Nobles Acct10 Tif 24

Horngren's Accounting, 10e, Global Edition (Nobles/Mattison/Matsumura)
Chapter 24 Cost Allocation and Responsibility Accounting
Learning Objective 24-1
1) Direct material costs and direct labor costs cannot be easily traced to products. Therefore, they are
allocated to products.
Answer: FALSE
Diff: 1
LO: 24-1
AACSB: Concept
AICPA Functional: Measurement
2) Manufacturing overhead costs, which are also known as indirect costs, cannot be cost-effectively traced
to products.
Answer: TRUE
Diff: 1
LO: 24-1
AACSB: Concept
3) The predetermined overhead allocation rate is an estimated overhead cost per unit of the allocation
base and is calculated at the beginning of the accounting period.
Answer: TRUE
Diff: 1
LO: 24-1
AACSB: Concept
4) Companies calculate predetermined overhead rate at the beginning of an accounting period using the
actual values of overhead costs.
Answer: FALSE
Diff: 1
LO: 24-1
AACSB: Concept
5) Activity-based costing focuses on a single predetermined overhead rate for cost analysis.
Answer: FALSE
Diff: 1
LO: 24-1
AACSB: Concept
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6) The main difference between activity-based costing and traditional costing systems is that activity-
based costing uses a separate allocation base for each activity.
Answer: TRUE
Diff: 1
LO: 24-1
AACSB: Concept
7) Activity-based costing refines the cost allocation process even more than the traditional allocation
costing.
Answer: TRUE
Diff: 1
LO: 24-1
AACSB: Concept
8) Traditional costing provides more detailed information on costs of activities and the drivers of these
costs than activity-based costing.
Answer: FALSE
Diff: 1
LO: 24-1
AACSB: Concept
9) The first step in developing an activity-based costing system is to identify the activities that will be
used to assign the manufacturing overhead and estimate their total costs.
Answer: TRUE
Diff: 1
LO: 24-1
AACSB: Concept
10) Activity-based management focuses on making decisions that improve customers' satisfaction while
also increasing profits.
Answer: TRUE
Diff: 1
LO: 24-1
AACSB: Concept
11) Activity-based costing uses a common allocation base for all activities.
Answer: FALSE
Diff: 1
LO: 24-1
AACSB: Concept
2
12) Indirect costs allocated to products using activity-based costing are more accurate than traditional
allocation systems.
Answer: TRUE
Diff: 1
LO: 24-1
AACSB: Concept
13) Companies with diverse products can obtain better costing information by using a single plant wide
rate.
Answer: FALSE
Diff: 1
LO: 24-1
AACSB: Concept
14) Traditional costing systems employ multiple allocation rates, but an activity-based costing system
uses only one rate for allocating manufacturing overhead.
Answer: FALSE
Diff: 1
LO: 24-1
AACSB: Concept
15) An activity-based costing system is developed in four steps.

a. Compute the allocation rate for each activity
b. Identify activities and estimate their total costs
c. Identify the cost driver for each activity and then estimate the quantity of each driver's allocation base
d. Allocate the indirect costs to the cost object
Which of the following is the correct order of performing these steps?
A) a, b, c, d
B) c, a, b, d
C) b, c, a, d
D) b, a, c, d
Answer: C
Diff: 1
LO: 24-1
AACSB: Concept
3
16) For a pharmaceutical company, the most suitable base for allocating research and development costs
to the finished products would be:
A) direct labor hours.
B) cost of raw materials purchased.
C) number of new patents filed.
D) number of set ups.
Answer: C
Diff: 2
LO: 24-1
AACSB: Concept
17) Which of the following is the most appropriate cost driver for allocating the cost of warranty services?
A) number of employees
B) number of materials purchased
C) number of machine hours
D) number of service calls
Answer: D
Diff: 2
LO: 24-1
AACSB: Concept
18) Which of the following statements is correct regarding the activity-based costing system?
A) It uses separate indirect cost allocation rates for each activity.
B) It is not as accurate or precise as traditional costing systems.
C) It accumulates overhead costs by processing departments.
D) It is less complex and, therefore, less costly than traditional systems.
Answer: A
Diff: 1
LO: 24-1
AACSB: Concept
19) Which of the following is the last step in developing an activity-based costing system?
A) estimate the total quantity of the cost driver
B) estimate the total indirect costs of each activity
C) identify the activities
D) allocate indirect costs to the cost object
Answer: D
Diff: 1
LO: 24-1
AACSB: Concept
4
20) Brannon Company manufactures ceiling fans and uses an activity-based costing system. Each ceiling
fan consists of 20 separate parts. The direct material cost is $95 and each ceiling fan requires 2.5 hours of
machine time to manufacture. Additional information is as follows:
Activity Allocation Base Cost Allocation Rate $

Materials handling Number of parts 0.08
Machining Machine hours 7.20
Assembling Number of parts 0.35
Packaging Number of finished units 2.70
What is the cost of materials handling per ceiling fan?

A) $1.60
B) $7.20
C) $6.00
D) $5.00
Answer: A
Explanation: A)
Calculation of material handling cost per unit:
Number of parts used 20.00
Material handling cost per part $0.08
Material handling cost per unit ($0.08 × 20) $1.60
Diff: 1
LO: 24-1
AACSB: Concept
5

What is the cost of machining per ceiling fan?

A) $18
B) $180
C) $30
D) $144
Answer: A
Explanation: A)
Calculation of machining cost per unit:
Number of machine hours per fan 2.50
Machining cost per hour $7.20
Machining cost per unit ($7.20 × 2.5) $18.00
Diff: 1
LO: 24-1
AACSB: Application
6

What is the cost of assembling per ceiling fan?

A) $87.50
B) $7.00
C) $7.50
D) $35.00
Answer: B
Explanation: B)
Calculation of assembling cost per unit:
Number of parts assembled 20.00
Cost per part $0.35
Cost of assembling per fan ($0.35 × 20) $7.00
Diff: 2
LO: 24-1
AACSB: Application
7
machine time to manufacture. There is no direct labor cost. Additional information is as follows:

What is the total manufacturing cost per ceiling fan?

A) $125.75
B) $121.13
C) $115.32
D) $124.30
Answer: D
Explanation: D)
Calculation of total manufacturing cost per ceiling fan:
Direct material $95.00
Material handling cost per unit ($0.08 × 20) 1.60
Machining cost per unit($7.20 × 2.5) 18.00
Cost of assembling per fan ($0.35 × 20) 7.00
Packaging 2.70
Total manufacturing cost per ceiling fan $124.30
Diff: 2
LO: 24-1
AACSB: Application
24) Oscar prizes, a manufacturer of gift articles, uses a single plant wide rate to allocate indirect costs. The
company allocates manufacturing overhead using a single plantwide rate with machine hours as the
allocation base. Estimated overhead cost for the year is $5,000,000 and estimated machine hours are
25,000. During the year, the actual machine hours used were 30,000. Calculate the predetermined
overhead allocation rate.
A) $166
B) $250
C) $200
D) $150
Answer: C
Explanation: C)
Calculation of single plant wide allocation rate:
Estimated overhead cost for the year $5,000,000
Estimated machine hours for the year 25,000
Single plant wide rate ($5,000,000 ÷ 25,000) $200
Diff: 2
LO: 24-1
AACSB: Application
8
25) Archid, a manufacturer of spare parts, has two production departments: Assembling and Packaging.
The Assembling department is machine oriented, while the Packaging department is labor oriented.
Estimated manufacturing overhead costs for the year 2015 were $15,000,000 for Assembling and
$10,000,000 for Packaging. Calculate departmental wide allocation rates if total estimated machine hours
were 30,000 and labor hours were 20,000 for the year.
A) $250, $300
B) $500, $500
C) $300, $300
D) $450, $540
Answer: B
Explanation: B)
Calculation of departmental wide allocation rates:
Assembling Packaging
Estimated overhead cost $15,000,000 $10,000,000
Estimated machine hours 30,000 -
Estimated labor hours - 20,000
Allocation rate ($15,000,000 ÷ 30,000),
($10,000,000 ÷ 20,000) $500 $500
Diff: 2
LO: 24-1
AACSB: Application
9
26) Alpha Company manufactures breadboxes and uses an activity-based costing system. The following
information is provided for the month of May:
Estimated Indirect Estimated Quantity of

Activity Activity Costs Allocation Base Allocation Base
Materials handling $3,500 Number of parts 5,000 parts
Assembling $12,000 Number of parts 5,000 parts
Number of bread
Packaging $5,750 boxes 1,250 bread boxes
Each breadbox consists of 4 parts, and the direct materials cost per breadbox is $7.00. There is no direct
labor. What is the total manufacturing cost per breadbox?
A) $17.40
B) $24.00
C) $12.40
D) $26.00
Answer: B
Explanation: B)
Calculation of total manufacturing cost per bread box:
Materials handling [($3,500 ÷ 5,000 parts) × 4 parts] 2.80
Assembling [($12,000 ÷ 5,000 parts) × 4 parts] 9.60
Packaging [($5,750 ÷ 1,250 boxes) × 1 box] 4.60
Total manufacturing cost $24.00
Diff: 2
LO: 24-1
AACSB: Concept
10
27) Pitt Jones Company had the following activities, allocated costs, and allocation bases:
Activities Allocated Costs Allocation Base

Account inquiry (hours) $60,000 2,000 hours
Account billing (lines) $30,000 20,000 lines
Account verification (accounts) $15,000 20,000 accounts
Correspondence (letters) $10,000 1,000 letters
The above activities are carried out at two of their regional offices.
Northeast Office Midwest Office

Account inquiry (hours) 100 hours 200 hours
Account billing (lines) 10,000 lines 7,000 lines
Account verification (accounts) 1,000 accounts 600 accounts
Correspondence (letters) 50 letters 100 letters
What is the cost per hour for the account inquiry activity?
A) $0.75
B) $30.00
C) $10.00
D) $1.50
Answer: B
Explanation: B)
Total cost of account inquiry $60,000
Quantity of allocation base 2,000
Cost of account inquiry per hour ($60,000 ÷ 2,000) $30
Diff: 1
LO: 24-1
AACSB: Application
11


What is the cost per line for the account billing activity?
A) $1.50
B) $30.00
C) $1.60
D) $1.43
Answer: A
Explanation: A)
Cost of account billing:
Total cost of billing $30,000
Cost of account billing per line ($30,000 ÷ 20,000) $1.50
Diff: 1
LO: 24-1
AACSB: Application
12


What is the cost per account for the account verification activity?
A) $30.00
B) $0.50
C) $2.25
D) $0.75
Answer: D
Explanation: D)
Cost of account verification:
Total cost of account verification $15,000
Cost of account verification per account ($15,000 ÷ 20,000) $0.75
Diff: 1
LO: 24-1
AACSB: Application
13


What is the cost per letter for the correspondence activity?

A) $10.00
B) $30.50
C) $25.00
D) $0.75
Answer: A
Explanation: A)
Cost of correspondence:
Total cost of correspondence: $10,000
Quantity of allocation base (letters) 1,000
Cost of correspondence per letter ($10,000 ÷ 1,000) $10
Diff: 2
LO: 24-1
AACSB: Application
14


How much of the account inquiry cost will be assigned to the Midwest Office?
A) $2,000
B) $6,500
C) $3,000
D) $6,000
Answer: D
Explanation: D) Midwest Office
Number of account inquiry hours utilized 200
Cost per hour ($60,000 ÷ 2,000 hours) $30
Cost of account inquiry for Midwest office ($30 × 200) $6,000
Diff: 2
LO: 24-1
AACSB: Application
15


How much of the correspondence cost will be assigned to the Northeast Office?
A) $500
B) $1,200
C) $2,500
D) $800
Answer: A
Explanation: A)
Cost of correspondence: Northeast Office
Number of letters 50
Cost of correspondence per letter ($10,000 ÷ 1,000 letters) $10
Cost of correspondence ($10 × 50) $500
Diff: 2
LO: 24-1
AACSB: Application
16


How much of the account verification costs will be assigned to the Northeast Office?
A) $800
B) $2,500
C) $750
D) $1,500
Answer: C
Explanation: C)
Cost of account verification: Northeast Office
Number of accounts verified 1,000
Cost per account verified ($15,000 ÷ 20,000) $0.75
Cost of account verification ($0.75 × 1,000) $750.00
Diff: 2
LO: 24-1
AACSB: Application
34) Which of the following statements is true?

