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THEORY

1) Statement 1: In a plant operating at capacity, every machine and person in the plant would be working
at the maximum possible rate.
Statement 2: Payment of overtime to a worker in order to relax a production constraint could increase
the profits of a company.
a) Statement 1 is True, Statement 2 is False
b) Statement 1 is False, Statement 2 is True
c) Both Statements are True
d) Both Statement are False
(Garrison, 12th Ed)

2) Statement 1: In an outsourcing decision, rent received from an outside party for facility use is a
relevant cash inflow.
Statement 2: In a special order decision, unavoidable fixed costs are taken into consideration in setting
a sales price.

a) Statement 1 is True, Statement 2 is False


b) Statement 1 is False, Statement 2 is True
c) Both Statements are True
d) Both Statement are False
(Raiborn, 2nd Ed)

3) Edison Power of light has an outstanding issue of cumulative preferred stock with an annual fixed
dividend of $2.00 per share. It has not paid the preferred dividend for the last 3 years, but intends to
pay a dividend on the common stock in the coming year. Before Edison can pay a dividend on the
common stock
a) Preferred shareholders may cast all their votes for a single director.
b) Preferred shareholders must receive dividends totaling $8.00 per share.
c) Preferred shareholders must receive $2.00 per share.
d) Will not necessarily receive any dividend.
(Titman, 11th Ed)

4) Why do the NPV method and the IRR method sometimes produce different rankings of mutually
exclusive investment projects?
a) The NPV method does not assume reinvestment of cash flows while the IRR method assumes the
cash flows will be reinvested at the internal rate of return.
b) The NPV method assumes a reinvestment rate equal to the discount rate while the IRR method
assumes a reinvestment rate equal to the internal rate of return.
c) The IRR method does not assume reinvestment of the cash flows while the NPV assumes the
reinvestment rate is equal to the discount rate.
d) The NPV method assumes a reinvestment rate equal to the bank loan interest rate while the IRR
method assumes a reinvestment rate equal to the discount rate.
(Bobadilla, 2015)

5) Relevant costs of a make-or-buy decision include all of the following EXCEPT:


a) Fixed salaries that will not be incurred if the part is outsourced
b) Current direct material costs of the part
c) Special machinery for the part that has no resale value
d) Material-handling costs that can be eliminated
(Horngren, 9th Ed)

6) Project KFM requires an initial investment of $50,000, and has a net present value of $12,000. Project
PAK requires an initial investment of $100,000, and has a net present value of $13,000. The projects
are proposals for increasing revenue and are not mutually exclusive. The firm should accept:
a) Project KFM.
b) Project PAK.
c) Both projects.
d) Neither project.
(Titman, 11th Ed)

7) The primary advantages of the average rate of return method are its ease of computation and the fact
that:
a) It is especially useful to managers whose primary concern is liquidity
b) There is less possibility of loss from changes in economic conditions and obsolescence when the
commitment is short-term
c) It emphasizes the amount of income earned over the life of the proposal
d) Rankings of proposals are necessary
(Bobadilla, 2015)
8) If a project has a profitability index greater than 1,
a) The NPV will also be positive.
b) The IRR will be higher than the required rate of return.
c) The present value of future cash flows will exceed the amount invested in the project.
d) All of the above.
(Titman, 11th Ed)

9) Under the time-adjusted rate of return capital budgeting technique, it is assumed that cash flows are
reinvested at the
a) Cost of capital
b) Hurdle rate of return
c) Rate earned by the investment
d) There is no assumption about reinvestment of cash flows
(Past CPA Board Exam)

10) Statement 1: Peak-load pricing is the practice of charging a lower price for the same product or service
when the demand for it approaches the physical limit of the capacity to produce that product or service.
Statement 2: When price discrimination is effective, cost is NOT a major factor in setting prices
a) Statement 1 is True, Statement 2 is False
b) Statement 1 is False, Statement 2 is True
c) Both Statements are True
d) Both Statement are False
(Horngren, 9th Ed)
11) The relationship between payback period and IRR is that
a) A payback period of less than one-half the life of a project will yield an IRR lower than the target
rate.
b) The payback period is the present value factor for the IRR.
c) A project whose payback period does not meet the companys cutoff rate for payback will not
meet the companys criterion for IRR.
d) None of the above.
(Bobadilla, 2015)
12) Which of the following is considered to be a deficiency of the IRR?
a) It fails to properly rank capital projects.
b) It could produce more than one rate of return.
c) It fails to utilize the time value of money.
d) It is not useful in accounting for risk in capital budgeting.
(Titman, 11th Ed)
13) All other factors equal, which of the following would affect a project's internal rate of return, net
present value, and payback period?
a) An increase in the discount rate
b) A decrease in the life of the project
c) An increase in the initial cost of the project
d) All of the above
(Raiborn, 2nd Ed)

