
C) fixed costs and variable costs are covered.
D)fixed costs, variable costs, and depreciation are covered.

Question 57

Which one of the following descriptions is representative of scenario analysis?

A) One variable at a time is allowed to change.
B) It isolates the unknowns that belong in the model.
C) Different combinations of variables are analyzed.
D)It represents the "top-down" approach.

Question 58

Which one of the following variables would you suspect to be least significant in a sensitivity analysis of a fast-food establishment?

A) Sales
B) Depreciation
C) Labor cost
D)Food cost

Question 59

Assume a 5-year project has a base-case NPV of $213,000, a tax rate of 34%, and a cost of capital of 14%. What will be the worst-case NPV if the annual cash flows are reduced in that scenario by $35,000 for each of the 5 years?

A) -$92,842.17
B) -$120,157.83
C) $92,842.17
D)$120,157.83

Question 60

Weston's has variable costs that average 68% of sales. If fixed costs increase by $1, what will be the increase in the break-even level of revenues?

A) An increase of $0.68
B) An increase of $1.00
C) An increase of $1.471
D)An increase of $3.125

Question 61

If a decision tree indicates an expected NPV of $1 million, then:

A) at least one of the outcomes had a negative NPV.
B) all of the outcomes had a positive NPV.
C) $1 million is the firm's minimum guaranteed profit.
D)the project still contains uncertainty.

Question 62

What is the fixed-cost expenditure for a firm with a DOL of 4.5 that generates pretax profits of $1 million and has $600,000 in depreciation expense?

A) $1.1 million
B) $2.1 million
C) $2.9 million
D)$3.9 million

Question 63

A project that adds zero economic value:

A) has a positive NPV.
B) has an NPV of zero.
C) has a negative NPV.
D)is at the accounting break-even point.

Question 64

The difference between an NPV break-even level of sales and an accounting break-even level of sales is the:

A) consideration of opportunity cost.
B) consideration of interest expense.
C) allowance of the sales level to vary in response to changes in demand.
D)inclusion of income taxes.

Question 65

Fixed costs including depreciation have increased at Leverage Inc., from $4 million to $5.3 million in an effort to reduce variable costs. What must the new variable cost percentage of sales be to break even from an accounting perspective at $20 million?

A) 69.2%
B) 65.8%
C) 73.5%
D)76.7%

Question 66

Which one of the following offers the most plausible scenario for a firm that maintained a constant degree of operating leverage when its level of fixed costs doubled?

A) Depreciation expense increased.
B) The variable cost percentage decreased.
C) Sales revenues declined.
D)Pretax profits decreased.

Question 67

The option for a firm to expand future production has value because:

A) future production will be profitable.
B) the option requires no investment today.
C) the future holds uncertainty.
D)today's production costs are lower than in the future.

Question 68

When management selects new production technologies that require a higher proportion of fixed costs than that of its operations, then the implementation of those technologies will:

A) decrease the DOL.
B) increase the DOL.
C) decrease the NPV-breakeven level of sales.
D)reduce the NPV of the cash flows.

Question 69

What percentage change in sales occurs if profits increase by 3% when the firm's degree of operating leverage is 4.5?

A) 0.33%
B) 0.67%
C) 3.03%
D)1.50%

Question 70

What happens to a firm with high operating leverage when the overall level of sales is very high?

A) The firm will have higher levels of fixed costs.
B) The firm will enjoy high profits.
C) The firm will not break even in accounting terms.
D)The firm will have a reduced level of depreciation.

Question 71

A firm with $600,000 of fixed costs and $200,000 of depreciation is expected to produce $225,000 in profits. What is its DOL?

A) 3.56
B) 3.67
C) 4.56
D)4.67

Question 72

According to decision-tree analysis, investment projects should be discontinued when the:

A) probability of success is less than 50%.
B) NPV is calculated to be negative.
C) DOL increases from previous levels.
D)possibility of a failing outcome exists.

Question 73

A decision tree shows a 30% probability of $2 million in returns and a 70% chance of $1 million in returns. What is the maximum you would invest today in this project if the cash inflow occurs one year in the future and the discount rate is 10%?

A) $818,181.82
B) $1,181,818.18
C) $1,300,000.00
D)$1,430,000.00

Question 74

If a firm's DOL is 3.6 with a profit of $2,000,000 and depreciation of $500,000, what are its fixed costs?

A) $5,250,000
B) $4,700,000
C) $5,520,000
D)$5,800,000

Question 75

A decision tree indicates a 30% chance of making a $250,000 profit and a 70% chance of sustaining a $140,000 loss. Given this, the project should be:

A) accepted because the amount of potential profit exceeds the amount of potential loss.
B) rejected because there is more than a 50% chance of loss.
C) accepted because the expected value is positive before discounting.
D)rejected because the expected value is negative before discounting.

Question 76

A project with which one of these sets of values would you be most apt to reject?

A) High operating leverage, sales projected at the accounting break-even level, and no option to abandon
B) High operating leverage, sales projected at the economic break-even level, and an option to abandon
C) Low operating leverage, sales projected at the accounting break-even level, and an option to abandon
D)Low operating leverage, sales projected at the economic break-even level, and an option to expand

Question 77

A firm with high operating leverage is expected to:

A) have high variable costs.
B) have low fixed costs.
C) have a high degree of profitability.
D)perform better when sales are high.

Question 78

Fixed costs:

A) are a constant percentage of sales revenues.
B) vary with the level of depreciation expense.
C) are constant over a given range of output.
D)are inversely related to the level of output.

Question 79

For a firm with a DOL of 3.5, an increase in sales of 6% will:

A) increase pretax profits by 3.5%.
B) decrease pretax profits by 3.5%.
C) increase pretax profits by 21.0%.
D)increase pretax profits by 1.71%.

Question 80

What percentage change in sales will occur if pretax profits decrease by 13.8% when the DOL is 3.8?

A) 0.28%
B) -2.75%
C) -3.63%
D)10.00%