A) Many traditional costing systems can distort product costs and profitability.
B) Traditional costing systems tend to be more costly than activity-based costing systems.
C) Activity-based costing systems tend to combine various costs into a single cost pool.
D) Activity-based costing systems tend to use fewer cost pools than does a traditional costing system.
Answer: A
Diff: 2
LO: 24-1
AACSB: Concept
17
35) Quality Stereo Company has provided the following information regarding its activity-based costing
system:
• Purchasing department costs are allocated based on the number of purchase orders and the cost
allocation rate is $75 per purchase order.
• Assembly department costs are allocated based on the number of parts used and the cost allocation
rate is $1.00 per part.
• Packaging department costs are allocated based on the number of units produced and the allocation
rate is $2.00 per unit produced.
Each stereo produced has 50 parts, and the direct materials cost per unit is $70. There are no direct labor
costs. Quality Stereo has an order for 1,000 stereos which will require 50 purchase orders in all. What is
the total cost of the 1,000 stereos?
A) $125,750
B) $55,750
C) $123,750
D) $122,000
Answer: A
Explanation: A)
Computation of total cost of 1,000 stereos:
Direct material $70,000
Purchasing department costs 3,750
Assembly department costs 50,000
Packing department costs 2,000
Total cost $125,750
Diff: 3
LO: 24-1
AACSB: Application
18
36) Orlando Avionics makes three types of radios for small aircraft: Model A, Model B, and Model C. The
manufacturing operations are mechanized and there is no direct labor. Manufacturing overhead costs are
significant, and Orlando has adopted an activity-based costing system. Direct materials costs per unit for
each model are as follows:
Model A $28
Model B $32
Model C $40
Orlando has three activities: assembly, materials management, and testing. The cost driver for assembly
is machine hours. The cost driver for materials management is number of parts, and the cost driver for
testing is the number of units of product. Total costs and production volumes for the year 2015 were
estimated as follows:
Total cost Total units Cost Driver

Assembly $780,000 120,000 Machine hours
Materials management $120,000 80,000 Parts
Testing $22,500 5,000 Units
The Model A radio requires 12 parts to construct, and requires 16 machine hours of processing. What is
the manufacturing cost to make one unit of Model A?
A) $150.00
B) $132.00
C) $126.50
D) $154.50
Answer: D
Explanation: D) Calculation of manufacturing cost per unit of Model A:

Assembly 104.00
Materials management 18.00
Testing 4.50
Total manufacturing cost $154.50
Diff: 2
LO: 24-1
AACSB: Application
37) The activity-based costing system improves the allocation of:

A) indirect manufacturing costs.
B) direct labor.
C) direct materials.
D) sales commissions.
Answer: A
Diff: 1
LO: 24-1
AACSB: Concept
19
38) Which of the following would most likely be treated as an activity in an activity-based costing
system?
A) Direct labor cost
B) Machine processing
C) Direct materials cost
D) Sales revenues
Answer: B
Diff: 1
LO: 24-1
AACSB: Concept
20
39) Ace Plastics produces different kinds of products, all in one manufacturing facility. They have
identified four activities for their costing system:
Materials management—allocated by number of purchase orders

Chemical processing—allocated on metric tons
Molding—allocated on direct labor hours
Packaging—allocated by number of units produced
The activity rates are as follows:
Materials management $12.00 Per purchase order

Chemical processing $7.50 Per metric ton
Molding $24.00 Per direct labor hour
Packaging $0.10 Per unit
Engineering design shows that the order will require direct material worth $540, direct labor cost being
$90, require 4 purchase orders to be placed, use 2 metric tons of chemical base, need 8 direct labor hours.
The size of the order is to produce 3,000 units of product. Calculate total cost of production of the order.
Answer:
Calculation of total cost of the order:
Direct labor 90.00
Overhead cost* 555.00
Total production cost $1,185.00
Computation of overhead cost of the order:*

Level of Cost
utilization driver Cost
Activity Cost driver of activity rate allocated
Materials management Purchase order 4 $12.00 $48.00
Chemical processing Metric ton 2 $7.50 $15.00
Molding Direct labor hour 8 $24.00 $192.00
Packaging Number of units 3,000 $0.10 $300.00
Total overhead cost $555.00
Diff: 2
LO: 24-1
AACSB: Application
21
40) AAA Metal Bearings produces two sizes of metal bearings (sold by the crate)—standard and heavy.
The standard bearings require $200 of direct materials per unit (per crate) and the heavy bearings require
$245 of direct materials per unit. The operation is mechanized and there is no direct labor. Previously
AAA used a single plant-wide allocation rate for manufacturing overhead, which was $1.55 per machine
hour. Based on the single rate, gross profit was as follows:
Per unit Standard Heavy

Direct material cost $200.00 $245.00
Manufacturing overhead cost 124.00 93.00
Total manufacturing cost $324.00 $338.00
Price per unit 350.00 370.00

Gross profit per unit $26.00 $32.00
Although the data showed that the heavy bearings were more profitable than the standard bearings, the
plant manager knew that the heavy bearings required much more processing in the metal fabrication
phase than the standard bearings, and that this factor was not adequately reflected in the single allocation
rate. He suspected that it was distorting the profit data. He suggested adopting an activity-based costing
approach.
Working together, the engineers and accountants identified the following three manufacturing activities,
and broke down the annual overhead costs as shown below:
Activities: Estimated Cost

Metal fabrication $420,000
Machine processing $152,000
Packaging $17,000
Total overhead costs $589,000
Engineers believed that metal fabrication costs should be allocated by weight, and estimated that the
plant processed 12,000 kilos of metal per year. Machine processing costs were correlated to machine
hours, and the engineers estimated a total of 380,000 machine hours for the year. Packaging costs were
the same for both types of products, and so they could be allocated simply by the number of units
produced. The production plan provided for 4,000 units of standard and 1,000 units of heavy bearings to
be produced during the year. Additional data on a per unit basis was as given below:
Standard Heavy
Kilos per unit 2.00 4.00
Machine hours per unit 80.00 60.00
Using the data above, calculate activity rates. Then, following the ABC methodology, calculate the
production cost and gross profit for one unit of standard bearings. (Round your intermediate calculations
to two decimal places).
22
Answer:
Calculation of cost driver rates:
Cost of Cost Quantity of Cost Driver

Activity Activity driver allocation base rate
Metal fabrication $420,000 kilos 12,000 $35.00
Machine processing $152,000 machine hours 380,000 $0.40
Packaging $17,000 number of units 5,000 $3.40
Calculation of production cost of Standard Bearings (per unit):

Cost per unit
Metal fabrication 70.00
Machine processing 32.00
Packaging 3.40
Total production cost: $305.40
Calculation of gross profit:

Price per unit $350.00
Total production cost per unit $305.40
Gross profit per unit $44.60
Diff: 3
LO: 24-1
AACSB: Application
41) Cardec, a leading manufacturer of car spare parts, divided its manufacturing process into two
departments: 1) Production 2) Packing. Estimated overhead costs for the Production and Packing
department amounted to $25,000,000 and $20,000,000, respectively. The company produces two types of
parts: Part-1 and Part-2. The total estimated labor hours for the year 2015 were 40,000 and estimated
machine hours were 50,000. The Production department was mechanized whereas the Packing
department was labor oriented. Calculate departmental overhead allocation rates.
Production Packing
Machine hours Labor hours
Part-1 15,000 25,000
Part-2 35,000 15,000
50,000 40,000
Answer: Calculation of departmental allocation rates:
Production Packing
Estimated overhead cost $25,000,000 $20,000,000
Estimated machine hours 50,000
Estimated labor hours 40,000
Departmental overhead cost $500 $500
Diff: 3
LO: 24-1
AACSB: Application
23
1) A company in which major planning and controlling decisions are made by top management is
considered as a centralized company.
Answer: TRUE
Diff: 1
LO: 24-2
AACSB: Concept
2) In a decentralized company, all the planning and controlling decisions are made by the top
management.
Answer: FALSE
Diff: 1
LO: 24-2
AACSB: Concept
3) Centralized operations are better for small companies due to the smaller scope of their operations.
Answer: TRUE
Diff: 1
LO: 24-2
AACSB: Concept
4) Centralized companies split their operations into different divisions, or operating units, and top
management delegates decision making to the division/unit managers.
Answer: FALSE
Diff: 1
LO: 24-2
AACSB: Concept
5) One of the advantages of decentralization is that it allows top management to concentrate on long-term
strategic planning.
Answer: TRUE
Diff: 1
LO: 24-2
AACSB: Concept
24
6) A system of evaluating the performance of each responsibility center and its manager is known as
responsibility accounting system.
Answer: TRUE
Diff: 1
LO: 24-2
AACSB: Concept
7) The manager of a cost center is responsible for controlling costs and generating revenues of the
company.
Answer: FALSE
Diff: 1
LO: 24-2
AACSB: Concept
8) The manager of a profit center is responsible for generating revenues and managing the center's
invested capital.
Answer: FALSE
Diff: 1
LO: 24-2
AACSB: Concept
9) The responsibilities of a manager of an investment center are to generate profits and to efficiently
manage the center's invested capital.
Answer: TRUE
Diff: 1
LO: 24-2
AACSB: Concept
10) The product line of a manufacturing company is most likely to be considered as:
A) cost centers.
B) profit centers.
C) revenue centers.
D) investment centers.
Answer: B
Diff: 1
LO: 24-2
AACSB: Concept
25
11) Responsibility reports for a profit center includes:
A) revenues only.
B) invested capital.
C) both revenues and costs.
D) returns on investments.
Answer: C
Diff: 1
LO: 24-2
AACSB: Concept
12) Long-term investments are made by the manager of an investment division for the purpose of:
A) increasing profits.
B) decreasing profits.
C) increasing interest liability.
D) decreasing debt liability.
Answer: A
Diff: 1
LO: 24-2
AACSB: Concept
13) Which of the following is a disadvantage of decentralization?

A) increases the customer response time
B) only the top management is allowed to make decisions
C) demotivates employees as the decision making powers are not delegated
D) problems in achieving goal congruence
Answer: D
Diff: 1
LO: 24-2
AACSB: Concept
14) Which of the following would most likely be evaluated using residual income?
A) cost center
B) profit center
C) revenue center
D) investment center
Answer: D
Diff: 1
LO: 24-2
AACSB: Concept
26
15) Brad, one of the managers of a multi-national company, is responsible to generate revenues and
control costs in order to increase the operating income of his division. However, he is not concerned with
investment-related decisions. Brad is most likely to be the manager of a(n):
A) cost center.
B) investment center.
C) profit center.
D) revenue center.
Answer: C
Diff: 1
LO: 24-2
AACSB: Concept
16) The responsibility report of Keith Paul, a manager of one of the divisions of a manufacturing
company, includes profits as well as return on investment and residual income. Keith is most likely to the
manager of a(n):
A) investment center.
B) profit center.
C) cost center.
D) revenue center.
Answer: A
Diff: 1
LO: 24-2
AACSB: Concept
17) The term goal congruence refers to the:

A) matching of financial goal of the company with its nonfinancial goals.
B) aligning the goals of business segment managers with the goals of top management.
C) achievement of the goals set by the management by utilizing the resources available.
D) duplication of costs as a result of decentralization.
Answer: B
Diff: 1
LO: 24-2
AACSB: Concept
18) The payroll department of a manufacturing company is most likely to be a(n):

A) cost center.
B) revenue center.
C) investment center.
D) profit center.
Answer: A
Diff: 1
LO: 24-2
AACSB: Concept
27
1) Performance evaluation systems provide top management with a framework for maintaining control
over the entire organization.
Answer: TRUE
Diff: 1
LO: 24-3
AACSB: Content
2) Communicating the expectations of top management to segment managers improves goal congruence.
Answer: TRUE
Diff: 1
LO: 24-3
AACSB: Content
3) The practice of comparing a company's achievements against the best practices in the industry is
known as goal congruence.
Answer: FALSE
Diff: 1
LO: 24-3
AACSB: Content
4) A lag indicator is a performance measure that forecasts future performance.

