MAS Preboard Ctdi May 2018 Answers

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MANAGEMENT ADVISORY SERVICES 11 1st Preboard

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May 2018

ECONOMICS

1. Which one of the following statements about supply and demand is true? a. If supply increases and demand remains constant, equilibrium price will rise. b. If demand increases and supply increases, equilibrium quantity will fall. c. If demand increases and supply decreases, equilibrium price will increase. d. If demand increases and supply remains constant, equilibrium price will fall. Choice "c" is correct. If quantity q uantity demanded for a product goes up, this drives price up. dditionally, dditionally, if supply decreases, this will also drive prices u p. !herefore, it is a certainty that price will be driven up, given an increase in demand and a decrease in supply. Choice "a" is incorrect. Increased supply will reduce not increase# prices, assuming demand remains constant. Choice "b" is incorrect. Increased demand will increase price, and increased supply will reduce price. !he net impact on price cannot be determined without more facts. Choice "d" is incorrect. Increased demand will increase not reduce# price, assuming supply remains constant. $. When the supply of and demand for a good both increase% a. &quilibrium price will increase. b. &quilibrium price will decrease. c. &quilibrium price may increase, decrease, or remain unchanged. d. &quilibrium quantity may increase, decrease, or remain unchanged. CPA-03694 Explanation

Choice "c" is correct. When the supply of and demand for a good both increase, equilibrium quantity increases. 'owever, 'owever, the impact on price is indeterminate. If demand and supply increase by the same amount, price will remain unchanged as illustrated above#. 'owever, if demand increases by more than supply, supply, price will increase. Conversely, Conversely, if supply increases by more than demand, price will decrease. Choices "a" and "b" are incorrect, since the impact on price is indeterminate. Choice "d" is incorrect, since equilibrium quantity will increase. (.  basic basic determinant of the elasticity of demand for a normal good is the% a. )ength of time producers have to respond to mar*et changes. b. +umber of substitutes available for the product. c. +umber of sellers of the product. d. +umber of complements available for the product. CPA-03697 Explanation

Choice "b" is correct. !he change in demand for a product, based upon a given change in that products price, is dependent on whether or not other presumably cheaper# goods can be substituted for the product. Choice "a" is incorrect. !he elasticity of supply not demand# would ta*e into account the response time producers might have to mar*et changes. Choice "c" is incorrect. !he number of sellers is irrelevant when calculating the elasticity of demand. Choice "d" is incorrect.  complement complement goods demand is the same as the primary good. -or eample, an increase in the demand for a given food would cause the demand for its complement to also increase. !he increased demand of the complement is irrelevant when calculating the elasticity of demand. /. In the long run in a competitive mar*et, a maimum or ceiling price set below the equilibrium price will% a. Cause a surplus to be produced. b. 'ave no effect on the mar*et. c. Cause a shortage to be created. d. 0esult in a decrease in price. CPA-03728 Explanation

Choice "c" is correct. etting a ceiling price below the price dictated by mar*et forces which is the equilibrium price set by the supply and demand curves# would create ecess demand for the product at its reduced price# and, consequently, consequently, a shortage. Choice "a" is incorrect.  surplus would be produced if a floor price under which no supplier could sell# were set above the equilibrium price, because suppliers would supply ecess product at the inflated price. Choices "b" and "d" are incorrect, per the above eplanation. 2. !he *in*ed demand curve is associated with%

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a. !he analysis of agricultural mar*ets. b. !he analysis of monopolistic competition. c. !he analysis of pure competition. d. !he analysis of oligopoly. CPA-03446 Explanation

Choice "d" is correct. !he demand curve for any individual oligopolist is *in*ed sharply downward. !his occurs because, in oligopoly mar*et conditions, the other firms in the mar*et will match any price reduction so they do not lose mar*et share but will not match any price increase of an individual firm. !herefore, for the individual firm attempting to raise its prices beyond equilibrium, consumers will quic*ly buy from other firms in the mar*et and demand will drop off sharply creating a *in*ed demand curve. Choices "a", "b", and "c" are incorrect, per the above eplanation. 3. If consumption is 456b, investment 426b, government spending 4$6b, eports 45b, and imports 42b, what is 789? a. 412$b. b. 41(:b. c. 41/6b. d. 41/$b. CPA-03406 Explanation

Choice "d" is correct. ;y the ependiture approach to measuring 789, 789, 789 equals% Consumption < Investment < 7overnment pending < &ports &ports = Imports. !hus, 789 > 56 < 26 < $6 < 5 = 2 > 1/$b. CPA-03407 Type1 M/C A-D Corr Ans D PM!24 " 2-02

/1. C9=6(/65 C- 5:$ 9age 15 5. When a wor*er quits wor* to stay at home with the children, it is an eample of% a. -rictional unemployment. b. tructural unemployment. c. Cyclical unemployment. d. +ot counted in unemployment figures. CPA-03407 Explanation

Choice "d" is correct. @nemployment only tallies wor*ers actively see*ing e mploymentA it does not count retirees or stay=at=home parents. Choice "a" is incorrect. -rictional unemployment describes wor*ers who leave wor* voluntarily to see* a better position. Choice "b" is incorrect. tructural unemployment describes wor*ers whose s*ills are no longer needed. Choice "c" is incorrect. Cyclical unemployment describes wor*ers unemployed due to the business cycle. (6. C9=6((3: 1;.C6$ = 1( 9age 1/ :. @nder the ependiture approach, 789 can be calculated as the sum of% a. Consumption, money supply, government purchases, and eports. b. Consumption, investment, transfer payments, and imports. c. Consumption, investment, government purchases, and net eports. d. Consumption, investment, government purchases, and foreign echange. CPA-03368 Explanation

