File: ch23, Chapter 23: Incremental Analysis and Capital Budgeting

Multiple Choice

1. Three of the steps in managements decision process are: (1) Review results of decision. (2) Develop data relevant to each course of action. (3) Make the decision. The steps are performed in the following order. a) (1), (2), (3). b) (3), (2), (1). c) (2), (1), (3). d) (2), (3), (1). Ans: d Response A: The order of the steps in the decision process is (2) develop data relevant to each course of action, (3) make the decision and (1) review the results of decision. Response B: The order of the steps in the decision process is (2) develop data relevant to each course of action, (3) make the decision and (1) review the results of decision. Response C: The order of the steps in the decision process is (2) develop data relevant to each course of action, (3) make the decision and (1) review the results of decision. Response D: Correct! The order of the steps in the decision process is (2) develop data relevant to each course of action, (3) make the decision and (1) review the results of decision.

2. Incremental analysis is the process of identifying the financial data that: a) do not change under alternative courses of action. b) change under alternative courses of action. c) are mixed under alternative courses of action. d) No correct answer is given. Ans: b Response A: Incremental analysis is the process of identifying the financial data that change under alternative courses of action. Response B: Correct! Incremental analysis is the process of identifying the financial data that change under alternative courses of action. Response C: Incremental analysis is the process of identifying the financial data that change under alternative courses of action. Response D: Since b is correct, this answer cannot be correct.

3. It costs a company $14 of variable costs and $6 of fixed costs to produce product A that sells for $30. A foreign buyer offers to purchase 3,000 units at $18 each. If the special offer is accepted and produced with unused capacity, net income will: a) decrease $6,000. b) increase $6,000. c) increase $12,000. d) increase $9,000. Ans: c Response A: If the offer is produced with unused capacity, fixed costs will not increase. The amount of the sales price above variable costs will contribute to covering fixed costs. The firm will have $12,000 [3,000 units X ($18 - $14)] more than if it does not accept the offer. Thus, net income will increase by $12,000.

Response B: If the offer is produced with unused capacity, fixed costs will not increase. The amount of the sales price above variable costs will contribute to covering fixed costs. The firm will have $12,000 [3,000 units X ($18 - $14)] more than if it does not accept the offer. Thus, net income will increase by $12,000. Response C: Correct! If the offer is produced with unused capacity, fixed costs will not increase. The amount of the sales price above variable costs will contribute to covering fixed costs. The firm will have $12,000 [3,000 units X ($18 - $14)] more than if it does not accept the offer. Thus, net income will increase by $12,000. Response D: If the offer is produced with unused capacity, fixed costs will not increase. The amount of the sales price above variable costs will contribute to covering fixed costs. The firm will have $12,000 [3,000 units X ($18 - $14)] more than if it does not accept the offer. Thus, net income will increase by $12,000.

4. In a make-or-buy decision, relevant costs are: a) manufacturing costs that will be saved. b) the purchase price of the units. c) opportunity costs. d) all of the above. Ans: d Response A: Manufacturing costs that will be saved are relevant costs in a make-or-buy decision, but d is a better answer. Response B: The purchase price of the units are relevant costs in a make-or-buy decision, but d is a better answer. Response C: Opportunity costs are relevant costs in a make-or-buy decision, but d is a better answer. Response D: Correct! All the costs mentioned above are relevant in a make-or-buy decision. Therefore this is the correct answer.

5. The decision rule in a sell-or-process-further decision is: Process further as long as the incremental revenue from such processing exceeds: a) incremental processing costs. b) variable processing costs. c) fixed processing costs. d) No correct answer is given. Ans: a Response A: Correct! The decision rule in a sell-or-process-further decision is to process further as long as the incremental revenue from such processing exceeds incremental processing costs. Response B: The decision rule in a sell-or-process-further decision is to process further as long as the incremental revenue from such processing exceeds incremental processing costs, not variable processing costs. Response C: The decision rule in a sell-or-process-further decision is to process further as long as the incremental revenue from such processing exceeds incremental processing costs, not fixed processing costs. Response D: Since a is correct, this answer cannot be correct.

6. In a decision to retain or replace equipment, the book value of the old equipment is a(n): a) opportunity cost. b) sunk cost. c) incremental cost. d) marginal cost.

Ans: b Response A: In the decision to retain or replace equipment, the book value of the old equipment is a sunk cost, not an opportunity cost. Response B: Correct! In the decision to retain or replace equipment, the book value of the old equipment is a sunk cost. This is because the book value reflects the original cost less accumulated depreciation and neither of these values are relevant to the decision. Response C: In the decision to retain or replace equipment, the book value of the old equipment is a sunk cost, not an incremental cost. Response D: In the decision to retain or replace equipment, the book value of the old equipment is a sunk cost, not a marginal cost.

7. If an unprofitable segment is eliminated: a) net income will always increase. b) variable expenses of the eliminated segment will have to be absorbed by other segments c) fixed expenses allocated to the eliminated segment will have to be absorbed by other segments. d) net income will always decrease. Ans: c Response A: Net income can either increase or decrease if a segment is eliminated. Response B: When a segment is eliminated, the variable costs of that segment will also be eliminated and will not need to be absorbed by other segments. Response C: Correct! Even though the segment is eliminated, the fixed costs allocated to that segment will still have to be covered. This is done by having other segments absorb the fixed costs of the segment to be eliminated. Response D: Net income can either increase or decrease if a segment is eliminated.

8. If the contribution margin per unit is $15 and it takes 3.0 machine hours to produce the unit, the contribution margin per unit of limited resource is: a) $25. b) $5. c) $45. d) No correct answer is given. Ans: b Response A: The contribution margin per unit of limited resource is computed by dividing the contribution margin per unit by the amount of limited resource required to produce the unit. In this case, $15/3 hours = $5 contribution margin per unit of limited resource. Response B: Correct! The contribution margin per unit of limited resource is computed by dividing the contribution margin per unit by the amount of limited resource required to produce the unit. In this case, $15/3 hours = $5 contribution margin per unit of limited resource. Response C: The contribution margin per unit of limited resource is computed by dividing the contribution margin per unit by the amount of limited resource required to produce the unit. In this case, $15/3 hours = $5 contribution margin per unit of limited resource. Response D: Since b is correct, this answer cannot be correct.

9. Which of the following is incorrect about the annual rate of return technique? a) The calculation is simple. b) The accounting terms used are familiar to management. c) The timing of the net cash flows is not considered. d) The time value of money is considered.

Ans: d Response A: This is an accurate statement about the annual rate of return technique. Response B: This is an accurate statement about the annual rate of return technique. Response C: This is an accurate statement about the annual rate of return technique. Response D: Correct! The time value of money is not considered in the annual rate of return technique.

10. A positive net present value means that the: a) projects rate of return is less than the cutoff rate. b) projects rate of return exceeds the required rate of return. c) projects rate of return equals the required rate of return. d) project is unacceptable. Ans: b Response A: When the net present value is positive, the return on the project is higher than, not less than the required rate of return. Response B: Correct! When the net present value is positive, the return on the project is higher than the required rate of return. Response C: When the net present value is positive, the return on the project is higher than, not equal to the required rate of return. Response D: When the net present value is positive, the project is acceptable, not unacceptable.