Answer: FALSE
Diff: 1
LO: 24-3
AACSB: Content
5) The balanced scorecard is a performance evaluation system that requires management to consider
financial performance measures of performance, but not nonfinancial measures.
Answer: FALSE
Diff: 1
LO: 24-3
AACSB: Content
6) Key performance indicators (KPIs) are summary performance measures that help managers assess
whether the company is achieving its goals.
Answer: TRUE
Diff: 1
LO: 24-3
AACSB: Content
28
7) A good balanced scorecard focuses only on lead indicators, because lag indicators are not important for
the scorecard.
Answer: FALSE
Diff: 1
LO: 24-3
AACSB: Content
8) A company that uses a balanced scorecard has established a KPI for product quality. If the actual
warranty claims are higher than expected it indicates that the quality standards have been met.
Answer: FALSE
Diff: 1
LO: 24-3
AACSB: Content
9) The performance measurement system should provide incentives to segment managers for
coordinating activities of the subunits and focusing them toward the overall company objectives. Which
of the following performance measurement goals has been described by this statement?
A) Motivating segment managers
B) Promoting goal congruence
C) Providing feedback
D) Benchmarking
Answer: B
Diff: 1
LO: 24-3
AACSB: Content
10) One part of the balanced scorecard helps management answer the question "How do we look to
shareholders?" Which of the four perspectives is being described here?
A) financial perspective
B) customer perspective
C) internal business perspective
D) learning and growth perspective
Answer: A
Diff: 1
LO: 24-3
AACSB: Content
29
11) Which of the following four perspectives of the balanced score card enables the management to
answer the question: "How can we continue to improve and create value?"
Answer: D
Diff: 1
LO: 24-3
AACSB: Content
12) Which of the following internal business perspective key performance indicators (KPIs) is commonly
used to assess the innovation process?
A) number of new products developed
B) number of warranty claims
C) employee turnover rate
D) rate of on-time deliveries
Answer: A
Diff: 1
LO: 24-3
AACSB: Content
13) Which of the following perspectives of the balanced scorecard focuses on revenue growth and
productivity?
Answer: A
Diff: 1
LO: 24-3
AACSB: Content
14) Sales revenue growth, gross margin growth, and return on investment are the key performance
indicators (KPIs) for the:
A) financial perspective.
B) customer perspective.
C) internal business perspective.
D) learning and growth perspective.
Answer: A
Diff: 1
LO: 24-3
AACSB: Content
30
15) Increased number of repeat customers and increased rate of on-time deliveries are the indicators of:
A) product quality.
B) market share.
C) customer satisfaction.
D) skills and knowledge of the employees.
Answer: C
Diff: 1
LO: 24-3
AACSB: Content
16) Which of the following affects the company's ability to make on-time deliveries?
A) return on investment
B) product's price
C) warranty claims
D) production cycle time
Answer: D
Diff: 1
LO: 24-3
AACSB: Content
17) A high rate of employee turnover indicates that:

A) employees of the organization leave jobs frequently.
B) pay packages of employees are at par with that of industry.
C) the employees' retention ratio is also high.
D) employees also participate in the decision making process.
Answer: A
Diff: 1
LO: 24-3
AACSB: Content
18) Which of the following statements most accurately describes the company's "climate for action?"
A) a corporate culture that encourages communication, change, and growth
B) a corporate culture that is focused on strong, top-down command and control
C) a corporate culture which is aimed exclusively at period earnings
D) a corporate culture that encourages physical activity, sports and recreation to improve employee
health and morale
Answer: A
Diff: 1
LO: 24-3
AACSB: Content
31
19) In a balanced scorecard, which of the following is a key performance indicator of the financial
perspective?
A) hours of employee training
C) percentage of market share
D) return on investment
Answer: D
Diff: 1
LO: 24-3
AACSB: Content
20) In a balanced scorecard, which of the following is a key performance indicator of the internal business
perspective?
A) hours of employee training
C) percentage of market share
Answer: B
Diff: 1
LO: 24-3
AACSB: Content
21) The goal of the balanced scorecard is to:

A) maximize profits.
B) maximize operational efficiency.
C) develop a set of organizational performance measures.
D) increase the market share and maximize shareholders' wealth.
Answer: C
Diff: 1
LO: 24-3
AACSB: Content
22) In a balanced scorecard, which of the following is a key performance indicator of the customer
perspective?
A) Defect rate
B) Employee satisfaction
C) Gross margin growth
D) Number of repeat customers
Answer: D
Diff: 1
LO: 24-3
AACSB: Content
32
1) Management by exception directs management's attention to important differences between actual and
budgeted amounts.
Answer: TRUE
Diff: 1
LO: 24-4
AACSB: Content
2) Uncontrollable costs are the costs that can be influenced by the decisions of a manager.
Answer: FALSE
Diff: 1
LO: 24-4
AACSB: Content
3) A unique factor of responsibility accounting performance reports is the focus on responsibility and
controllability.
Answer: TRUE
Diff: 1
LO: 24-4
AACSB: Content
4) Regardless of the type of responsibility center, responsibility reports should focus on information, not
blame.
Answer: TRUE
Diff: 1
LO: 24-4
AACSB: Content
5) Cost center responsibility reports generally focus on the static budget variance.
Answer: FALSE
Diff: 1
LO: 24-4
AACSB: Content
6) The flexible budget uses budgeted costs at the actual level of activity.
Answer: TRUE
Diff: 1
LO: 24-4
AACSB: Content
33
7) Smaller variances signal that operations are close to target and do not require management's
immediate attention.
Answer: TRUE
Diff: 1
LO: 24-4
AACSB: Content
8) Responsibility reports for revenue centers show all costs incurred by the department and are useful
when management needs to know the total cost of operating the department.
Answer: FALSE
Diff: 1
LO: 24-4
AACSB: Content
9) Performance report of a profit center includes both revenues and expenses.

Answer: TRUE
Diff: 1
LO: 24-4
AACSB: Content
10) Johnson Construction Materials Company has a sales office which sells concrete culvert pipe to
property developers. The sales office is a revenue center and must prepare a monthly performance report.
It has provided the following information.
How much is the flexible budget variance for the 40 inch pipe?
A) $1,850 U
B) $3,000 F
C) $10,000 U
D) $1,500 F
Answer: D
Explanation: D) $1,500 (Flexible budget variance) = $31,500 (Actual sales revenue) - $30,000 (Flexible
budget sales)
Diff: 2
LO: 24-4
AACSB: Application
34
It has provided the following information.
How much is the sales volume variance for the 36 inch long pipe?
A) $1,850 U
B) $9,000 F
C) $10,000 U
D) $1,500 F
Answer: B
Explanation: B)
$9,000 (Sales volume variance) = $42,000 (Flexible budget sales revenue) - $33,000 (Static budget sales)
Diff: 2
LO: 24-4
AACSB: Application
35
Below is the partially completed performance report.
The company uses management by exception to address flexible budget variances. On which variance
would the company focus first?
A) 40 inch
B) 36 inch long
C) 36 inch short
D) 32 inch
Answer: C
Explanation: C)
Actual Sales Flexible Budget Flexible
Product type: Revenue Variance U/F Budget
40 inch $31,500 $1,500 F $30,000
36 inch long $40,150 $1,850 U $42,000
36 inch short $36,200 $3,200 F $33,000
32 inch $19,000 $1,000 U $20,000
Diff: 2
LO: 24-4
AACSB: Application
36
13) Zhongfang Consumer Products has a small car division that operates as a profit center. Below is a
partially completed performance report for the first quarter.
Flexible
Flexible Budget
Actual Budget Variance U/F % Variance U/F
Sales Revenue $688,000 $700,000
Variable expenses 309,000 320,000
Contribution margin 379,000 380,000
Traceable fixed expenses 371,000 368,000
Division margin $8,000 $12,000
How much is the percentage flexible budget variance for sales revenue?
A) 1.7 % F
B) 1.7 % U
C) 3.4 % U
D) 3.4 % F
Answer: B
Explanation: B)
Calculation of percentage variances of Sales Revenue:
Flexible
Flexible Budget
Sales revenue $688,000 $700,000 $12,000 U 1.71429 U
Diff: 3
LO: 24-4
AACSB: Application
37
14) Zhongfang Consumer Products has a small car division that operates as a profit center. Below is a
partially completed performance report for the first quarter.
Flexible
Flexible Budget
Sales Revenue $688,000 $700,000
Variable expenses 309,000 320,000
Contribution margin 379,000 380,000
Traceable fixed expenses 371,000 368,000
Division margin $8,000 $12,000
How much is the percentage flexible budget variance for traceable fixed expenses?
A) 0.8 % F
B) 0.8 % U
C) 0.3 % U
D) 0.3 % F
Answer: B
Explanation: B)
Calculation of percentage variances of Traceable fixed expenses:
Flexible
Flexible Budget
Traceable fixed
expenses: $371,000 $368,000 $3,000 U 0.81522 U
Diff: 2
LO: 24-4
AACSB: Application
15) Which of the following statements is true of performance reporting?

A) Responsibility reports should focus on the person responsible for unfavorable variances, rather than
information.
B) Managers should not be held accountable for uncontrollable variances.
C) Only unfavorable variances should be explained in the reports.
D) Every variance, regardless of magnitude, must be investigated by the managers.
Answer: B
Diff: 1
LO: 24-4
AACSB: Concept
38
1) Companies evaluate investment centers using the same measures as the profit centers.
Answer: FALSE
Diff: 1
LO: 24-5
AACSB: Concept
2) Operating income alone does not indicate how efficiently a segment is using its assets.
Answer: TRUE
Diff: 1
LO: 24-5
AACSB: Concept
3) Managers of investment centers are responsible not only for generating profits, but also for ensuring
efficient use of assets of the investment center.
Answer: TRUE
Diff: 1
LO: 24-5
AACSB: Concept
4) To adequately evaluate an investment center's financial performance, summary performance measures

that include both the division's operating income and its assets are required.
Answer: TRUE
Diff: 1
LO: 24-5
AACSB: Concept
5) ROI (Return on Investment) measures the profitability of an investment center, not efficiency.
Answer: FALSE
Diff: 1
LO: 24-5
AACSB: Concept
6) The ROI (Return on Investment) formula focuses on the amount of operating income earned before
other revenue/expense items, such as interest expense, by utilizing the average total assets employed for
the year.
Answer: TRUE
Diff: 1
LO: 24-5
AACSB: Concept
39
7) RI (Residual Income) considers both the division's operating income and its average total assets. In
addition, it also incorporates another piece of information known as top management's target rate of
return.
Answer: TRUE
Diff: 1
LO: 24-5
AACSB: Concept
8) The target rate of return is the maximum rate of return that top management expects a division to earn
with its average total assets.
Answer: FALSE
Diff: 1
LO: 24-5
AACSB: Concept
9) RI (Residual Income) compares the division's actual operating income with the minimum operating
income expected given the size of the division's average total assets.
Answer: TRUE
Diff: 1
LO: 24-5
AACSB: Concept
10) Recreation Equipment Company has several divisions that are investment centers. Data for the Boat
Division and the Trailer Division are shown here:
Boat Division Trailer Division

Operating income $90,000 $36,000
Total assets at Jan 1 $670,000 $230,000
Total assets at Dec 31 $710,000 $220,000
With regard to the efficient use of assets, the Boat Division has a higher ROI (Return on Investment)
because it has the highest operating income.
Answer: FALSE
Explanation:
Calculation of ROI:
Average total assets $690,000 $225,000
ROI (Operating income ÷ Average
total assets) 13.043% 16.000%
Diff: 2
LO: 24-5
AACSB: Application
40
11) To evaluate the performance of an investment center, a business needs key performance indicators
that measure:
A) manufacturing efficiency and product defect rate.
B) operating income and efficient use of assets.
C) customer satisfaction and market share.
D) generation of sales revenues and control of operating expenses.
Answer: B
Diff: 1
LO: 24-5
AACSB: Concept
12) Which of the following is the correct formula for calculating return on investment?
A) Net profit ÷ Sales
B) Gross profit ÷ Sales
C) Operating profit ÷ Average total assets
D) Earnings available to stockholders ÷ Number of outstanding stock.
Answer: C
Diff: 1
LO: 24-5
AACSB: Concept
13) Which of the following is the correct formula for calculating residual income?
A) Weighted Average Cost of Capital - Net Operating Profit After Tax
B) Operating income - Minimum acceptable operating income
C) Historical cost of assets - Accumulated depreciation
D) Operating income ÷ Average assets
Answer: B
Diff: 1
LO: 24-5
AACSB: Concept
41
14) Parkinson Company provides the following financial information:
Income from operations $200,000

Interest expense 45,000
Gains/(losses) on sale of equipment (2,500)
Net income 152,500
Total assets at Jan 1 2,600,000
Total assets at Dec 31 3,200,000
Calculate return on investment based on the information given above.

A) 6.3%
B) 5.3%
C) 6.9%
D) 7.2%
Answer: C
Explanation: C)
Calculation of ROI:
Operating income $200,000
Average assets [($2,600,000 + $3,200,000) ÷ 2] 2,900,000
ROI (Operating income ÷ Average assets) 6.9%
Diff: 1
LO: 24-5
AACSB: Application
42
15) Recreation Equipment Company has several divisions which are investment centers. Data for the Boat
Division and the Trailer Division are shown here:

Total assets at Jan 1 $670,000 $230,000
Total assets at Dec 31 $710,000 $220,000
Which of the following statements would be the most meaningful interpretation of this data?
A) Performance of Boat Division is better than that of Trailer Division because Boat Division has higher
assets.
B) Trailer Division uses its assets more efficiently than Boat Division because it has higher ROI.
C) Boat Division shows more efficient use of assets than Trailer Division because it has higher operating
income.
D) Boat Division is more financially successful than Trailer Division because it shows an increase in assets
Answer: B
Explanation: B)
Calculation of ROI:
Average total assets $690,000 $225,000
ROI = Operating income/Average assets 13% 16%
Diff: 1
LO: 24-5
AACSB: Application
16) Which of the following is an expanded form of calculating return on investment?

