Question 1

When computing payback period, the year in which a capital investment is made is year 1.

Accepted Answer

The year in which a capital investment is made is considered year 0 in computing the payback period, as this is the initial outlay year, and the counting of years for payback typically starts from the following year (year 1).

Question 2

An opportunity cost is the potential benefit that is lost by taking a specific action when two or more alternative choices are available.

Accepted Answer

This statement accurately defines what an opportunity cost is. It refers to the trade-off between the two or more available options and the potential benefits that could have been received from choosing the alternative option.

Question 3

The concept of incremental cost is the same as the concept of differential cost.

Accepted Answer

The concepts of incremental cost and differential cost are interchangeable and refer to the additional cost incurred from making a particular decision over an alternative option.

Question 4

Capital budgeting is the process of analyzing alternative long-term investments and deciding which assets to acquire or sell.

Accepted Answer

Capital budgeting is indeed the process of evaluating and selecting long-term investment opportunities. It involves assessing the potential benefits and risks associated with each option and choosing the most profitable one.

Question 5

Relevant benefits refer to the additional or incremental revenue generated by selecting a particular course or action over another.

Accepted Answer

Relevant benefits are indeed the additional revenue generated by selecting a particular course of action over another.

Question 6

An out-of-pocket cost requires a current and/or future outlay of cash.

Accepted Answer

An out-of-pocket cost refers to an expense that requires a current or future cash outlay. Therefore, the statement "an out-of-pocket cost requires a current and/or future outlay of cash" is true.

Question 7

If a company has the capacity to produce either 10,000 units of Product X or 10,000 units of Product Y; assuming fixed costs remain constant, production restrictions are the same for both products, and the markets for both products are unlimited; the company should commit 100% of its capacity to the product that has the higher contribution margin.

Accepted Answer

Committing 100% of its capacity to the product with the higher contribution margin will maximize the company's profits. Even if the market for Product X or Product Y is unlimited, focusing on the one with the higher contribution margin will ensure that the company is making the most profit per unit produced.

Question 8

In ranking choices with the break-even time (BET) method, the investment with the highest BET measure gets the highest rank.

Accepted Answer

In ranking choices with the break-even time (BET) method, the investment with the lowest BET measure gets the highest rank. This is because a lower BET indicates that the investment will break even sooner and start generating profits.

Question 9

A special order of goods or services should always be accepted when the incremental revenue exceeds the incremental costs.

Accepted Answer

While incremental revenue exceeding incremental costs is a key consideration, other factors such as capacity constraints, impact on regular sales, and long-term strategic goals should also be considered before accepting a special order.

Question 10

Another name for relevant cost is unavoidable cost.

Accepted Answer

Relevant costs are costs that are affected by a specific decision and are therefore avoidable if that decision is not made. Unavoidable costs, on the other hand, cannot be avoided regardless of the decision made. Therefore, relevant cost and unavoidable cost are not the same thing.

Question 11

Significant sunk costs are relevant to decisions about the future.

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered, so they should not influence future decision-making since they cannot be changed by any future actions.

Question 12

A sunk cost will change with a future course of action.

Accepted Answer

A sunk cost is a cost that has already been incurred and cannot be recovered. Therefore, it is a fixed cost that is unaffected by future course of action.

Question 13

Part of the decision to accept additional business should be based on a comparison of the incremental (differential) costs of the added production with the additional revenues to be received.

Accepted Answer

This statement is true. When considering taking on additional business, it is essential to analyze the incremental (differential) costs of the added production compared to the additional revenues that can be received. This analysis helps determine if taking on more business is financially viable and profitable.

Question 14

If the internal rate of return (IRR) of an investment is below the hurdle rate, the project should be accepted.

Accepted Answer

If the internal rate of return (IRR) of an investment is below the hurdle rate, it means that the project is not expected to generate a return higher than the minimum required return, and therefore, it should not be accepted.

Question 15

Capital budgeting decisions are risky because the outcome is uncertain, large amounts are usually involved, the investment involves a long-term commitment, and the decision could be difficult or impossible to reverse.

Accepted Answer

Capital budgeting decisions involve significant financial commitments, and the outcome is often uncertain due to various factors such as market volatility, changing economic conditions, and unforeseen risks. Moreover, the investments usually involve a long-term commitment, and reversing the decision may not be possible or could be extremely difficult. As a result, capital budgeting decisions are inherently risky, and managers must carefully evaluate the potential risks and returns before committing significant resources.

Question 16

In a make or buy decision, management should focus on costs that are constant under the two alternatives.

Accepted Answer

In a make or buy decision, management should focus on all the relevant costs associated with each alternative, not just the constant costs. These costs may include variable costs, opportunity costs, and intangible costs. Therefore, it is false to say that management should only focus on constant costs.

Question 17

The decision to accept an additional volume of business should be based on a comparison of the revenue from the additional business with the sunk costs of producing that revenue.

Accepted Answer

Sunk costs are costs that have already been incurred and cannot be recovered, so they should not be considered in the decision to accept additional business. The decision should be based on comparing the additional revenue with the incremental or variable costs of producing that revenue.

Question 18

Incremental costs should be considered in a make or buy decision.

Accepted Answer

Incremental costs, which are the additional costs incurred by producing an additional unit or taking a specific action, should be considered when making a decision to make or buy a product or service. This is because the decision should be based on the lowest total cost, taking into account all relevant costs, including incremental costs.

Question 19

Neither the payback period nor the accounting rate of return methods of evaluating investments considers the time value of money.

Accepted Answer

Both the payback period and accounting rate of return methods do not take into account the concept of time value of money. This means that they do not consider the fact that a dollar received in the future is worth less than a dollar received today due to inflation and other factors. This makes these methods less accurate in evaluating the profitability of investments over the long term.

Question 20

An advantage of the break-even time (BET) method over the payback period method is that it recognizes the time value of money.

Accepted Answer

The break-even time method considers the time value of money by calculating the time required for the cash inflows to equal the initial investment, taking into account the cost of capital. This makes it a more accurate measure of profitability compared to the simple payback period method that does not consider the time value of money.

Quiz 25: Capital Budgeting and Managerial Decisions