Choice "c" is correct. @nder the ependiture approach, 789 is calculated as the sum of% consumption ependitures  investment ependitures  government purchases  net eports. Choice "a" is incorrect. ee definition above. Choice "b" is incorrect. ee definition above. Choice "d" is incorrect. ee definition above. B.  recession recession can be caused by% a. n increase in aggregate demand. b.  decrease in aggregate supply. c.  decrease in aggregate demand. d. ;oth "b" and "c". CPA-03233 Explanation

Choice "d" is correct. ;oth choices "b" and "c" can cause a recession.  recession is defined as a period of falling 789 and rising unemployment. 789 will fall if there is a decrease in aggregate demand or a decrease in aggregate supply. supply. Choice "a" is incorrect. n increase in aggregate demand will cause 789 to increase +! decrease. Choice "b" is incorrect, per the above eplanation. Choice "c" is incorrect, per the above eplanation. CPA-03246 Type1 M/C A-D Corr Ans C PM!# " 2-01

2. C9=6($/3 C9=6($/3 1;.C6$ = $6 9age ( 16.  period period during which real 789 is rising and unemployment is falling is called an#% a. 0ecession. b. 9ea*. c. &pansion. d. !rough. CPA-03246 Explanation

Choice "c" is correct. 8uring an epansion, real 789 is rising and unemployment is falling.

2

a. !he analysis of agricultural mar*ets. b. !he analysis of monopolistic competition. c. !he analysis of pure competition. d. !he analysis of oligopoly. CPA-03446 Explanation

Choice "d" is correct. !he demand curve for any individual oligopolist is *in*ed sharply downward. !his occurs because, in oligopoly mar*et conditions, the other firms in the mar*et will match any price reduction so they do not lose mar*et share but will not match any price increase of an individual firm. !herefore, for the individual firm attempting to raise its prices beyond equilibrium, consumers will quic*ly buy from other firms in the mar*et and demand will drop off sharply creating a *in*ed demand curve. Choices "a", "b", and "c" are incorrect, per the above eplanation. 3. If consumption is 456b, investment 426b, government spending 4$6b, eports 45b, and imports 42b, what is 789? a. 412$b. b. 41(:b. c. 41/6b. d. 41/$b. CPA-03406 Explanation

Choice "d" is correct. ;y the ependiture approach to measuring 789, 789, 789 equals% Consumption < Investment < 7overnment pending < &ports &ports = Imports. !hus, 789 > 56 < 26 < $6 < 5 = 2 > 1/$b. CPA-03407 Type1 M/C A-D Corr Ans D PM!24 " 2-02

/1. C9=6(/65 C- 5:$ 9age 15 5. When a wor*er quits wor* to stay at home with the children, it is an eample of% a. -rictional unemployment. b. tructural unemployment. c. Cyclical unemployment. d. +ot counted in unemployment figures. CPA-03407 Explanation

Choice "d" is correct. @nemployment only tallies wor*ers actively see*ing e mploymentA it does not count retirees or stay=at=home parents. Choice "a" is incorrect. -rictional unemployment describes wor*ers who leave wor* voluntarily to see* a better position. Choice "b" is incorrect. tructural unemployment describes wor*ers whose s*ills are no longer needed. Choice "c" is incorrect. Cyclical unemployment describes wor*ers unemployed due to the business cycle. (6. C9=6((3: 1;.C6$ = 1( 9age 1/ :. @nder the ependiture approach, 789 can be calculated as the sum of% a. Consumption, money supply, government purchases, and eports. b. Consumption, investment, transfer payments, and imports. c. Consumption, investment, government purchases, and net eports. d. Consumption, investment, government purchases, and foreign echange. CPA-03368 Explanation

Choice "c" is correct. @nder the ependiture approach, 789 is calculated as the sum of% consumption ependitures  investment ependitures  government purchases  net eports. Choice "a" is incorrect. ee definition above. Choice "b" is incorrect. ee definition above. Choice "d" is incorrect. ee definition above. B.  recession recession can be caused by% a. n increase in aggregate demand. b.  decrease in aggregate supply. c.  decrease in aggregate demand. d. ;oth "b" and "c". CPA-03233 Explanation

Choice "d" is correct. ;oth choices "b" and "c" can cause a recession.  recession is defined as a period of falling 789 and rising unemployment. 789 will fall if there is a decrease in aggregate demand or a decrease in aggregate supply. supply. Choice "a" is incorrect. n increase in aggregate demand will cause 789 to increase +! decrease. Choice "b" is incorrect, per the above eplanation. Choice "c" is incorrect, per the above eplanation. CPA-03246 Type1 M/C A-D Corr Ans C PM!# " 2-01

2. C9=6($/3 C9=6($/3 1;.C6$ = $6 9age ( 16.  period period during which real 789 is rising and unemployment is falling is called an#% a. 0ecession. b. 9ea*. c. &pansion. d. !rough. CPA-03246 Explanation

Choice "c" is correct. 8uring an epansion, real 789 is rising and unemployment is falling.

2

Choice "a" is incorrect.  recession is when real 789 is falling +! rising. Becker CPA Review, PassMaster Questions Lecture: Business 

! D $66B 8eEryF;ec*er 8eEryF;ec*er &ducational 8evelopment Corp. ll rights reserved.