A) Profit margin ratio × Asset turnover ratio
B) Net profit ratio × Inventory turnover ratio
C) Gross profit ratio × EVA
D) Asset turnover ratio × inventory turnover ratio
Answer: A
Diff: 1
LO: 24-5
AACSB: Concept
17) Which of the following is the correct formula for profit margin ratio?
A) Net profit ÷ Sales
B) Net sales ÷ Average total assets
C) Net profit × Capital invested
D) Operating income ÷ Net sales
Answer: D
Diff: 1
LO: 24-5
AACSB: Concept
43
18) Which of the following is the correct formula for asset turnover ratio?
A) Net sales ÷ Average total assets
B) Net sales ÷ Cost of goods sold
C) Net Sales ÷ Net assets
D) Net profit ÷ Net sales
Answer: A
Diff: 1
LO: 24-5
AACSB: Concept
19) Which of the following statements most accurately describes residual income?
A) how efficiently a division uses its average assets to generate sales there by profits
B) how much operating income the division earns on every dollar of sales
C) how much return a division generates on average assets
D) how much extra income a division generates above the minimum acceptable level
Answer: D
Diff: 1
LO: 24-5
AACSB: Concept
20) Huntswell Corporation has two major divisions: Agricultural Products and Industrial Products. It
provides the following information for the year 2014.
Agriculture Division Industrial Division

Sales revenue $140,000 $1,040,000
Average assets $300,000 $5,540,000
Calculate the profit margin ratio for the Industrial Division of the company.
A) 10.5%
B) 11.1%
C) 21.0%
D) 11.7%
Answer: C
Explanation: C)
Calculation of profit margin:
Industrial division
Net sales $1,040,000
Profit margin ($218,400 ÷ $1,040,000 × 100) 21%
Diff: 1
LO: 24-5
AACSB: Application
44
21) Huntswell Corporation has two major divisions: Agricultural Products and Industrial Products. It
provides the following information for the year 2014
Agriculture Division Industrial Division

Sales revenue $140,000 $1,040,000
Average total assets $300,000 $5,540,000
Target rate of return 14.0% 14.0%
Calculate the residual income for the Agriculture division.

A) $5,500
B) $4,400
C) $2,500
D) $1,800
Answer: B
Explanation: B)
Calculation of Residual Income:
Agriculture Division
Average total assets $300,000
Target rate of return 14%
Minimum acceptable operating income $42,000
Residual Income ($46,400 - $42,000) $4,400
Diff: 2
LO: 24-5
AACSB: Application
22) A company may prefer to use residual income over return on investment for performance evaluation
because:
A) return on investment is absolute figure but residual income is a ratio.
B) residual income is more likely to lead to goal congruence than return on investment.
C) it is easier to calculate residual income than return on investment.
D) residual income considers three elements but return on investment considers only two elements.
Answer: B
Diff: 2
LO: 24-5
AACSB: Concept
45
1) The transfer price is the transaction amount of one unit of goods when the transaction occurs between
the company and its customers.
Answer: FALSE
Diff: 1
LO: 24-6
AACSB: Concept
2) The primary objective in setting transfer prices is to achieve goal congruence by selecting a price that
will maximize overall company profits.
Answer: TRUE
Diff: 1
LO: 24-6
AACSB: Concept
3) In many cases, the amount of the transfer price does not affect the overall company profits.
Answer: TRUE
Diff: 1
LO: 24-6
AACSB: Concept
4) The transfer price should be an amount between the market price and the variable cost.
Answer: TRUE
Diff: 1
LO: 24-6
AACSB: Concept
5) When a division is operating at full capacity, the transfer price can be any of variable cost, full cost or
cost plus a mark-up.
Answer: FALSE
Diff: 1
LO: 24-6
AACSB: Concept
6) If a company allows division managers to negotiate a cost-based transfer price, it is better to use actual
costs rather than standard costs. Otherwise, the selling division has no motivation to control costs.
Answer: FALSE
Diff: 1
LO: 24-6
AACSB: Concept
46
7) When a division is operating at full capacity, the transfer price must be:
A) based on opportunity cost.
B) a market-based transfer price.
C) a cost-based transfer price.
D) total manufacturing cost.
Answer: B
Diff: 1
LO: 24-6
AACSB: Concept
8) Opportunity cost means:

A) benefit received by selling goods on behalf of other division.
B) benefit received by selling goods to one of the other divisions within the company.
C) benefit foregone by purchasing goods at a price lower than its total manufacturing cost.
D) benefit foregone by choosing an alternative course of action.
Answer: D
Diff: 1
LO: 24-6
AACSB: Concept
9) A market-based transfer price considers the ________ when determining the price.
A) variable costs
B) sales price of goods
C) cost of the goods
D) contribution margin
Answer: B
Diff: 1
LO: 24-6
AACSB: Concept
10) WAX-D Inc. has a division that manufactures a component that sells for $150 and has a variable cost
of $45. Another division of the company wants to purchase the component. Fixed cost per unit of
component is $25. What is the minimum transfer price if the division is operating at capacity?
A) $150
B) $45
C) $55
D) $140
Answer: A
Diff: 1
LO: 24-6
AACSB: Concept
47
component is $25. What is the minimum transfer price if the division is operating below its capacity?
A) $50
B) $45
C) $30
D) $40
Answer: B
Diff: 1
LO: 24-6
AACSB: Concept
component is $25. What is the maximum transfer price if the division is operating below its capacity?
A) $70
B) $170
C) $150
D) $30
Answer: C
Diff: 1
LO: 24-6
AACSB: Concept
48
Chapter 25 Short-Term Business Decisions
1) If a business is considering buying a new vehicle, the cost of insurance on the new vehicle is
information that is relevant to the business decision.
Answer: TRUE
Diff: 1
LO: 25-1
AACSB: Application
2) When considering whether to have a new roof installed on a building, the money spent previously on
roof repairs to the old roof is information that is relevant to the business decision.
Answer: FALSE
Diff: 1
LO: 25-1
AACSB: Application
3) When a business is considering whether to replace old equipment with newer equipment, the cost of
operating the old equipment, compared to the cost of operating the new equipment, is relevant
information to the business decision.
Answer: TRUE
Diff: 1
LO: 25-1
AACSB: Application
4) When a business is considering whether to replace old equipment with newer equipment, the
replacement cost of the old equipment, compared to the cost of the new equipment, is relevant
information to the business decision.
Answer: TRUE
Diff: 1
LO: 25-1
AACSB: Application
5) A depreciable asset's original cost is relevant when considering whether to replace the depreciable
asset.
Answer: FALSE
Diff: 1
LO: 25-1
AACSB: Concept
49
6) A sunk cost is a cost that was incurred in the past and cannot be changed regardless of which future
action is taken.
Answer: TRUE
Diff: 1
LO: 25-1
AACSB: Concept
7) Managers' decisions are based primarily on quantitative data because the qualitative factors are not
usually relevant to the decision making process.
Answer: FALSE
Diff: 1
LO: 25-1
AACSB: Concept
8) Fixed costs that do not differ between two alternatives are:

A) relevant to the decision.
B) considered opportunity costs.
C) considered irrelevant to the decision.
D) important only if they represent a material dollar amount.
Answer: C
Diff: 1
LO: 25-1
AACSB: Concept
9) When replacing an old asset with a new one, the original purchase price of the old asset represents:
A) relevant cost.
B) differential costs.
C) opportunity cost.
D) sunk cost.
Answer: D
Diff: 1
LO: 25-1
AACSB: Concept
50
10) A company is planning to replace an old machine with a new one. Which of the following is a sunk
cost in this decision?
A) cost of the new machine
B) selling price of the old machine
C) future maintenance costs of the old machine
D) original cost of the old machine
Answer: D
Diff: 1
LO: 25-1
AACSB: Application
11) Which of following statements is true of short-term decision making?

A) Fixed costs and variable costs must be analyzed separately.
B) All costs behave in the same way.
C) Unit manufacturing costs are variable costs.
D) All costs involved in a decision are considered relevant.
Answer: A
Diff: 1
LO: 25-1
AACSB: Application
12) Which of the following is a historical cost that is always irrelevant?

A) relevant cost
B) differential cost
C) opportunity cost
D) sunk cost
Answer: D
Diff: 1
LO: 25-1
AACSB: Concept
13) The contribution margin approach helps managers in short-term decision making because:
A) it treats fixed manufacturing overhead as a product cost.
B) it reports only mixed costs.
C) it reports costs and revenues at present value.
D) it isolates costs by behavior.
Answer: D
Diff: 1
LO: 25-1
AACSB: Concept
51
14) Smith Industries is considering replacing a machine that is presently used in its production process.
The following information is available:
Replacement
Old Machine Machine
Original cost $45,000 $35,000
Remaining useful life in years 5 5
Current age in years 5 0
Book value $25,000
Current disposal value in cash $8,000
Future disposal value in cash (in 5 years) $0 $0
Annual cash operating costs $7,000 $4,000
Which of the information provided in the table is irrelevant to the replacement decision?
A) the price of the new machine
B) the original cost of the old machine
C) the current disposal value of the old machine
D) annual operating costs
Answer: B
Diff: 1
LO: 25-1
AACSB: Application
15) Smith Industries is considering replacing a machine that is presently used in its production process.
The following information is available:
Replacement
Old Machine Machine
Original cost $55,000 $45,000
Remaining useful life in years 3 3
Current age in years 3 0
Book value $33,000
Current disposal value in cash $9,000
Future disposal value in cash (in 5 years) $0 $0
Annual cash operating costs 8,500 $3,500
Which of the following amounts represent a sunk cost?

A) $55,000
B) $33,000
C) $9,000
D) $45,000
Answer: A
Diff: 1
LO: 25-1
AACSB: Application
52
16) Which of the following pieces of information would be irrelevant in deciding to upgrade a company's
heating and air conditioning system?
A) The energy efficiency of the old equipment versus the energy efficiency of the new equipment
B) The safety of the new equipment compared to the old equipment
C) The purchase price of the old equipment compared to the purchase price of the new equipment
D) The productivity of the old equipment compared to that of the new equipment
Answer: C
Diff: 1
LO: 25-1
AACSB: Concept
17) Which of the following is the most important key to short-term business decision making?
A) focus on costs which do not change under two alternatives and on historic costs
B) focus on qualitative data only and ignore future cash flows
C) focus on sunk costs and quantitative data
D) focus on relevant costs and use the contribution margin approach
Answer: D
Diff: 2
LO: 25-1
AACSB: Concept
1) Special sales orders increase operating income if the revenue from the order exceeds the incremental
variable and fixed costs incurred to fill the order.
Answer: TRUE
Diff: 2
LO: 25-2
AACSB: Concept
2) In deciding whether to accept a special sales order, management should only consider the quantitative
data and disregard qualitative factors.
Answer: FALSE
Diff: 1
LO: 25-2
AACSB: Concept
3) Fixed costs are relevant to a special sales order decision if those fixed costs are subject to change as a
result of the special order.
Answer: TRUE
Diff: 1
LO: 25-2
AACSB: Concept
53
4) Revenue at the market price less the desired operating income equals the product's target full product
cost.
Answer: TRUE
Diff: 1
LO: 25-2
AACSB: Concept
5) Price-setters emphasize a cost-plus pricing approach.

Answer: TRUE
Diff: 1
LO: 25-2
AACSB: Concept
6) If a company is a price-taker, it has considerable flexibility in setting its products' prices.

Answer: FALSE
Diff: 1
LO: 25-2
AACSB: Concept
7) Polynesia Company manufactures sonars for fishing boats. Model 70 sells for $300. Polynesia produces
and sells 5,500 of them per year. Cost data are as follows:
Variable manufacturing $100 per unit

Variable marketing $15 per unit
Fixed manufacturing $280,000 per year
Fixed marketing & admin $150,000 per year
The sales manager says he has an opportunity to pitch a special sale to a new Canadian fishing company
that is outfitting new boats. He proposes a sale of 40 units at a special price of $150 per unit. He says it
will not cannibalize the company's regular sales and is a one-time transaction. It will require the normal
amount of variable costs, both marketing and manufacturing, but will not impact fixed costs in any way.
The president of the company has some reservations, but finally agrees to make the deal if and only if it
adds a minimum of $1,500 to operating income. Based on the president's criteria, Polynesia will decline
the offer.
Answer: TRUE
Explanation: Incremental Revenue $6,000
Less: Incremental Cost
Variable manufacturing $4,000
Variable marketing $600 $4,600
Incremental Profit $1,400
Diff: 2
LO: 25-2
AACSB: Application
54
8) Polynesia Company manufactures sonars for fishing boats. Model 70 sells for $250. Polynesia produces

A potential deal has come up for a one-time sale of 30 units at a special price of $115 per unit. The
marketing manager says that the sale will not negatively impact the company's regular sales activities,
but it will require the normal amount of variable marketing costs. The production manager says that
there is plenty of excess capacity and the deal will not impact fixed costs in any way. The controller points
out, however, that because the incremental revenues are just equal to the incremental costs to fill the
order, the deal will not have any impact on the bottom line. The controller is correct in his statement.
Answer: FALSE
Explanation: Incremental Revenue $3,450
Incremental Costs
Variable manufacturing $3,300
Variable marketing $450 $3,750
Difference ($300)
Diff: 2
LO: 25-2
AACSB: Application
9) Which of the following is a major consideration when analyzing a special order?