14) Which of the following is NOT considered in the calculation of incremental cash flows?
a) Depreciation tax shield
b) Sunk costs
c) Opportunity costs
d) Both A and B
(Titman, 11th Ed)

15) The basis for measuring the cost of capital derived from bonds and preferred stock, respectively, is the
a) pre-tax rate of interest for bonds and stated annual dividend rate less the expected earnings per
share for preferred stock
b) pre-tax rate of interest for bonds and stated annual dividend rate for preferred stock
c) after-tax rate of interest for bonds and stated annual dividend rate less the expected earnings per
share for preferred stock
d) after-tax rate of interest for bonds and stated annual dividend rate for preferred stock
(Raiborn, 2nd Ed)

16) A weakness of the internal rate of return method for screening investment projects is that it:
a) Does not consider the time value of money
b) Implicitly assumes that the company is able to reinvest cash flows from the project at the
companys discount rate
c) Implicitly assumes that the company is able to reinvest cash flows from the project at the internal
rate of return
d) Fails to consider the timing of cash flows
(Bobadilla, 2015)

17) In a noncompetitive environment, the key factor affecting pricing decisions is the:
a) Customers willingness to pay
b) Price charged for alternative products
c) Cost of producing and delivering the product
d) All of these answers are correct.
(Horngren, 9th Ed)
18) Which of the following would cause free cash flow to differ from operating cash flow when an
investment project is terminated?
a) Sale of assets
b) Recovery of net working capital
c) Income taxes
d) All of the above
(Titman, 11th Ed)

19) The ___________________ is the highest rate of return that can be earned from the most attractive,
alternative capital project available to the firm.
a) Accounting rate of return
b) Internal rate of return
c) Hurdle rate
d) Opportunity cost of capital
(Raiborn, 2nd Ed)

20) Collusive pricing occurs when:


a) A company wants two products to sell for the same, or almost the same, amount
b) A company wants a product to sell for the same as a competitor's product
c) Two or more companies agree to sell a product at a price higher than should be expected
d) Competitors are part of the same large parent organization
(Horngren, 9th Ed)
21) The cost to produce Part A was $20 per unit in 2013 and in 2014 it has increased to $22 per unit. In
2014, Supplier ABC has offered to supply Part A for $18 per unit. For the make-or-buy decision:
a) incremental revenues are $4 per unit
b) incremental costs are $2 per unit
c) net relevant costs are $2 per unit
d) differential costs are $4 per unit
(Horngren, 9th Ed)

22) When a profitable corporation sells an asset at a loss, the after-tax cash flow on the sale will
a) Exceed the pre-tax cash flow on the sale
b) Be less than the pre-tax cash flow on the sale
c) Be the same as the pre-tax cash flow on the sale
d) Increase the corporation's overall tax liability
(Raiborn, 2nd Ed)

23) Problems that should be avoided when identifying relevant costs include all of the following
EXCEPT:
a) Assuming all variable costs are relevant
b) Assuming all fixed costs are irrelevant
c) Using unit costs that do not separate variable and fixed components
d) Using total costs that separate variable and fixed components
(Horngren, 9th Ed)

24) Which investor incurs the greatest risk?


a) Mortgage bondholder
b) Preferred stockholder
c) Common stockholder
d) Debenture bondholder
(Titman, 11th Ed)
25) Sensitivity analysis is
a) An appropriate response to uncertainty in cash flow projection
b) Useful in measuring the variance of the Fisher rate
c) Typically conducted in the post investment audit
d) Useful to compare projects requiring vastly different levels of initial investment
(Raiborn, 2nd Ed)

26) JMC, Inc. has developed and patented a new laser disc reading device that will be marketed
internationally. Which of the following factors should JMC consider in pricing the device?
I. Quality of the new device.
II. Life of the new device.
III. Customers relative preference for quality compared to price.
a) I and II only.
b) I and III only.
c) II and III only.
d) I, II, and III.
(Wiley, 2016)

27) In a make-or-buy decision, relevant costs include:


a) unavoidable fixed costs
b) avoidable fixed costs
c) fixed factory overhead costs applied to products
d) fixed selling and administrative expenses
(Garrison, 12th Ed)