Choice "b" is incorrect.  pea* is the highest point of economic activity. activity. It is the point where real 789 is at its highest level in the cycle and unemployment is at its lowest level in the cycle. Choice "d" is incorrect.  trough is the lowest level of economic activity. It is the point where real 789 is at its lowest level in the cycle and unemployment is at its highest level in the cycle. COS" BE#A$IOR

11. !he management of 8in*y !ree !rimming believes that the number of trees trimmed each month is an appropriate activity measure for total operating cost. hown below are the number of trees trimmed and operating costs in each of the last three months%

Trees rees Trimm rimmed ed Oper Operat atin ing g Cost Cost March..................... 12 $2,600 April....................... 18 $2,990 May........................ 20 $,2!0 What is 8in*ys cost formula for monthly operating cost using the least=squares regression method? # G > 4/5:./6 < 4153.:6H ;# G > 41,3$2 < 4:1.$2H C# G > 41,322 < 455.26H 8# G > 4:,:/6 < 4153.:6H ns% C C;% nalytic IC9 IC9 ;;% Critical !hin*ing ppendi% 2 )% 2 )evel% 'ard olution% !he solution using icrosoft &cel functions is% slope > 455.26 per tree intercept > 41,322 per month

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IC9 IC9 -+% 0eporting

1$. Gour boss would li*e you to estimate the fied and variable components of a particular cost. ctual data for this cost over four recent periods appear below%

#eriod 1...... #eriod 2...... #eriod ...... #eriod ......

Acti"ity 26 29 2! 2

Cost $269 $28! $2!6 $2!

@sing the least=squares regression method, what is the cost formula for this cost? # G > 46.66 < 416.$(H ;# G > 4B5.66 < 43.26H C# G > 4B1./6 < 43.5$H 8# G > 4BB.16 < 42.11H ns% ; C;% nalytic IC9 ;;% Critical !hin*ing ppendi% 2 )% 2 )evel% 'ard

IC9 -+% 0eporting

olution% !he solution using icrosoft &cel functions is% slope > 43.26 per activity unit intercept > 4B5.66 per period @se the following to answer questions 1(=12% Callaghan Corporation is a wholesaler that sells a single product. anagement has provided the following cost data for two levels of monthly sales volume. !he company sells the product for 41(:.$6 per unit.

%ales "ol&me '&nits(....................... 6,000 ),000 Cost o* sales................................... $99,200 $!82,00 %elling and administrati"e costs..... $28!,600 $0,800

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1(. !he best estimate of the total monthly fied cost is% # 4153,/66 ;# 4:(2,266 C# 45:/,:66 8# 4::3,$66 ns%  C;% nalytic )% 1,( )evel% edium

IC9 ;;% Critical !hin*ing

olution%

+ariale component o* cost o* goods sold+ariale cost  Change in costs/Change in &nits +ariale cost  '$!82,00  $99,200(/'),000  6,000( +ariale cost  $8.20 ied cost3igh "ol&me- $!82,00  $8.20 4 ),000  $0 5o "ol&me- $99,200  $8.20 4 6,000  $0 +ariale component o* selling and administrati"e epenses+ariale cost  Change in costs/Change in &nits +ariale cost  '$0,800  $28!,600(/'),000  6,000( +ariale cost  $18.20 ied cost3igh "ol&me- $0,800  $18.20 4 ),000  $1)6,00 5o "ol&me- $28!,600  $18.20 4 6,000  $1)6,00 Total "ariale cost per &nit$8.20 7 $18.20  $101.0 Total *ied cost$0 7 $1)6,00  $1)6,00

#


1/. !he best estimate of the total variable cost per unit is% # 4:(.$6 ;# 41$3.36 C# 4161./6 8# 41(6.:6 ns% C )% 1,(

C;% nalytic )evel% edium


olution%

+ariale component o* cost o* goods sold+ariale cost  Change in costs/Change in &nits +ariale cost  '$!82,00  $99,200(/'),000  6,000( +ariale cost  $8.20 ied cost3igh "ol&me- $!82,00  $8.20 4 ),000  $0 5o "ol&me- $99,200  $8.20 4 6,000  $0 +ariale component o* selling and administrati"e epenses+ariale cost  Change in costs/Change in &nits +ariale cost  '$0,800  $28!,600(/'),000  6,000( +ariale cost  $18.20 ied cost3igh "ol&me- $0,800  $18.20 4 ),000  $1)6,00 5o "ol&me- $28!,600  $18.20 4 6,000  $1)6,00 Total "ariale cost per &nit$8.20 7 $18.20  $101.0 Total *ied cost$0 7 $1)6,00  $1)6,00

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12. !he best estimate of the total contribution margin when 3,(66 units are sold is% # 45(,6:6 ;# 4$(1,:/6 C# 4/3,3$6 8# 4(/3,266 ns% ; C;% nalytic )% 1,(,/ )evel% edium



olution%

+ariale component o* cost o* goods sold+ariale cost  Change in costs/Change in &nits +ariale cost  '$!82,00  $99,200(/'),000  6,000( +ariale cost  $8.20 ied cost3igh "ol&me- $!82,00  $8.20 4 ),000  $0 5o "ol&me- $99,200  $8.20 4 6,000  $0 +ariale component o* selling and administrati"e epenses+ariale cost  Change in costs/Change in &nits +ariale cost  '$0,800  $28!,600(/'),000  6,000( +ariale cost  $18.20 ied cost3igh "ol&me- $0,800  $18.20 4 ),000  $1)6,00 5o "ol&me- $28!,600  $18.20 4 6,000  $1)6,00 Total "ariale cost per &nit$8.20 7 $18.20  $101.0 Total *ied cost$0 7 $1)6,00  $1)6,00 %ales re"en&e '$18.20 4 6,00(......................... $8)0,660 +ariale epenses+ariale cost o* goods sold '$8.20 4 6,00(... $!2,160 +ariale selling and administrati"e epense '$18.20 4 6,00(........................................... 11,660 68,820 Contri&tion margin............................................ $ 21,80 @se the following to answer questions 13=1:% Comparative income statements for ;oggs ports &quipment Company for the last two months are presented below%