A) the price must be high enough to cover any incremental costs to fill the order
B) the company must have a good stock turnover ratio
C) the profit margin of the special sale must be higher than the regular sales
D) the sunk costs of the decision must not exceed the irrelevant costs
Answer: A
Diff: 2
LO: 25-2
AACSB: Concept
55
10) Rica Company is a price-taker and uses a target-pricing approach. Refer to the following information:
Production volume 600,000 units per year

Market price $30 per unit
Desired operating income 15% of total assets
Total assets $13,900,000
How much is the desired profit for the year?

A) $1,440,000
B) $18,000,000
C) $2,700,000
D) $2,085,000
Answer: D
Explanation: D)
Desired operating income 15%
Desired Profit $2,085,000
Diff: 1
LO: 25-2
AACSB: Application
11) Rica Company is a price-taker and uses a target-pricing approach. Refer to the following information:

How much is the target full product cost in total for the year? Assume all units produced are sold.
A) $18,000,000
B) $15,915,000
C) $13,900,000
D) $2,085,000
Answer: B
Explanation: B)
Sales $18,000,000
Less: Desired Profit 2,085,000
Target Cost $15,915,000
Diff: 1
LO: 25-2
AACSB: Application
56
12) Rica Company is a price-taker and uses target pricing. Refer to the following information:

How much is the target full product cost per unit? (Round your answer to nearest cent.) Assume all units
produced are sold.
A) $30
B) $26.53
C) $23.17
D) $19.33
Answer: B
Explanation: B)
Sales $18,000,000.00
Less: Desired Profit ($13,900,000 × 15%) 2,085,000.00
Target Cost $15,915,000.00
Production Volume 600,000.00
Target Cost per unit ($15,915,000 ∕ 600,000) $26.53
Diff: 2
LO: 25-2
AACSB: Application
57

Variable cost per unit $18 per unit
Fixed cost per year $5,600,000 per year
With the current cost structure, Rica cannot achieve its profit goals. It will have to reduce either the fixed
costs or the variable costs. Assuming that variable costs cannot be reduced, how much will be the target
fixed costs per year?
A) $5,115,000
B) $5,600,000
C) $10,315,000
D) $5,200,000
Answer: A
Explanation: A)
Sales $18,000,000.00
Target Cost $15,915,000.00
Production Volume (units) 600,000.00
Target Cost per unit $26.53
Target Cost $15,915,000.00

Variable costs ($18 × 600,000) $10,800,000.00
Fixed Costs $5,115,000.00
Diff: 3
LO: 25-2
AACSB: Application
58
14) Rica Company is a price-taker and uses target pricing. Please refer to the following information:

costs or the variable costs. Assuming that fixed costs cannot be reduced, how much will be the target
variable costs per year?
A) $10,315,000
B) $5,115,000
C) $5,600,000
D) $5,200,000
Answer: A
Explanation: A)
Sales $18,000,000.00
Target Cost $15,915,000.00
Target Cost per unit $ 26.53
Target Cost $15,915,000.00

Fixed Costs $5,600,000.00
Variable costs $10,315,000.00
Diff: 2
LO: 25-2
AACSB: Application
59

costs or the variable costs. Assuming that fixed costs cannot be reduced, how much will be the target
variable costs per unit per year? (Round your answer to the nearest cent.)
A) $26.53
B) $9.33
C) $17.19
D) $18
Answer: C
Explanation: C)
Sales $18,000,000.00
Less: Desired Profit 2085000.00
Target Cost $15,915,000.00
Production Volume 600,000.00
Target Cost per unit $ 26.53
Target Cost $15,915,000.00

Fixed Costs $ 5,600,000.00
Variable costs $10,315,000.00
Variable costs $17.19
Diff: 2
LO: 25-2
AACSB: Application
60
16) Gotham Products is a price-taker and uses target pricing. Please refer to the following information:

How much is the target full product cost per year? Assume all units produced are sold.
A) $900,000
B) $600,000
C) $300,000
D) $390,000
Answer: B
Explanation: B)
Production volume 300,000
Market price $3
Target sales 900,000
Less: Desired Operating Profit ($2,000,000 × 15%) 300,000
Target full product cost per year $600,000
Diff: 1
LO: 25-2
AACSB: Application
17) Gotham Products is a price-taker and uses target pricing. Gotham has just done an analysis of their
revenues, costs and desired profits, and has calculated its target full product cost. Please refer to the
following information:
Target full product cost $500,000 per year

Actual fixed cost $280,000 per year
Actual variable cost $2 per unit
Actual costs are currently higher than target full product cost. Assuming that variable costs are
dependent on commodity prices and cannot be reduced, how much is the target fixed cost?
A) $180,000
B) $300,000
C) $200,000
D) $500,000
Answer: C
Explanation: C)
Target full product cost $500,000
Actual variable cost $300,000
Target Fixed Costs $200,000
Diff: 1
LO: 25-2
AACSB: Application
61
revenues, costs and desired profits, and has calculated its target full product cost. Please refer to the

Actual costs are currently higher than target full product cost. Assuming that fixed costs cannot be
reduced, how much is the target variable cost?
A) $180,000
B) $300,000
C) $220,000
D) $500,000
Answer: C
Explanation: C)
Actual Fixed Costs 280,000
Target Variable Costs $220,000
Diff: 1
LO: 25-2
AACSB: Application
62
revenues, costs and desired profits, and has calculated its target full product cost. Refer to the following
information:

Actual costs are currently higher than target full product cost. Assuming that fixed costs cannot be
reduced, how much is the target variable cost per unit?
A) $1.20
B) $1.47
C) $1.33
D) $3.33
Answer: B
Explanation: B)
Actual Fixed Costs 280,000
Production Volume 150,000

Target Variable Costs per unit $1.47
Diff: 2
LO: 25-2
AACSB: Application
20) Fantabulous Products sells 2,000 kayaks per year at a price of $450 per unit. Fantabulous sells in a
highly competitive market and uses target pricing. The company has $1,000,000 of assets and the
shareholders wish to make a profit of 18% on assets. How much is the target full product cost?
A) $1,800,000
B) $720,000
C) $1,062,000
D) $712,500
Answer: B
Explanation: B)
Revenue (2,000 × $450) $900,000
Less: Profit ($1,000,000 × 18%) 180,000
Diff: 2
LO: 25-2
AACSB: Application
63
shareholders wish to make a profit of 18% on assets. Fixed costs are $500,000 per year and cannot be
reduced. How much is the target variable costs?
A) $265,000
B) $500,000
C) $720,000
D) $220,000
Answer: D
Explanation: D)
Revenue (2,000 × $450) $900,000
Less: Profit ($1,000,000 × 18%) 180,000
Less: Fixed Costs 500,000
Diff: 2
LO: 25-2
AACSB: Application
22) Peacock Inc. sells 2,500 kayaks per year at a price of $500 per unit. It sells in a highly competitive
market and uses target pricing. The company has calculated its target full product cost at $820,000 per
year. Fixed costs are $350,000 per year and cannot be reduced. How much is the target variable cost per
unit?
A) $188
B) $328
C) $360
D) $172
Answer: A
Explanation: A)
Less: Fixed Costs 350,000
Target Variable Cost per unit = $470,000 ÷ 2,500 units = $188
Diff: 1
LO: 25-2
AACSB: Application
64
shareholders wish to make a profit of 18% on assets. Variable cost is $200 per unit and cannot be reduced.
How much is the target fixed costs?
A) $265,000
B) $720,000
C) $180,000
D) $320,000
Answer: D
Explanation: D)
Revenue (2,000 × $450) $900,000
Less: Profit 180,000
Target Full product cost $720,000

Less: Variable Costs (2,000 × $200) 400,000
Diff: 2
LO: 25-2
AACSB: Application
highly competitive market and uses target pricing. The company has calculated its target full product cost
at $720,000 per year. Total variable costs are $330,000 per year and cannot be reduced. How much are the
target fixed costs?
A) $570,000
B) $180,000
C) $330,000
D) $390,000
Answer: D
Explanation: D)
Less: Variable Costs 330,000
Diff: 1
LO: 25-2
AACSB: Application
65
25) If a company wishes to be a price-taker, which of the following strategies should they take?
A) enter a competitive market and focus on cost cutting
B) produce a unique product
C) exploit the value of a fashionable brand name
D) differentiate the product clearly from the competitors
Answer: A
Diff: 1
LO: 25-2
AACSB: Concept
26) Centric Sail Makers manufacture sails for sailboats. The company has the capacity to produce 35,000
sails per year, and is currently producing and selling 25,000 sails per year. The following information
relates to current production:
Sale price per unit $175

Variable costs per unit:
Manufacturing 60
Marketing and administrative 20
Total fixed costs:
Manufacturing $700,000
Marketing and administrative $300,000
If a special sales order is accepted for 5,500 sails at a price of $150 per unit, and fixed costs remain
unchanged, what is the change in operating income? (Assume the special sales order will require variable
manufacturing costs and variable marketing and administrative costs.)
A) Operating income decreases by $825,000.
B) Operating income increases by $825,000.
C) Operating income decreases by $385,000.
D) Operating income increases by $385,000.
Answer: D
Explanation: D)
Sales $825,000
Less: Variable costs
Manufacturing 330,000
Marketing and administrative 110,000 440,000
Increase in operating income $385,000
Diff: 2
LO: 25-2
AACSB: Application
66

Manufacturing 60
Total fixed costs:
If a special sales order is accepted for 5,500 sails at a price of $150 per unit, fixed costs remain unchanged,
and there are no variable marketing and administrative costs for this order, what is the change in
operating income?
B) Operating income decreases by $495,000.
C) Operating income increases by $385,000.
Answer: D
Explanation: D)
Change in operating income = (Special Sale Price - Variable Manufacturing Cost) × Special Sales Order
Change in operating income = ($150 - $60) × 5,500 units = $495,000
Diff: 2
LO: 25-2
AACSB: Application
67

Manufacturing 60
Total fixed costs:
If a special sales order is accepted for 5,500 sails at a price of $150 per unit, and if the order requires both
variable manufacturing and variable marketing and administrative costs, and incremental fixed costs of
$400,000, what will be the impact on operating income?
B) Operating income decreases by $15,000.
C) Operating income increases by $385,000.
Answer: B
Explanation: B)
Sales $825,000
Marketing and administrative 110,000 440,000
Change in Operating income = $385,000 - $400,000 (Incremental fixed costs) = ($15,000)