28) The owner of a small construction business has asked you to evaluate the purchase of a new front end
loader. You have determined that this investment has a large, positive, NPV, but are afraid that your
client will not understand the method. A good alternative method in this circumstance might be
a) The payback method
b) The profitability index
c) The internal rate of return
d) The modified internal rate of return
(Titman, 11th Ed)

29) Which of the following minimize the risks of outsourcing?


a) the use of short-term contracts that specify price
b) the responsibility for on-time delivery is now the responsibility of the supplier
c) building close relationships with the supplier
d) All of these answers are correct.
(Horngren, 9th Ed)

30) When demand for a product is inelastic and prices are increased, usually demand will:
a) Increase, and operating profits will increase
b) Remain the same, and operating profits will increase
c) Decrease, and operating profits will decrease
d) Remain the same, and operating profits will decrease
(Horngren, 9th Ed)

PROBLEM

Yekahs Pizzas, Inc., operates pizza shops in several cities. One of the companys most profitable shops is
located adjacent to the large CPA review center in Manila. A small bakery next to the shop has just gone
out of business, and Yekahs Pizzas has an opportunity to lease the vacated space for P18,000 per year
under a 15-year lease. Yekahs management is considering two ways in which the available space might be
used.

Alternative 1. The pizza shop in this location is currently selling 40,000 pizzas per year. Management is
confident that sales could be increased by 75% by taking out the wall between the pizza shop and the
vacant space and expanding the pizza outlet. Costs for remodeling and for new equipment would be
P550,000. Management estimates that 20% of the new sales would be small pizzas, 50% would be medium
pizzas, and 30% would be large pizzas. Selling prices and costs for ingredients for the three sizes of pizzas
follow (per pizza):

Selling Price Cost of Ingredients


Small P 6.70 P1.30
Medium 8.90 2.40
Large 11.00 3.10

An additional P7,500 of working capital would be needed to carry the larger volume of business. This
working capital would be released at the end of the lease term. The equipment would have a salvage value
of P30,000 in 15 years, when the lease ends.
Alternative 2. Yekahss sales manager feels that the company needs to diversify its operations. He has
suggested that an opening be cut in the wall between the pizza shop and the vacant space and that video
games be placed in the space, along with a small snack bar. Costs for remodeling and for the snack bar
facilities would be P290,000. The games would be leased from a large distributor of such equipment. The
distributor has stated that based on the use of game centers elsewhere, Yekahs could expect about 26,000
people to use the center each year and to spend an average of P5 each on the machines. In addition, it is
estimated that the snack bar would provide a net cash inflow of P15,000 per year. An investment of P4,000
in working capital would be needed. This working capital investment would be released at the end of the
lease term. The snack bar equipment would have a salvage value of about P12,000 in 15 years.
Yekahs management is unsure which alternative to select and has asked you to help in making the
decision. You have gathered the following information relating to added costs that would be incurred each
year under the two alternatives:

Expand the Pizza Shop Install the Game Center


Rent- building space P18,000 P18,000
Rent- video games --- 30,000
Salaries 54,000 17,000
Utilities 13,200 5,400
Insurance and other 7,800 9,600

The company is currently using a 16 percent minimum acceptable rate of return for its capital investment.
The present value of annuity of 1 at 16 percent for 15 periods is 5.575 and end of 15 periods is 0.108. The
company is not liable to pay income taxes.
1. The incremental expected annual cash inflows from Alternative 1 is:
a. P 90,000 c. P100,200
b. P108,000 d. P201,000

2. The incremental expected annual cash inflows from Alternative 2 is:


a. P 17,000 c. P 59,600
b. P 65,000 d. P145,000

3. The net present value for Alternative 1 is:


a. P48,650 c. P45,000
b. P47,840 d. P32,500.

4. The net present value for Alternative 2 is:


a. P21,021 c. P68,375
b. P70,103 d. P12,807

5. Assume that the company decides to accept alternative 2. At the end of the first year, the company
finds that only 21,000 people used the game center during the year (each person spent P5 on
games). Also, the snack bar provided a net cash inflow of only P13,000. In light of this
information, what is the net present value for alternative 2?
a. P (80,422) c. P(82,150)
b. P (76,422) d. P(80,854)

6. The sales manager has suggested that an advertising program be initiated to draw another 5,000
people into the game center each year. Assuming that another 5,000 people can be attracted into
the center and that the snack bar receipts increase to the level originally estimated, how much can
be spent on advertising each year and still allow the game center to provide a 16% rate of return?
a. P 70,103.00 c. P58,953.00
b. P 4,673.53 d. P12,574.53
(Bobadilla, 2015)

MAMA V Corporation budgeted the following costs for the production of its one and only product for the
next fiscal year:

Direct materials $1,125,000


Direct labor 780,000
Manufacturing overhead
Variable 840,000
Fixed 645,000
Selling and administrative
Variable 360,000
Fixed 480,000
Total costs $4,230,000

Oscar has an annual target operating income of $900,000.