%ales in &nits.................................................... %ales................................................................. Cost o* goods sold............................................ ross margin.................................................... %elling and administrati"e epenses:ent............................................................... %ales commissions........................................ Maintenance epenses.................................. Clerical epense............................................ Total selling and administrati"e epenses........ ;et operating income....................................... 7

&ly A&g&st 11,000 10,000 $16!,000 $1!0,000 )2,600 66,000 92,00 8,000 12,000 1,200 1,!00 16,000 !,)00 $ ),)00

12,000 12,000 1,000 1!,000 !2,000 $ 2,000

ll of the companys costs are either fied, variable, or a miture of the two i.e., mied#. ssume that the relevant range includes all of the activity levels mentioned in this problem. 13. Which of the selling and administrative epenses of the company is variable? # 0ent ;# ales Commissions C# aintenance &pense 8# Clerical &pense ns% ; C;% nalytic )% 1 )evel% &asy 15. !he # ;# C# 8#



total monthly fied cost for ;oggs porting &quipment Company is% 41$,666 4$$,266 4$2,666 4/6,666

ns% C )% 1,(

C;% nalytic )evel% 'ard


8


olution%

+ariale component o* sales commissions+ariale cost  Change in costs/Change in &nits +ariale cost  '$1,200  $12,000(/'11,000  10,000( +ariale cost  $1.20 ied cost o* sales commissions3igh "ol&me- $1,200  $1.20 4 11,000  $0 'anser ill e
9

1:. If sales are proJected to be :,666 units in eptember, total epected selling and administrative epenses would be% # 4/B,(66 ;# 4/1,366 C# 4//,526 8# 4/3,366 ns% 8 )% 1,(

C;% nalytic )evel% edium



olution%

+ariale component o* sales commissions+ariale cost  Change in costs/Change in &nits +ariale cost  '$1,200  $12,000(/'11,000  10,000( +ariale cost  $1.20 ied cost o* sales commissions3igh "ol&me- $1,200  $1.20 4 11,000  $0 'anser ill e a < bH, what does the KbL represent? # total cost ;# total fied cost C# total variable cost 8# variable cost per unit ns% 8 C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% 1 )evel% edium $6. In the standard cost formula G > a < bH, what does the KHL represent? # total cost ;# total fied cost C# units of activity 8# variable cost per unit 10

ns% C C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% 1 )evel% &asy

11

12

13

C$P

$1. ;rea*=even analysis assumes that% # !otal revenue is constant. ;# @nit variable epense is constant. C# @nit fied epense is constant. 8# elling prices must fall in order to generate more revenue. ns% ; C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% 2 )evel% &asy $$. !arget profit analysis is used to answer which of the following questions? # What sales volume is needed to cover all epenses? ;# What sales volume is needed to cover fied epenses? C# What sales volume is needed to earn a specific amount of net operating income? 8# What sales volume is needed to avoid a loss? ns% C C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% 3 )evel% &asy

14

$(. !he margin of safety can be calculated by% # ales M -ied epensesFContribution margin ratio#. ;# ales M -ied epensesFEariable epense per unit#. C# ales M -ied epenses < Eariable epenses#. 8# ales M +et operating income. ns%  C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% 5 )evel% edium $/. If the degree of operating leverage is /, then a one percent change in quantity sold should result in a four percent change in% # unit contribution margin. ;# revenue. C# variable epense. 8# net operating income. ns% 8 C;% nalytic IC9 ;;% Critical !hin*ing )% : )evel% &asy ource% CA adapted


$2. Which of the following is the correct calculation for the degree of operating leverage? # net operating income divided by total epenses. ;# net operating income divided by total contribution margin. C# total contribution margin divided by net operating income. 8# variable epense divided by total contribution margin. ns% C C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% : )evel% &asy $3. 8ata concerning Nardas Corporations single product appear below%

#er >nit %elling price....................... $10 +ariale epenses............... 28 Contri&tion margin........... $112

#ercent o* %ales 100? 20? 80?

!he company is currently selling :,666 units per month. -ied epenses are 451B,666 per month. !he mar*eting manager believes that a 4$6,666 increase in the monthly advertising budget would result in a 1:6 unit increase in monthly sales. What should be the overall effect on the companys monthly net operating income of this change? # decrease of 4136 ;# increase of 4$6,136 C# decrease of 4$6,666 8# increase of 4136 ns% 8 C;% nalytic )% / )evel% &asy



olution%

%ales '8,000 &nits, 8,180 &nits 4 $10(.......... +ariale epenses '$1,120,000, $1,1!,200 4 20?(................ Contri&tion margin....................................... ied epenses................................................ ;et operating income.....................................

8,000 &nits $1,120,000

8,180 &nits $1,1!,200

22,000 896,000 )19,000 $ 1)),000

229,00 916,160 )9,000 $ 1)),160

@ncrease in net operating income- $1)),160  $1)),000  $160 $5.Chovanec Corporation produces and sells a single product. 8ata concerning that product appear below% 1#

#er >nit %elling price....................... $1)0 +ariale epenses............... 68 Contri&tion margin........... $102

#ercent o* %ales 100? 0? 60?