Diff: 2
LO: 25-2
AACSB: Application
68

Manufacturing 60
Total fixed costs:
Fixed manufacturing costs increase by $100,000 for every 500 units produced beyond the maximum
capacity of the plant. If a special sales order is accepted for 5,500 sails at a price of $150 per unit, and if the
order requires no variable and fixed marketing and administrative costs, what will be the effect on
operating income?
A) Operating income increases $395,000.
B) Operating income decreases $395,000.
C) Operating income increases $385,000.
D) Operating income decreases $385,000.
Answer: A
Explanation: A)
Sales $825,000
Increase in manufacturing fixed costs 100,000
Diff: 2
LO: 25-2
AACSB: Application
30) Paragon Products sells a special kind of navigation equipment for $1,200. Variable costs are $900 per
unit. When a special order arrived from a foreign contractor to buy 40 units at a reduced price of $1,000
per unit, there was a discussion among management. The controller said that as long as the special price
was greater than the variable costs, the sale would contribute to the company's profits, and so it should be
accepted as offered. The vice-president, however, decided to decline the order. Which of the following
statements, if true, will support the decision of the vice-president?
A) The order is not likely to affect the regular sales.
B) The company is operating at 70% of its production capacity.
C) The variable costs of $900 includes variable costs of packing the product.
D) The company will need to hire additional staff to execute this order.
Answer: D
Diff: 2
LO: 25-2
AACSB: Reflective Thinking
69
31) Felix Time Company manufactures and sells watches for $40 each. Times Products Company has
offered Felix Time $25 per watch for a one-time order of 6,000 watches. The total manufacturing cost per
watch is $30 per unit, and consists of variable costs of $22 per watch and fixed overhead costs of $8 per
watch. Assume that Felix Time has excess capacity and that the special order would not adversely affect
regular sales. What is the change in operating income that would result from accepting the special sales
order?
A) increase of $18,000
B) decrease of $18,000
C) increase of $150,000
D) decrease of $150,000
Answer: A
Explanation: A)
Incremental revenue $150,000
Less: Incremental cost
Variable cost 132,000
Incremental profit $18,000
Diff: 1
LO: 25-2
AACSB: Application
32) Fox Inc. manufactures and sells pens for $5 each. Wolf Corp. has offered Fox Inc. $3 per pen for a one-
time order of 3,500 pens. The total manufacturing cost per pen, using traditional costing, is $1 per unit,
and consists of variable costs of $0.85 per pen and fixed overhead costs of $0.15 per watch. Assume that
Fox Inc. has excess capacity and that the special order would not adversely affect regular sales. What is
the change in operating income that would result from accepting the special sales order?
Answer: C
Explanation: C)
Variable Cost = 3,500 × $0.85 = $2,975
Offer price = 3,500 × $3 = $10,500
Increase in operating income = $10,500 - $2,975 = $7,525
Diff: 1
LO: 25-2
AACSB: Application
70
33) Hilltop Golf Course is planning for the coming season. Investors would like to earn a 15% return on
the company's $60,000,000 of assets. The company primarily incurs fixed costs to groom the greens and
fairways. Fixed costs are projected to be $30,000,000 for the golfing season. About 600,000 rounds of golf
are expected to be played each year. Variable costs are about $15 per round of golf. Hilltop golf course
has a favorable reputation in the area and therefore, has some control over the price of a round of golf.
Using a cost-plus pricing approach, what price should Hilltop charge for a round of golf to achieve the
desired profit?
A) $50
B) $60
C) $70
D) $80
Answer: D
Explanation: D)
Variable Cost (600,000 × $15) $9,000,000
Fixed Cost 30,000,000
Total Cost $39,000,000
Profit ($60,000,000 × 15%) 9,000,000
Revenue $48,000,000
Rounds of golf 600,000
Price per round of golf $80
Diff: 2
LO: 25-2
AACSB: Application
34) Hilltop Golf Course is planning for the coming season. Investors would like to earn a 15% return on
the company's $60,000,000 of assets. The company primarily incurs fixed costs to groom the greens and
fairways. Fixed costs are projected to be $30,000,000 for the golfing season. About 600,000 rounds of golf
are expected to be played each year. Variable costs are about $15 per round of golf. Hilltop golf course is
a price-taker and will not be able to charge more than its competitors, who charge $75 per round of golf.
What profit will it earn in terms of dollars?
A) $6,000,000
B) $9,000,000
C) $48,000,000
D) $45,000,000
Answer: A
Explanation: A)
Maximum price which can be charged $75
Price to be charged $75
Therefore Revenue (600,000 × $75) $45,000,000
Less: Total Cost [$30,000,000 + (600,000 × $15)] $39,000,000
Profit $6,000,000
Diff: 2
LO: 25-2
AACSB: Application
71
35) Gabriel Metalworks produces a special kind of metal ingots which are unique, and it allows Gabriel to
follow a cost-plus pricing strategy. Gabriel has $10,000,000 of assets and shareholders expect
approximately 9% return on assets. Additional data are as follows:
Sales volume 400,000 units per year

Variable costs $15 per unit
Fixed cost $1,500,000 per year
Using the cost-plus pricing approach, what should be the price per unit?
A) $19
B) $20
C) $21
D) $22
Answer: C
Explanation: C)
Variable costs (400,000 × $15) $6,000,000
Fixed cost 1,500,000
Total Cost $7,500,000
Profit ($10,000,000 × 9%) $900,000
Revenue $8,400,000
Sales Volume 400,000
Price per unit $21
Diff: 2
LO: 25-2
AACSB: Application
72
36) Fine Arts Inc. produces a special kind of light weight, recreational vehicle that has a unique design. It
allows the company to follow a cost-plus pricing strategy. It has $9,000,000 of assets and shareholders
expect a 10% return on assets. Additional data are as follows:

Variable costs $2,000 per unit
Fixed cost $3,500,000 per year
Using the cost-plus pricing approach, what should be the price per unit?
A) $3,100
B) $2,875
C) $2,225
D) $3,015
Answer: A
Explanation: A)
Variable Cost = 4,000 × $2,000 = $8,000,000
Profit = $9,000,000 × 10% = $900,000
Target Revenue = $8,000,000 + $3,500,000 + $900,000 = $12,400,000
Price per unit = $12,400,000 ÷ 4,000 = $3,100
Diff: 2
LO: 25-2
AACSB: Application
37) Yummy Foods sells jars of special spices used in Spanish cooking. The variable cost is $1 per unit.
Fixed costs are $9,000,000 per year. It has $40,000,000 of assets, and investors expect a return of 5% on
their assets. Yummy Foods sells 5,000,000 units per year. They use cost-plus pricing because they are the
only company which produces this kind of product. Using cost-plus pricing methodology, determine the
price per unit. (Round your answer to the nearest cent)
A) $1.40
B) $3.20
C) $2.80
D) $1.90
Answer: B
Explanation: B)
Variable cost = 5,000,000 × $1 = $5,000,000
Desired profit = $40,000,000 × 5% = $2,000,000
Price per unit = ($5,000,000 + $9,000,000 + $2,000,000) ÷ 5,000,000 units = $3.2
Diff: 2
LO: 25-2
AACSB: Application
73
38) Companies are price-takers when:
A) it is operating in a highly competitive market.
B) its product is unique.
C) it has considerable flexibility in setting prices of its products.
D) it has very high fixed costs.
Answer: A
Diff: 1
LO: 25-2
AACSB: Application
39) Sprint Company makes special equipment used in cell towers. Each unit sells for $400. Sprint uses
just-in-time inventory procedures; it produces and sells 12,500 units per year. It has provided the
following income statement data:
Traditional Costing Contribution Margin

Revenue $5,000,000 Revenue $5,000,000
Cost of goods sold 3,000,000 Variable Expenses
Gross Profit 2,000,000 Manufacturing 1,000,000
Selling & admin expenses 650,000 Selling & admin 400,000
Contribution Margin 3,600,000
Fixed Expenses
Manufacturing 2,000,000
Selling & admin 250,000
Operating income $1,350,000 Operating income $1,350,000
A foreign company has offered to buy 100 units for a reduced price of $250 per unit. The marketing
manager says the sale will not negatively impact the company's regular sales. The sales manager says that
this sale will not require any incremental selling & administrative costs, as it is a one-time deal. The
production manager reports that there is plenty of excess capacity to accommodate the deal without
requiring any additional fixed costs. If Sprint accepts the deal, how will this impact operating income?
A) up $17,000
B) down $8,000
C) up $25,000
D) down $800
Answer: A
Explanation: A)
Incremental Revenue (100 × $250) $25,000
Less: Incremental Cost (100 × $80) 8,000
Incremental profit $17,000
Diff: 2
LO: 25-2
AACSB: Application
74
40) Sprint Company makes special equipment used in cell towers. Each unit sells for $400. Sprint
produces and sells 12,500 units per year. They have provided the following income statement data:

Revenue $5,000,000 Revenue $5,000,000
Fixed Expenses
manager says the sale will not negatively affect the company's regular sales. The sales manager says that
this sale will require incremental selling & administrative costs, as it is a one-time deal. The production
manager reports that there is plenty of excess capacity to accommodate the deal without requiring any
additional fixed costs. If Sprint accepts the deal, how will this impact operating income?
A) up $15,040
B) down $15,040
C) up $24,000
D) down $24,000
Answer: A
Explanation: A)
Offer = 80 × $300 = $24,000
Variable Manufacturing Cost per unit = $1,000,000 ÷ 12,500 = $80
Total Manufacturing Variable Cost = 80 × $80 = $6,400
Variable Selling and Administrative Expenses per unit = $400,000 ÷ 12,500 = $32
Total Variable Selling and Administrative Expenses = 80 × $32 = $2,560
Change in Operating Income = $24,000 - $6,400 - $2,560 = $15,040
Diff: 2
LO: 25-2
AACSB: Application
75
41) Sprint Company makes special equipment used in cell towers. Each unit sells for $400. Sprint
produces and sells 12,500 units per year. They have provided the following income statement data:

Revenue $5,000,000 Revenue $5,000,000
Fixed Expenses
manager says the sale will not negatively affect the company's regular sales. The sales manager says that
this sale will require incremental selling & administrative costs, as it is a one-time deal. The production
manager reports that it would require an additional $30,000 of fixed manufacturing costs to accommodate
the specifications of the buyer. If Sprint accepts the deal, how will this impact operating income?
A) operating income will increase by $5,440
B) operating income will decrease by $14,960
C) operating income will increase by $24,000
D) operating income will decrease by $800
Answer: B
Explanation: B)
Offer = 80 × $300 = $24,000
Variable Manufacturing Cost per unit = $1,000,000 ÷ 12,500 units = $80
Total Manufacturing Variable Cost = 80 × $80 = $6,400
Variable Selling and Administrative Expenses per unit = $400,000 ÷ 12,500 = $32
Total Variable Selling and Administrative Expenses= 80 × $32 = $2,560
Additional Fixed Cost = $30,000
Change in Operating Income = $24,000 - $6,400 - $2,560 - $30,000 = ($14,960)
Diff: 2
LO: 25-2
AACSB: Application
76
42) Grand Products is a price-setter, and they use cost-plus pricing methodology for pricing their
products which are unique, artistically designed architectural decorations. They produce and sell 6,000
units per year, at their maximum capacity. Variable costs are $330 per unit. Total fixed costs are $900,000
per year. The CEO has a target of $50,000 operating income which he wants to hit by year-end. Using the
cost-plus pricing method, what price should Grand use? (Round to nearest whole dollar.)
A) $338 per unit
B) $480 per unit
C) $488 per unit
D) $378 per unit
Answer: C
Explanation: C)
Variable costs $1,980,000
Fixed cost 900,000
Total Cost 2,880,000
Profit 50,000
Revenue 2,930,000
Sales Volume 6,000
Price per unit $488
Diff: 2
LO: 25-2
AACSB: Application
43) Nelson Products is a price-setter, and they use cost-plus pricing methodology for pricing their
products which are specialty vacuum tubes used in sound equipment. The CEO is certain that he can
produce and sell 300,000 units per year, due to the high demand for the product. Variable costs are $2.40
per unit. Total fixed costs are $980,000 per year. The CEO will receive stock options if he reports $200,000
of operating income for the year. Using the cost-plus pricing method, what price would allow the CEO to
achieve his target? (Please round to nearest cent.)
A) $5.67 per unit
B) $6.33 per unit
C) $3.07 per unit
D) $6.15 per unit
Answer: B
Explanation: B)
Variable Cost = 300,000 × $2.40 = $720,000
Target Revenue = $720,000 + $980,000 + $200,000 = $1,900,000
Price to be charged = $1,900,000 ÷ 300,000 = $6.33
Diff: 2
LO: 25-2
AACSB: Application
77
44) Meson Production is a price-taker. It produces large spools of electrical wire in a highly competitive
market, so it practices target pricing. The current market price of the electric wire is $780 per unit. The
company has $3,000,000 in assets and its shareholders expect a return of 6% on assets. The company
provides the following information:

Fixed costs $12,000,000 per year
If variable costs cannot be reduced, how much reduction in fixed costs will be needed to achieve the
profit target?
A) $4,180,000
B) $12,000,000
C) $7,820,000
D) $4,200,000
Answer: A
Explanation: A)
Variable costs ($700 per unit) $70,000,000
Fixed costs 12,000,000
Total costs $82,000,000
Total sales ($780 per unit) $78,000,000

Less: Target profit ($3,000,000 × 6%) 180,000
Target cost $77,820,000
Fixed costs must be reduced by $4,180,000 ($82,000,000 - $77,820,000) to achieve the profit target.
Diff: 3
LO: 25-2
AACSB: Application
78
45) Meson Production is a price-taker. It produces large spools of electrical wire in a highly competitive
market, so it practices target pricing. The current market price of the electric wire is $800 per unit. The
company has $3,000,000 in assets and its shareholders expect a return of 6% on assets. The company
provides the following information:

If fixed costs cannot be reduced, how much reduction in variable costs will be needed to achieve the
profit target?
A) $180,000
B) $12,000,000
C) $2,180,000
D) $4,200,000
Answer: C
Explanation: C)

Variable costs must be reduced by $2,180,000 ($ 82,000,000 - $79,820,000) to achieve the profit target.
Diff: 3
LO: 25-2
AACSB: Application
79
46) Meson Production is a price-taker. They produce large spools of electrical wire in a highly competitive
market, and so they practice target pricing. The current market price is $800 per unit. The company has
$3,000,000 in assets and shareholders expect a return of 6% on assets. The company provides the

Currently the cost structure is such that the company cannot achieve its profit objective and must cut
costs. If fixed costs cannot be reduced, how much reduction in variable cost per unit will be needed to hit
the profit target?
A) reduction in variable cost per unit by $120
B) reduction in variable cost per unit by $1.80
C) reduction in variable cost per unit by $20.30
D) reduction in variable cost per unit by $21.80
Answer: D
Explanation: D)

Variable costs per unit must be reduced by $21.80 per unit ($2,180,000 ÷ 100,000 units; $2,180,000 =
$82,000,000 - $79,820,000) to achieve the profit target.
Diff: 3
LO: 25-2
AACSB: Application
47) Which of the following statements is true?