7. The markup percentage for setting prices as a percentage of total manufacturing costs is:
A) 51% B) 125% C) 185% D) 245%

8. The markup percentage for setting prices as a percentage of variable manufacturing costs is:
A) 54% B) 87% C) 169% D) 122%

9. The markup percentage for setting prices as a percentage of variable costs is:
A) 328% B) 36% C) 228% D) 65%

(Horngren, 9th Ed)

RIKKI Engine Company manufactures part TE456 used in several of its engine models. Monthly
production costs for 1,000 units are as follows:

Direct materials $ 20,000

Direct labor 5,000

Variable overhead costs 15,000

Fixed overhead costs 10,000

Total costs $50,000

It is estimated that 10% of the fixed overhead costs assigned to TE456 will no longer be incurred if the
company purchases TE456 from the outside supplier. RIKKI Engine Company has the option of purchasing
the part from an outside supplier at $42.50 per unit.

10. If RIKKI Engine Company accepts the offer from the outside supplier, the monthly avoidable
costs (costs that will no longer be incurred) total:
a. $ 41,000
b. $ 49,000
c. $ 25,000
d. $50,000

11. If RIKKI Engine Company purchases 1,000 TE456 parts from the outside supplier per month,
then its monthly operating income will:
a. Increase by $1,000
b. Increase by $40,000
c. Decrease by $1,500
d. Decrease by $42,500

12. The maximum price that RIKKI Engine Company should be willing to pay the outside supplier is:
a. $40 per TE456 part
b. $41 per TE456 part
c. $49 per TE456 part
d. $50 per TE456 part
(Horngren, 9th Ed)
13. Based on potential sales of 500 units per year, a new product has estimated traceable costs of
$990,000. What is the target price to obtain a 15% profit margin on sales?
a. $2,329
b. $2,277
c. $1,980
d. $1,935
(Wiley, 2016)

GERAH foundation, a tax exempt organization, invested P200, 000 in a five-year project at the beginning
of 19x5. GERAH estimates that the annual cash savings from this project will amount to P65, 000. The
P200, 000 of assets will be depreciated over their five-year life on the straight line basis. On investments of
this type, GERAHs desired rate of return is 12%

14. The net present value of the project


a. P34,325
b. P36,400
c. P90,000
d. P125,000
15. GERAHs time-adjusted rate of return on this project is
a. Less than 12%
b. Less than 14%, but more than 12%
c. Less than 16%, but more than 14%
d. More than 16%
(Past CPA Board Exam)
JEREMY and RABENA Manufacturing is approached by a European customer to fulfill a one-time-only
special order for a product similar to one offered to domestic customers. The following per unit data apply
for sales to regular customers:

Direct materials $66


Direct labor 30
Variable manufacturing support 48
Fixed manufacturing support 104
Total manufacturing costs 248
Markup (50%) 124
Targeted selling price $372

JEREMY and RABENA Manufacturing has excess capacity.

16. What is the full cost of the product per unit?


a. $ 372
b. $ 144
c. $ 248
d. $ 66
17. How much costs are relevant for making the decision regarding this one-time-only special order?
a. $ 372
b. $ 144
c. $ 248
d. $ 66
(Horngren, 9th Ed)

Vonah Auto Company manufactures a part for use in its production of automobiles. When 10,000 items are
produced, the costs per unit are:
Direct materials $12
Direct labor 60
Variable manufacturing support 24
Fixed manufacturing support 32
Total manufacturing costs $128

Monty Company has offered to sell Vonah Auto Company 10,000 units of the part for $120 per unit. The
plant facilities could be used to manufacture another part at a savings of $180,000 if Vonah Auto accepts
the supplier's offer. In addition, $20 per unit of fixed manufacturing overhead on the original part would be
eliminated.