-ied epenses are 42$1,666 per month. !he company is currently selling 5,666 units per month. anagement is considering using a new component that would increase the unit variable cost by 43. ince the new component would increase the features of the companys product, the mar*eting manager predicts that monthly sales would increase by 266 units. What should be the overall effect on the companys monthly net operating income of this change? # decrease of 4/:,666 ;# decrease of 43,666 C# increase of 4/:,666 8# increase of 43,666 ns% 8 C;% nalytic )% / )evel% &asy



olution%

%ales '),000 &nits, ),!00 &nits 4 $1)0(............ +ariale epenses '),000 &nits 4 $68, ),!00 &nits 4 $)(......... Contri&tion margin......................................... ied epenses................................................. ;et operating income.......................................

),000 &nits $1,190,000

),!00 &nits $1,2)!,000

)6,000 )1,000 !21,000 $ 19,000

!!!,000 )20,000 !21,000 $ 199,000

@ncrease in net operating income- $199,000  $19,000  $6,000 $:.Cherry treet ar*et reported the following information for the sales of their only product, cherries sold by the pint%

%ales................................... +ariale epenses............... Contri&tion margin........... ied epenses................... ;et operating income.........

Total #er >nit $1,!00 $.!0 9,!0 1.! 22,0!0 $.1! 1,000 $ 9,0!0

Cherry treet would li*e to increase their selling price by 26 cents per unit, and feel that this will decrease sales volume by 16O. hould Cherry treet increase the price, and what will the effect be on net operating income? # GesA 4(,266 increase ;# GesA 4B/2 increase C# +oA no change 8# +oA 4B/2 decrease ns% ; C;% nalytic )% / )evel% edium



olution%

C&rrent sales 'dollars(  C&rrent per &nit price 4 C&rrent sales '&nits( $1,!00  $.!0 4 C&rrent sales '&nits( ),000  C&rrent sales '&nits(

%ales '),000 &nits 4 $.!0, 6,00 &nits 4 $!.00(... +ariale epenses '),000 &nits 4 $1.!, 6,00 &nits 4 $1.!(......... Contri&tion margin............................................... 16

),000 &nits $1,!00

6,00 &nits $1,!00

9,!0 22,0!0

8,!0! 22,99!

ied epenses....................................................... ;et operating income................................... .......... @ncrease in net operating income- $9,99!  $9,0!0  $9!

17

1,000 $ 9,0!0

1,000 $ 9,99!

$B.  company ma*es a single product that it sells for 413 per unit. -ied costs are 453,:66 per month and the product has a contribution margin ratio of /6O. If the companys actual sales are 4$$/,666, its margin of safety is% # 4($,666 ;# 4B3,666 C# 41$:,666 8# 41B$,666 ns%  C;% nalytic )% 2A 5 )evel% edium

IC9 ;;% Critical !hin*ing ource% CIA adapted


olution% ;rea*=even in total sales dollars > -ied epensesFC ratio > 453,:66F6./66 > 41B$,666 argin of safety in dollars > ales = ;rea*=even sales > 4$$/,666 = 41B$,666 > 4($,666 (6. ;endel Inc. has an operating leverage of 5.(. If the companys sales increase by (O, its net operating income should increase by about% # $/(.(O ;# 5.(O C# $1.BO 8# (.6O ns% C C;% nalytic )% : )evel% &asy



olution% 9ercent increase in net operating income > 9ercent increase in sales P 8egree of operating leverage > (O P 5.( > $1.BO $ARIABLE %&LL COS"IN'

(1.In its first year of operations, ;ronfren Corporation produced :66,666 sets and sold 5:6,666 sets of artificial tan lines. What would have happened to net operating income in this first year under the following costing methods if ;ronfren had produced $6,666 fewer sets? ssume that ;ronfren has both variable and fied production costs.#

A( B( C( (

+ariale costing @ncrease ecrease ecrease ;o e**ect

Asorption costing @ncrease @ncrease ecrease ecrease

ns% 8 C;% nalytic )% $ )evel% edium



($. When sales are constant, but the production level fluctuates, net operating income determined by the variable costing method will% # fluctuate in direct proportion to changes in production. ;# remain constant. C# fluctuate inversely with changes in production. 8# be greater than net operating income under absorption costing. ns% ; C;% nalytic )% $ )evel% edium



((. @nder the variable costing method, which of the following is always epensed in its entirety in the period in which it is incurred? # fied manufacturing overhead cost ;# fied selling and administrative epense C# variable selling and administrative epense 18

8#

all of the above

ns% 8 C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% $ )evel% 'ard

19

(/. Which of the following will usually be found on an income statement prepared using the absorption costing method?

Contri&tion Margin A( Des B( Des C( ;o ( ;o

ross Margin Des ;o Des ;o

ns% C C;% 0eflective !hin*ing IC9 ;;% Critical !hin*ing IC9 -+% 0eporting )% $ )evel% &asy (2. +et operating income under variable and absorption costing will generally% # always be equal. ;# never be equal. C# be equal only when production and sales are equal. 8# be equal only when production eceeds sales. ns% C C;% nalytic )% ( )evel% edium



(3. manufacturing company that produces a single product has provided the following data concerning its most recent month of operations%

%elling price...............................................

$9)

>nits in eginning in"entory..................... >nits prod&ced........................................... >nits sold................................................... >nits in ending in"entory...........................

0 2,200 2,100 100

+ariale costs per &nitirect materials....................................... irect laor............................................. +ariale man&*act&ring o"erhead........... +ariale selling and administrati"e.........