A) Companies are price-takers when their products are unique.
B) Companies are price-setters for a product when there is intense competition.
C) Companies are price-takers for a product when pricing approach emphasizes cost-plus pricing.
D) Companies are price-takers when they have little or no control over the prices of their products or
services.
Answer: D
Diff: 2
LO: 25-2
AACSB: Application
80
48) Potlatch Company manufactures sonars for fishing boats. Model 100 sells for $200. Potlatch produces

An offer has come in for a one-time sale of 100 units at a special price of $120 per unit. The marketing
manager says that the sale will not negatively affect the company's regular sales activities, and that it will
not require any variable marketing costs. The production manager says that there is plenty of excess
capacity and the deal will not impact fixed costs in any way. What is the effect of this deal on operating
income?
A) increase $200
B) increase $500
C) decrease $1,000
D) increase $1,500
Answer: D
Explanation: D)
Increase in revenue $12,000
Increase in costs 10,500
Increase in operating profit 1,500
Diff: 2
LO: 25-2
AACSB: Application
49) If a company wishes to be a price-setter, which of the following strategies should they take?
A) produce a generic mass-market product
B) enter a competitive market and boost profits by cost cutting
C) produce a unique product
D) produce a commodity and outsource the manufacturing operations
Answer: C
Diff: 1
LO: 25-2
AACSB: Concept
81
1) A company has two different products that sell to separate markets. Financial data are as follows:
Product A Product B Total

Revenue $15,000 $9,000 $24,000
Variable cost (8,000) (9,200) (17,200)
Fixed cost (allocated) (4,000) (1,000) (5,000)
Operating income $3,000 $(1,200) $1,800
Assume that fixed costs are all unavoidable and that dropping one product would not impact sales of the
other. Because the contribution margin of Product B is negative, it should be dropped.
Answer: TRUE
Diff: 1
LO: 25-3
AACSB: Application
2) The income statement for Eagle Inc. is divided by its two product lines—blankets and pillows—is as
follows:
Blankets Pillows Total

Sales revenue $700,000 $500,000 $1,200,000
Variable expenses 450,000 430,000 880,000
Contribution margin 250,000 70,000 320,000
Fixed expenses 85,000 85,000 170,000
Operating income (loss) $165,000 $(15,000) $150,000
If total fixed costs remain unchanged and Eagle Inc. drops the pillows line, operating income will fall by
$70,000.
Answer: TRUE
Diff: 1
LO: 25-3
AACSB: Application
82
3) The income statement for Sweet Dreams Company is divided by its two product lines, blankets and
pillows, as follows:

Sales revenue $620,000 $300,000 $920,000
Fixed expenses 76,000 76,000 152,000
If Sweet Dreams can eliminate total fixed costs of $30,000 by dropping the pillows line, operating income
will go up by $16,000.
Answer: FALSE
Explanation:
Expected decrease in revenue $ (300,000)
Expected decrease in total variable costs $240,000
Expected decrease in Fixed costs 30,000
Expected decrease in total costs 270,000
Expected decrease in operating income $(30,000)
Diff: 2
LO: 25-3
AACSB: Application
4) The income statement for Eagle Inc. is divided into two product lines, blankets and pillows, as follows:

Sales revenue $700,000 $500,000 $1,200,000
Fixed expenses 85,000 85,000 170,000
Eagle Inc. should eliminate the pillows product line only, if by doing so, they can eliminate more than
$70,000 of fixed costs.
Answer: TRUE
Diff: 2
LO: 25-3
AACSB: Application
83
5) Sand Corporation manufactures two styles of lamps: a Bedford Lamp and a Lowell Lamp. The
following per unit data are available:
Bedford Lamp Lowell Lamp

Sale price $30 $40
Variable costs $18 $24
Machine hours required for 1 lamp 2 4
Total fixed costs are $40,000. Machine hour capacity is 30,000 hours per year. The Lowell lamp has the
highest contribution margin per unit, and also has the highest contribution margin per machine hour, so
the company should focus sales on the Lowell lamp.
Answer: FALSE
Explanation: Bedford Lamp Lowell Lamp
Sale price $30 $40
Variable cost per unit 18 24
Contribution margin per unit $12 $16
Machine hours per unit 2 4
Contribution margin per machine hour $6 $4
Since contribution margin per machine hour of Lowell Lamp is less than Bedford Lamp, therefore the
above statement is false.
Diff: 2
LO: 25-3
AACSB: Application
6) Freemen Company's western territory's forecasted income statement for the upcoming year is as
follows:
Sales $800,000
Variable expenses 500,000
Contribution margin $300,000
Fixed expenses 396,000
Operating income ($96,000)
Freemen Company's management is considering dropping the western territory. This move would be
financially advantageous only if the company could eliminate $96,000 of fixed costs or more.
Answer: TRUE
Diff: 1
LO: 25-3
AACSB: Application
84
7) Tyler Corporation has provided you with the following budgeted income statement for one of their
products:
Sales $750,000
Variable expenses 500,000
Fixed expenses 280,000
Operating income ($30,000)
Tyler Corporation believes that 80% of the fixed costs would be avoidable if the product line was
dropped. Based on the impact of company's operating income, Tyler should not drop the product line.
Answer: TRUE
Explanation: Unavoidable fixed expenses$56,000
Operating loss $30,000
As operating loss is less than unavoidable fixed costs company must continue to operate.
Diff: 2
LO: 25-3
AACSB: Application
8) Lit Furniture manufactures a small table and a large table. The small table sells for $900, has variable
costs of $750 per table, and takes 7.5 labor hours to manufacture. The large table sells for $1,500, has
variable costs of $900, and takes 15 direct labor hours to manufacture. If the company has no sales
limitations on either product, they should make and sell as many of the large tables as possible to
maximize operating income.
Answer: TRUE
Explanation: Small Large
Sales $900.0 $1,500
Variable Costs 750.0 900
Contribution Margin 150.0 600
Direct Labor Hours 7.5 15
Contribution margin per unit per labor hour $ 20.0 $ 40
Diff: 2
LO: 25-3
AACSB: Application
85
9) Lit Furniture manufactures a small table and a large table. The small table sells for $900, has variable
costs of $750 per table, and takes 7.5 labor hours to manufacture. The large table sells for $1,500, has
variable costs of $900, and takes 15 direct labor hours to manufacture. The small table has a lower
contribution margin per unit, but a higher contribution margin per direct labor hour.
Answer: FALSE
Explanation: Small Large
Sales $900.00 $1,500
Variable Costs 750.00 900
Contribution margin 150.00 600
Direct Labor Hours 7.50 15
Contribution margin per unit per labor hour $20.00 $40
Diff: 2
LO: 25-3
AACSB: Application
10) In making product mix decisions under constraining factors, a company should maximize sales of the
product with the highest contribution margin per unit.
Answer: FALSE
Diff: 1
LO: 25-3
AACSB: Application
11) A company sells two products with information as follows:
A B
Price per unit $12 $18
Variable cost per unit $4 $12
Products are made by machine. 4 units of product A can be made with 2 machine hour and 2 units of
product B can be made with 0.50 machine hour. If there are no constraints on production or sales of either
product, then the company should emphasize sales of Product B.
Answer: TRUE
Explanation: A B
Sales $12.00 $18.00
Variable Costs 4.00 12.00
Contribution margin $8.00 $6.00
Direct Labor Hours 0.50 0.25
Contribution margin per unit per labor hour $16.00 $24.00
If there are no constraints on production or sales of either product, then the company should emphasize
sales of Product B.
Diff: 2
LO: 25-3
AACSB: Application
86
12) If a product line has a negative contribution margin, the product line should probably be dropped,
assuming there are no other significant considerations.
Answer: TRUE
Diff: 1
LO: 25-3
AACSB: Concept
13) In deciding whether to drop its electronics product line, a company's manager should ignore:
A) the variable and fixed costs it could save by dropping the product line.
B) the revenues it would lose from dropping the product line.
C) how dropping the electronics product line would affect sales of its other products, like CDs.
D) the amount of unavoidable fixed costs.
Answer: D
Diff: 2
LO: 25-3
AACSB: Concept
14) Faros Hats, Etc. has two product lines—baseball helmets and football helmets. Income statement data
for the most recent year follow:
Total Baseball Helmets Football Helmets

Sales revenue $850,000 $500,000 $350,000
Variable expenses (530,000) (250,000) (280,000)
Contribution margin $320,000 $250,000 $70,000
Fixed expenses (180,000) (90,000) (90,000)
Operating income (loss) $140,000 $160,000 $(20,000)
Assuming fixed costs remain unchanged, and that there would be no adverse effect on other sales. What
will be the effect of dropping Football Helmets line on the operating income of the company?
A) Operating income will increase by $20,000.
B) Operating income will increase by $90,000.
C) Operating income will decrease by $70,000.
D) Operating income will decrease by $350,000.
Answer: C
Explanation: C)
Expected decrease in revenue $(350,000)
Expected decrease in Fixed costs 0
Diff: 1
LO: 25-3
AACSB: Application
87
15) Faros Hats, Etc. has two product lines-baseball helmets and football helmets. Income statement data

Sales revenue $850,000 $500,000 $350,000
Fixed expenses (180,000) (90,000) (90,000)
If $50,000 of fixed costs will be eliminated by dropping the Football Helmets line, how will dropping
Football Helmets affect the operating income of the company?
Answer: D
Explanation: D)
Expected decrease in Fixed costs __50,000
Expected decrease in total costs _330,000
Diff: 2
LO: 25-3
AACSB: Application
88

Sales revenue $850,000 $500,000 $350,000
Fixed expenses (180,000) (90,000) (90,000)
Assuming the Football Helmets line is dropped, total fixed costs remain unchanged, and the space
formerly used to produce the line is rented for $100,000 per year, how will operating income be affected?
A) Operating income will increase $30,000.
B) Operating income will increase $10,000.
C) Operating income will decrease $10,000.
D) Operating income will decrease $80,000.
Answer: A
Explanation: A)
Expected decrease in Fixed costs 0
Additional income 100,000
Expected increase in operating income $30,000
Diff: 3
LO: 25-3
AACSB: Application
89

Sales revenue $850,000 $500,000 $350,000
Fixed expenses (180,000) (90,000) (90,000)
Assuming the Football Helmet line is dropped, total fixed costs remain unchanged, and the space
formerly used to produce the Football Helmet line is used to double the production of Baseball Helmets,
operating income will be:
A) $250,000.
B) $180,000.
C) $320,000.
D) $410,000.
Answer: C
Explanation: C) Baseball
Helmets
Sales revenue $1,000,000
Variable expenses (500,000)
Contribution margin 500,000
Fixed expenses (180,000)
Operating income (loss) $320,000
Diff: 2
LO: 25-3
AACSB: Application
90
18) A company has two different products that are sold in different markets. Financial data are as follows:

Revenue $15,000 $9,500 $24,500
Variable cost (9,000) (9,800) (18,800)
Operating income $3,000 ($2,300) $700
Assume that fixed costs are all unavoidable and that dropping one product would not impact sales of the
other. If Product B is dropped, what would be the impact on total operating income of the company?
A) increase $2,000
B) increase $300
C) decrease $2,000
D) decrease $300
Answer: B
Explanation: B)
Variable Cost $9,800
Revenue 9,500
Increase in Operating Income $300
Diff: 1
LO: 25-3
AACSB: Application
91
19) A company has two different products that are sold in different markets. Financial data are as follows:

Revenue $ 15,000 $9,500 $24,500
Variable cost (9,000) (9,800) (18,800)
Operating income $3,000 ($2,300) $700
Assume that fixed costs of $1,000 could be eliminated if product B was dropped. Assume furthermore
that dropping one product would not impact sales of the other. If Product B is dropped, what would be
the impact on total operating income of the company?
A) increase $1,000
B) increase $1,300
C) increase $300
D) increase $2,000
Answer: B
Explanation: B)
Variable Cost $9,800
Less: Revenue 9,500
Add: Fixed Cost saving 1,000
Increase in Operating Income $1,300
Diff: 2
LO: 25-3
AACSB: Application
92
20) Healthier Cook Company manufactures two products: toaster ovens and bread machines. The
following data are available:
Toaster Ovens Bread Machines