18. Which alternative is best for Vonah Auto Company? By how much?
a. Make at $960,000
b. Buy at $960,000
c. Make at $820,000
d. Buy at $820,000
(Horngren, 9th Ed)

19. If an asset costs P35,000 and is expected to have a P5,000 salvage value at the end of its ten-year
life, and generates annual net cash inflows of P5,000 each year, the cash payback period is
a. 8 years c. 6 years
b. 7 years d. 5 years
(Bobadilla, 2015)
20. Claire Insurance Companys management is considering an advertising program that would
require an initial expenditure of P165,500 and bring in additional sales over the next five years.
The cost of advertising is immediately recognized as expense. The projected additional sales
revenue in Year 1 is P75,000, with associated expenses of P25,000. The additional sales revenue
and expenses from the advertising program are projected to increase by 10 percent each year. Paz
Insurance Companys tax rate is 40 percent.

The payback period for the advertising program is

a. 4.6 years c. 3.0 years


b. 1.9 years d. 2.5 years
(Bobadilla, 2015)

Solutions:
1) Answer: B
Additional contribution margin:
Small 6,000 x 5.40 32,400
Medium 15,000 x 6.50 97,500
Large 9,000 x 7.90 71,100
Total 201,000
Less Cash Fixed Expenses:
Rent 18,000
Salaries 54,000
Utilities 13,200
Insurance, etc. 7,800 93,000
Annual Cash Inflows 108,000

2) Answer: B
Additional rental income 130,000
Additional cash flow, snack bar 15,000
Total 145,000
Less Cash Fixed Expenses:
Rent 48,000
Salaries 17,000
Utilities 5,400
Insurance, etc. 9,600 80,000
Annual Cash Inflow 65,000

3) Answer: A
PV of annual cash inflow (108,000 x 5.575) 602,100
PV of salvage value (70,000 x 0.108) 3,240
PV of working capital return (7,500 x 0.108) 810
Total 606,150
Investment:
Remodeling cost 550,000
Working capital 7,500 557,500
Net Present Value 48,650

4) Answer: B
PV of annual cash inflow (65,000 x 5.575) 362,375
PV of salvage value 1,296
PV of working capital return 432
Total 364,103
Investment:
Remodeling cost 290,000
Working capital 4,000 294,000
Net Present Value 70,103

5) Answer: A
Rental income 21,000 x 5 105,000
Additional cash inflow, snack bar 13,000
Total 118,000
Less fixed expenses 80,000
Annual cash inflow 38,000

PV of annual cash inflow (38,000 x 5,575) 211,850


PV of salvage value 1,296
PV of working capital return 432
Total 213,578
Investment 294,000
Negative Net Present Value ( 80,422)

6) Answer: D
The annual cost of advertising can be easily calculated by dividing the net present value of alternative
2, at 16% by the present value of annuity of 1.
70,103 5,575 = 12,574.53

7) Answer: A
($900,000 + $360,000 + $480,000) / ($1,125,000 + $780,000 + $840,000 + $645,000) = 51.3%

8) Answer: C
$900,000 + $840,000 + $645,000 + $360,000 + $480,000) / ($1,125,000 + $780,000) = 169.3%

9) Answer: D
($900,000 + $645,000 + $480,000) / ($1,125,000+ $780,000 + $840,000 + $360,000) = 65.2%

10) Answer: A
$20,000 + $5,000 + $15,000 + ($10,000 10%) = $41,000
11) Answer: C
$41,000 - ($42.50 1,000 units) = decrease of $1,500

12) Answer: B
$41,000 / 1,000 units = $41 per part

13) Answer: A
Let x = Target price
RevenueCost = Profit
500x$990,000 =.15(500x)
.85(500x) = $990,000
425x = $990,000
x =$2,329
14) Answer: A
NPV = 65,000 x 3.605 200,000
NPV = P 34,325

15) Answer: D
IRR: 0=65,000x{[1-(1+x)^-5]/X}-200,000
Solve for X or use interpolation
X = 18.72%

16) Answer: C
Cost: 66+30+48+104 = $248

17) Answer: B
Cost: 66+30+48 = $144

18) Answer: D
Make Buy
Purchase price $1,200,000
Savings in space (180,000)
Direct Materials $ 120,000
Direct Labor 600,000
Variable Overhead 240,000
Fixed Overhead (200,000)
Total $ 960,000 $ 820,000

19) Answer: B
Payback period = Initial amount of investment Annual after-tax cash flows
P35,000 P5,000 = 7 years

20) Answer: C
Cash inflows Investment
Period 0 (99,300)
Period 1 (75,000 25,000) x .6 30,000 (69,300)
Period 2 ( 30,000 x 1.10) 33,000 (36,300)
Period 3 (33,000 x 1.10) 36,300 -0-
At the end of the third year, investment is fully recovered.
The net investment of 99,300 is net of tax benefit, (165,500 x .6)