$2 $2! $2 $9

ied costsied man&*act&ring o"erhead............... $8,800 ied selling and administrati"e............. $),800 What is the total period cost for the month under the absorption costing approach? # 423,566 ;# 432,266 C# 4:,:66 8# 4(5,:66 ns%  C;% nalytic )% 1 )evel% &asy



olution%

Total "ariale selling and administrati"e cost  $9 4 2,100  $18,900 #eriod cost  +ariale selling and administrati"e cost 7 ied selling and administrati"e cost  $18,900 7 $),800  $!6,)00

20

(5. ullee Corporation produces a single product and has the following cost structure%

;&mer o* &nits prod&ced each year..................... ),000 +ariale costs per &nitirect materials................................................... $!1 irect laor......................................................... $12 +ariale man&*act&ring o"erhead....................... $2 +ariale selling and administrati"e epense....... $! ied costs per yearied man&*act&ring o"erhead........................... $1,000 ied selling and administrati"e epense........... $112,000 !he unit product cost under absorption costing is% # 41/B ;# 432 C# 43( 8# 41$: ns% 8 C;% nalytic )% 1 )evel% &asy


olution% @nit fied manufacturing overhead > 4//1,666 Q 5,666 > 43( @nit product cost > 43( < 421 < 41$ < 4$ > 41$:

21


(:. toneberger Corporation produces a single product and has the following cost structure%

;&mer o* &nits prod&ced each year..................... ,000 +ariale costs per &nitirect materials................................................... $!0 irect laor......................................................... $)2 +ariale man&*act&ring o"erhead....................... $6 +ariale selling and administrati"e epense....... $ ied costs per yearied man&*act&ring o"erhead........................... $296,000 ied selling and administrati"e epense........... $)6,000 !he unit product cost under variable costing is% # 41$: ;# 41$2 C# 4$6$ 8# 41(1 ns%  C;% nalytic )% 1 )evel% &asy


olution% @nit product cost > 426 < 45$ < 43 > 41$:

22


(B. ;eamish Inc., which produces a single product, has provided the following data for its most recent month of operations%

;&mer o* &nits prod&ced..................................... +ariale costs per &nitirect materials................................................... irect laor......................................................... +ariale man&*act&ring o"erhead....................... +ariale selling and administrati"e epense....... ied costsied man&*act&ring o"erhead........................... ied selling and administrati"e epense...........

8,000 $) $!6 $ $2 $12,000 $8,000

!here were no beginning or ending inventories. !he unit product cost under absorption costing was% # 4B( ;# 4B5 C# 41(3 8# 41B/ ns% C C;% nalytic )% 1 )evel% &asy


olution% @nit fied manufacturing overhead > 4(1$,666 Q :,666 > 4(B @nit product cost > 4(5 < 423 < 4/ < 4(B > 41(3

23


/6. Nray Inc., which produces a single product, has provided the following data for its most recent month of operations%

;&mer o* &nits prod&ced............................................... ,000 +ariale costs per &nitirect materials............................................................ $91 irect laor................................................................... $1 +ariale man&*act&ring o"erhead................................. $) +ariale selling and administrati"e epense................. $6 ied costsied man&*act&ring o"erhead..................................... $2),000 ied selling and administrati"e epense..................... $16!,000 !here were no beginning or ending inventories. !he unit product cost under variable costing was% # 4111 ;# 41B6 C# 4115 8# 4116 ns%  C;% nalytic )% 1 )evel% &asy



olution% @nit product cost > 8irect materials < 8irect labor < Eariable manufacturing overhead > 4B1 < 41( < 45 > 4111 CAPI"AL B&('E"IN'

/1. Which of the following capital budgeting techniques i$nores the time value of money? a. paybac* period b. net present value c. internal rate of return d. profitability inde +%  8I-% &asy ;R% 1/=$ /$. Which of the following capital budgeting techniques may potentially ignore part of a proJects relevant cash flows? a. net present value b. internal rate of return c. paybac* period d. profitability inde +% C 8I-% &asy ;R% 1/=$ /(. In comparing two proJects, the SSSSSSSSSSS is often used to evaluate the relative ris*iness of the proJects. a. paybac* period b. net present value c. internal rate of return d. discount rate +%  8I-% &asy ;R% 1/=$ //. ssume that a proJect consists of an initial cash outlay of 4166,666 followed by equal annual cash inflows of 4/6,666 for / years. In the formula H > 4166,666F4/6,666, H represents the a. paybac* period for the proJect. b. profitability inde of the proJect. c. internal rate of return for the proJect. d. proJects discount rate. +%  8I-% &asy ;R% 1/=$ /2. If investment  has a paybac* period of three years and investment ; has a paybac* period of four years, then a.  is more profitable than ;. 24

b.  is less profitable than ;. c.  and ; are equally profitable. d. the relative profitability of  and ; cannot be determined from the information given. +% 8

8I-% &asy

;R% 1/=$

/3. If a proJect generates a net present value of Tero, the profitability inde for the proJect will a. equal Tero. b. equal 1. c. equal =1. d. be undefined. +% ; 8I-% &asy ;R% 1/=( /5. If the profitability inde for a proJect eceeds 1, then the proJects a. net present value is positive. b. internal rate of return is less than the proJects discount rate. c. paybac* period is less than 2 years. d. accounting rate of return is greater than the proJects internal rate of return. +%  8I-% &asy ;R% 1/=( /:. If a proJects profitability inde is less than 1, the proJects a. discount rate is above its cost of capital. b. internal rate of return is less than Tero. c. paybac* period is infinite. d. net present value is negative. +% 8

8I-% &asy

;R% 1/=(

/B. 'opwood Corporation bought a piece of machinery. elected data is presented below% @seful life Gearly net cash inflow alvage value Internal rate of return Cost of capital

3 years 4/2,666 =6= 1:O 1/O

!he initial cost of the machinery was a. 4125,(B$. b. 415/,BB$. c. 4132,:1$. d. 41//,(32. +%  @se 9E of nnuity for 3 years and 1:O 4/2,666 U (./B53 > 4125,(B$ 26.n investment proJect is epected to yield 416,666 in annual revenues, has 4$,666 in fied costs per year, and requires an initial investment of 42,666. 7iven a cost of goods sold of 36 percent of sales, what is the paybac* period in years? a. $.26 b. 2.66 c. $.66 d. 1.$2 +%  +et cash flow > 416,666 = 43,666 = 4$,666 +et cash flow > 4$,666 42,666F4$,666 > $.26 years COS" O% CAPI"AL

21. 8etermine the after=ta# percentage cost of a 426 million debt issue that the attingly Corporation is planning to place privately with a large insurance company. ssume that the 2#

company has a /6O marginal ta rate. !his long=term debt issue will yield 1$O to the insurance company. a. /.:O b. 5.$O c. 1$.6O d. 3.:O nswer% b 9roblem type% fter=ta cost of debt calculation olution% *i > *d1 = !# > 1$O 1= 6./6# > 5.$O 2$. Calculate the after=ta cost of preferred stoc* for hio Ealley 9ower Company, which is planning to sell 4166 million of 4(.$2 cumulative preferred stoc* to the public at a price of 4$2 per share. -lotation costs are 41.66 per share. hio Ealley has a marginal income ta rate of /6O. a. 1(.6O b. 5.:O c. :.1$O d. 1(.2/O nswer% d 9roblem type% Cost of preferred calculation olution% *p > 4(.$2F4$2 = 41# > 1(.2/O 2(. !he llegheny Ealley 9ower Company common stoc* has a beta of 6.:6. If the current ris*=free rate is 3.2O and the epected return on the stoc* mar*et as a whole is 13O, determine the cost of equity capital for the firm using the C9#. a. 1/.1O b. 5.3O c. 3.2O d. 1$.1O nswer% a 9roblem type% Cost of equity C9# olution% *e > r f < V*m = r f # > 3.2O < 6.:613O = 3.2O# > 1/.1O

2/. !he following financial information is available on 0awls anufacturing Company% Current per share mar*et price 4/:.66 Current t > 6# per share dividend 4(.26 &pected long=term growth rate 2.6O 0awls can issue new common stoc* to net the company 4// per share. 8etermine the cost of internal equity capital using the dividend capitaliTation model approach. Compute answer to the nearest 6.1O#. a. 1$.(O b. 1(./O c. 1(.6O d. 1$.5O nswer% d 9roblem type% Cost of internal equity = constant growth dividend valuation model olution% *e > 4(.261.62#F4/: < 6.62 > 6.1$33 or 1$.5O# 22. !he following financial information is available on 0awls anufacturing Company% Current per share mar*et price 4/:.66 ;eta 1.1 &pected rate of return on mar*et 1$.6O 0is*=free rate 3.6O 0awls can issue new common stoc* to net the company 4// per share. 8etermine the cost of internal equity capital using the capital asset pricing model approach. Compute answer to the nearest 6.1O#. 26

a. 1$.BO b. 1$.3O c. 1(.6O d. 1(.23O nswer% b 9roblem type% Cost of equity = C9 approach olution% *e > r f < V*m= r f # > 6.63 < 1.16.1$ = 6.63# > 6.1$3 > 1$.3O 23. lpha 9roducts maintains a capital structure of /6 percent debt and 36 percent common equity. !o finance its capital budget for net year, the firm will sell 426 million of 11 percent debentures at par and finance the balance of its 41$2 million capital budget with retained earnings. +et year lpha epects net income to grow 5 percent to 41/6 million, and dividends also are epected to increase 5 percent to 41./6 per share and to continue growing at that rate for the foreseeable future. !he current mar*et value of lphas stoc* is 4(6. If the firm has a marginal ta rate of /6 percent, what is its weighted cost of capital for the coming year? a. B.3/O b. :.3(O c. B.:/O d. 16.:(O nswer% a 9roblem type% Weighted cost of capital olution% *e > 41./6F4(6 < 6.65 > 6.1135 *a > 6.36.1135# < 6./6.11#1 = 6./# > 6.6B3/ or B.3/O 25. 7roves, Inc. pays an annual dividend of 41.$$. !his dividend is epected to continue growing at a rate of about 2 percent each year. !he firm is in a fairly ris*y business and has a beta of 1./2. !he epected mar*et rate of return is 1(.2 percent, and the ris*=free rate is B.( percent. What is the cost of equity for 7roves? a. 1B.3O b. 1(.2O c. 12./O d. 3.1O nswer% c 9roblem type% Cost of equity = C9 olution% *e > 6.6B( < 1./26.1(2 = 6.6B(# > 6.12/ 2:. Witins stoc* price is currently 4(/.$2 and the current quarterly dividend is 46.$2. Consensus estimates for Witin indicate a growth rate in earnings of 16O into the foreseeable future. If Witin plans to sell 1 million shares to raise new capital for epansion, what is the cost of new equity if the issuance costs are :O? a. 1(./BO b. 16.:5O c. 1(.$1O d. 1(.15O nswer% a 9roblem type% Cost of equity olution% *e > 1.661.16# < .16 > .1(/B or 1(./BO (1.21 2B. California ;est C;#, a sport shoe store, epects an operating income of 4$.( million this year. C; has no long=term debt. !he firm is considering as epansion proJect. !he current ris*=free rate of return is 5O and the current mar*et ris* premium is :.(O. If C;s beta is $6O greater than the overall mar*et, what is the firms cost of capital? ssume that C; has a marginal ta rate of /6O. a. :.(O b. 13.B3O c. B.B3O d. 12.(O nswer% b 9roblem type% Cost of equity olution% *a > *e > 5O < 1.$:.(O# > 13.B3O

27

36. Columbia 7as Companys C7# current capital structure is (2O debt and 32O equity. !his year C7 has earnings after ta of 42.(1 million and is paying 41.3 million in dividends. !o finance a transmission pipeline, C7 can borrow 4$ million at a cost of 16O, the same rate that C7 is currently paying on a total of 412 million long=term debt. C7 has 1,666,666 shares outstanding and its current mar*et price is 4(1. If C7s long=term growth rate of dividends is epected to be :O, what is the weighted cost of capital for the firm? ssume a marginal ta rate of /6O. a. 16.BO b. 1(.3O c. 1B.3O d. 13.BO nswer% a 9roblem type% Weighted cost of capital olution% *d > 16O1 = 6./# > 3O *e > 41.31.6:#F4(1 < 6.6: > .1(3 or 1(.3O *a > 6.(23O# < 6.321(.3O# > 16.BO LE$ERA'E AN( CAPI"AL S"R&C"&RE

31. 'eleveton Industries is 166O equity financed. Its current beta is 1.1. !he epected mar*et ris* premium is :.2O and the ris*=free rate is /.$O. If 'eleveton changes its capital structure to $2O debt, it estimates its beta will increase to 1.$. If the after=ta cost of debt will be 3O, should 'eleveton ma*e the capital structure change? a. Ges, cost of capital decreases by $.2$O b. Ges, cost of capital decreases 1.35O. c. +o, stoc* price would decrease due to increased ris* d. +o, cost of capital increases by 6.:2O. nswer% b 9roblem type% Cost of capital olution% ld *e > /.$ < 1.1:.2# > 1(.22O > *a +ew *e > /.$ < 1.$:.2# > 1/./O +ew *a > .51/./# < .(3# > 11.::O toc* price is maimiTed where the cost of capital is minimiTed.

3$. ;ay tate !echnology has determined that its cost of equity is 12O and its after=ta cost of debt is 5.$O. ;ay tate epects to earn 41/ million after taes net year and, as a new firm, does not pay any dividends. !he stoc* sells for 4$/. ;onds are currently selling at par value. Compute ;ay tates weighted cost of capital.  partial balance sheet is shown below% Current liabilities 4 (66,666 )ong=term debt 1,666,666 Common stoc* at 41 par 166,666 9aid in capital B66,666 0etained earnings (,666,666 !otal liabilities and stoc*= holders equity 42,(66,666 a. 1(./O b. 1(.1O 28

c. 11.3O d. 1$.5O nswer% d 9roblem type% Capital structure and cost of capital olution% Capital structure% 8ebt > 41,666,666 ar*et value of &quity% 166,666 shares4$/# > $,/66,666 !otal 4(,/66,666 Capital structure% 8ebt > 41F4(./ > $B./1O &quity>$./F(./ > 56.2BO *a > 6.$B/15.$O# < 6.562B12.6O# > 1$.51O 3(. ahlo is planing to diversify into the ba*ery industry. s a result, its beta should drop from 1./ to 1.$ and the epected long=term growth rate of dividends will drop from 1$O to BO. !he ris*=free rate is /O, the epected mar*et ris* premium is BO, and the current dividend per share paid by ahlo is 4$.16. hould ahlo complete the diversification into the ba*ery industry? a. +o, stoc* price drops about 411.56 b. Ges, stoc* price increases about 4B./6 c. Ges, stoc* price increases about 41.:6 d. +o, stoc* price drops about 4B./6 nswer% a 9roblem type% Cost of capital olution% Current *e > 6.6/ < 1./6.6B# > 6.133 or 13.3O 96 > 4$.161.1$# F 6.133 = 6.1$# > 421.1( +ew *e > 6.6/ < 1.$6.6B# > 6.1/: or 1/.:O 3/. !he less a firms business ris*, the the amount of structure, holding constant all other relevant factors. a. lessA financial leverage b. moreA financial leverage c. lessA equity capital d. moreA debt capital nswer% b !opic% ;usiness ris*

that will be used in the optimal capital

32. Illinois !ool Companys I!C# fied operating costs are 41,$36,666 and its variable cost ratio i.e., variable costs as a fraction of sales# is 6.56. !he firm has 4(,666,666 in bonds outstanding at an interest rate of : percent. I!C has (6,666 shares of 42 preferred stoc* and 126,666 shares of common stoc* outstanding. I!C is in the 26 percent corporate income ta brac*et. -orecasted sales for net year are 4B million. What is I!Cs degree of operating leverage at a sales level of 4B million? a. 1.36 b. 1.:52 c. (.6 d. /.6 nswer% b !opic% 8egree of operating leverage calculation olution% 8) > X4B,666,666 = 6.54B,666,666#YFX4B,666,666 = 6.54B,666,666# = 41,$36,666Y > 1.:52

33. Illinois !ool Companys I!C# fied operating costs are 41,$36,666 and its variable cost ratio i.e., variable costs as a fraction of sales# is 6.56. !he firm has 4(,666,666 in bonds outstanding at an interest rate of : percent. I!C has (6,666 shares of 42 preferred stoc* and 126,666 shares of common stoc* outstanding. I!C is in the 26 percent corporate income ta brac*et. -orecasted sales for net year are 4B million. What is I!Cs degree of financial leverage at an &;I! level of 41,//6,666. a. 1.$6 b. 1.:52 c. (.6 d. 1.36 nswer% d !opic% 8egree of financial leverage calculation 29

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