Sale price $80 $150
Healthier Cook can manufacture six toaster ovens per machine hour and four bread machines per
machine hour. Healthier Cook's production capacity is 1,800 machine hours per month. What is the
contribution margin per machine hour for bread machines?
A) $20
B) $240
C) $320
D) $7
Answer: C
Explanation: C)
Sale price $150.00
Variable costs 70.00
Contribution margin $80.00
Machine hour per unit (1 ÷ 4) 0.25
Contribution margin per machine hour $320
Diff: 1
LO: 25-3
AACSB: Application
93

Sale price $80 $150
machine hour. Healthier Cook's production capacity is 1,800 machine hours per month. What is the
contribution margin per machine hour for toaster ovens?
A) $235
B) $320
C) $7
D) $20
Answer: A
Explanation: A)
Sale price $80.00
Variable costs 40.00
Contribution margin $40.00
Machine hour per unit (1 ÷ 6) 0.17
Contribution margin per machine hour $235.00
Diff: 1
LO: 25-3
AACSB: Application
94

Sale price $80 $150
machine hour. Healthier Cook's production capacity is 1,800 machine hours per month, and Healthier
Cook can sell as many units of either type as it can produce. What product and how many units should
the company produce in a month to maximize profits?
A) 7,200 bread machines
B) 5,400 toaster ovens and 3,600 bread machines
C) 7,200 toaster ovens and 2,400 bread machines
D) 10,800 toaster ovens
Answer: A
Explanation: A) Toaster Bread
Sale price $80.00 $150.00
Variable costs 40.00 70.00
Contribution margin $ 40.00 $ 80.00
Machine hour per unit 0.17 0.25
Contribution margin per machine hour $235.00 $320.00
Ranking 2.00 1.00
Hours Available No. of units

Bread 1,800 1,800 × 4 = 7,200
Diff: 2
LO: 25-3
AACSB: Application
95

Sale price $80 $150
machine hour. Healthier Cook's production capacity is 1,800 machine hours per month. Marketing
limitations indicate that Healthier Cook can sell a maximum of 5,000 toasters a month, and 4,000 bread
machines per month. What product and how many units should the company produce in a month to
maximize profits?
A) 7,200 bread machines
B) 4,800 toaster ovens and 4,000 bread machines
C) 5,400 toaster ovens and 3,600 bread machines
D) 10,800 toaster ovens
Answer: B
Explanation: B) Toaster Bread
Sale price $80.00 $150.00
Contribution margin $ 40.00 $ 80.00
Contribution margin per machine hour $ 235.00 $320.00
Ranking 2.00 1.00
No. of units Hours required

Total 8,800 1,800
Bread 4,000 4,000 ÷ 4 = 1,000
Toaster 800 × 6 = 4,800 1,800 - 1,000 = 800
Diff: 3
LO: 25-3
AACSB: Application
96
24) Macaulay Company has three product lines—D, E, and F. The following information is available:
D E F
Sales $70,000 $40,000 $30,000
Variable costs (40,000) (20,000) (10,000)
Fixed expenses (15,000) (15,000) (25,000)
Operating income (loss) $15,000 $5,000 ($5,000)
Macaulay Company is thinking of dropping product line F because it is reporting an operating loss.
Assuming fixed costs are unavoidable, if Macaulay Company drops product line F and does not replace
it, what effect will this have on operating income?
A) Operating income will increase $5,000.
B) Operating income will increase $20,000.
C) Operating income will increase $25,000.
D) Operating income will decrease $20,000.
Answer: D
Explanation: D)
Expected decrease in fixed costs 0
Diff: 2
LO: 25-3
AACSB: Application
97
D E F
Sales $70,000 $40,000 $30,000
Variable costs (40,000) (20,000) (10,000)
Fixed expenses (15,000) (15,000) (25,000)
Assuming fixed costs are unavoidable, if Macaulay Company drops product line F, and rents the space
formerly used to produce product F for $17,000 per year, total income will be:
A) $10,000.
B) $12,000.
C) $20,000.
D) $25,000.
Answer: B
Explanation: B) D E Total
Sales $70,000 $40,000 $110,000
Variable costs 40,000 20,000 60,000
Contribution margin 30,000 20,000 $50,000
Fixed expenses (15,000) (15,000) (55,000)
Other income 17,000
Total income $12,000
Diff: 2
LO: 25-3
AACSB: Application
98
D E F
Sales $70,000 $40,000 $30,000
Variable costs (40,000) (20,000) (10,000)
Fixed expenses (15,000) (15,000) (25,000)
Assume that $15,000 of total fixed costs could be eliminated by dropping F. What effect would this
decision have on operating income?
Answer: C
Explanation: C)
Expected decrease in fixed costs 15,000
Diff: 2
LO: 25-3
AACSB: Application
99
D E F
Sales $70,000 $40,000 $30,000
Variable costs (40,000) (20,000) (10,000)
Fixed expenses (15,000) (15,000) (25,000)
Assume that $25,000 of total fixed costs could be eliminated by dropping F. What effect would this
decision have on operating income?
Answer: B
Explanation: B)
Expected decrease in fixed costs 25,000
Expected increase in operating income $5,000
Diff: 2
LO: 25-3
AACSB: Application
100
28) The income statement for Sweet Dreams Company is divided by its two product lines, blankets and
pillows, as follows:

Sales revenue $620,000 $300,000 $920,000
Fixed expenses (76,000) (76,000) (152,000)
Sweet Dreams is considering eliminating the pillows product line. If they do so, they will be able to
eliminate $76,000 of total fixed costs. How would that business decision impact operating income?
A) increase $76,000 in operating income
B) decrease $60,000 in operating income
C) increase $42,000 in operating income
D) increase of $16,000 in operating income
Answer: D
Explanation: D)
Avoidable fixed expenses $76,000
Contribution margin foregone 60,000
Diff: 2
LO: 25-3
AACSB: Application
29) Which of the following statements describes a scenario when management should consider dropping
a business division?
A) The division has been reporting an operating loss consistently.
B) The division's avoidable fixed costs are less than its contribution margin.
C) The division's avoidable fixed costs are greater than its contribution margin.
D) The division's unavoidable fixed costs are greater than its operating loss.
Answer: C
Diff: 2
LO: 25-3
AACSB: Application
101
30) Clay Corporation manufactures two styles of lamps—a Bedford Lamp and a Lowell Lamp. The

Sale price $25 $35
Total fixed costs are $30,000, and Clay can sell a maximum of 10,000 units of each style of lamp annually.
Machine hour capacity is 25,000 hours per year. What is the contribution margin per machine hour for the
Bedford lamp?
A) $4 per machine hour
B) $2 per machine hour
C) $6 per machine hour
D) $8 per machine hour
Answer: A
Explanation: A)
Sale price $25
Variable costs 17
Contribution margin $8
Machine hours required for 1 lamp 2
Diff: 2
LO: 25-3
AACSB: Application
102

Sale price $25 $35
Total fixed costs are $30,000, and Clay can sell a maximum of 10,000 units of each style of lamp annually.
Machine hour capacity is 25,000 hours per year. What is the contribution margin per machine hour for the
Lowell lamp?
A) $4 per machine hour
B) $2 per machine hour
C) $3 per machine hour
D) $12 per machine hour
Answer: C
Explanation: C)
Sale price $35
Variable costs $23
Machine hours required for 1 lamp 4
Diff: 2
LO: 25-3
AACSB: Application
103

Sale price $25 $35
Total fixed costs are $30,000. Machine hour capacity is 25,000 hours per year. Assuming that the company
can sell as many products as it can make, which product mix would deliver the highest operating
income?
A) 10,000 Bedford lamps, 1,250 Lowell lamps
B) Zero Bedford lamps, 6,250 Lowell lamps
C) 12,500 Bedford lamps, zero Lowell lamps
D) 12,500 Bedford lamps, 12,500 Lowell lamps
Answer: C
Explanation: C) Bedford Lowell
Sale price $25 $35
Variable costs 17 23
Contribution margin $8 $12
Machine hour per unit 2 4
Ranking 1 2
Hours available No. of units

Total 25000
Bedford 25000 12500
Lowell 0 0
Diff: 2
LO: 25-3
AACSB: Application
104

Sale price $25 $35
Total fixed costs are $30,000. Marketing data indicate that the company can sell up to 8,000 units of the
Bedford lamp and up to 4,000 units of the Lowell lamp. Machine hour capacity is 25,000 hours per year.
What product mix will deliver the optimum operating income?
A) 4,500 Bedford lamps, 4,000 Lowell lamps
B) 12,500 Bedford lamps, zero Lowell lamps
C) 8,000 Bedford lamps, 2,250 Lowell lamps
D) 7,500 Bedford lamps, 3,000 Lowell lamps
Answer: C
Explanation: C) Bedford Lowell
Sale price $25 $35
Machine hour per unit 2 4
Ranking 1 2
No. of units Hours Required

Total 25,000
Bedford 8,000 16,000
Lowell 2,250 9,000
Diff: 3
LO: 25-3
AACSB: Application
105
34) Todd Corporation produces two products, P and Q. P sells for $5 per unit; Q sells for $6.50 per unit.
Variable costs for P and Q are respectively, $3 and $4.50. There are 4,300 direct labor hours per month
available for producing the two products. Product P requires 4 direct labor hours per unit and Product Q
requires 5 direct labor hours per unit. The company can sell as many of either product as it can produce.
What is the maximum monthly contribution margin that Todd can generate under the circumstances?
Round to nearest whole dollar.
A) $2,150
B) $1,505
C) $1,500
D) $2,250
Answer: A
Explanation: A) P Q
Sale price $5.00 $6.50
Contribution margin $2.00 $ 2.00
Direct labor hours per unit 4.00 5.00
Contribution margin per direct labor hour $0.50 $0.40
Ranking 1.00 2.00

Total 4,300
P 4300 1075
Q 0 0
Sales of P $5,375.00
Less: Variable Cost 3,225.00
Contribution Margin $2,150.00
Diff: 3
LO: 25-3
AACSB: Application
106
35) Todd Corporation produces two products, P and Q. P sells for $5 per unit; Q sells for $6.50 per unit.
Variable costs for P and Q are respectively, $3 and $4.50. There are 4,300 direct labor hours per month
available for producing the two products. Product P requires 4 direct labor hours per unit and Product Q
requires 5 direct labor hours per unit. The company can sell up to 900 units of each kind per month. What
is the maximum monthly contribution margin that Todd can generate under the circumstances? Round to
nearest whole dollar.
A) $2,150
B) $1,505
C) $2,080
D) $1,500
Answer: C
Explanation: C) P Q
Sale price $5.00 $6.50
Direct labor hour per unit 4.00 5.00
Contribution margin per direct labor hour $0.50 $0.40
Ranking 1.00 2.00
No. of units Hours available

Total 4,300
P 900 3,600
Q 140 700
P Q Total
Sales $4,500 $910.00 $5,410.00
Variable Cost 2700 630.00 3330.00
Contribution margin $1,800 $280.00 $2,080.00
Diff: 3
LO: 25-3
AACSB: Application
107
36) Kim Company's western territory's forecasted income statement for the upcoming year is as follows:
Sales $850,000
Operating loss ($150,000)
Kim Company's management is considering dropping the western territory and has determined that 80%
of the fixed expenses are avoidable. What is the change in Kim Company's forecasted operating loss for
the upcoming year if the western territory is dropped? Assume the company predicts an operating loss
across the entire company.
A) Loss will be reduced by $54,000.
B) Loss will be increased by $60,000.
C) Loss will be reduced by $480,000.
D) Loss will be increased by $384,000.
Answer: A
Explanation: A)
Current operating loss ($150,000)
Unavoidable fixed costs (96,000)
Saving of loss ($54,000)
Diff: 2
LO: 25-3
AACSB: Application
108
37) Kim Company's western territory's forecasted income statement for the upcoming year is as follows:
Sales $850,000
Kim Company's management is considering dropping the western territory and has determined that
$310,000 of the fixed expenses is avoidable. What is the change in Kim Company's forecasted operating
for the upcoming year if the western territory is dropped? Assume the company predicts an operating
loss across the entire company.
A) Operating loss will increase by $20,000.

B) Operating profit will increase by $330,000.
C) Operating loss will decrease by $20,000.
D) Operating profit will decrease by $330,000.
Answer: A
Explanation: A)
Unavoidable fixed expenses $170,000
Current operating loss $150,000
Loss on dropping the territory operations ($20,000)
Diff: 2
LO: 25-3
AACSB: Application
109
38) DM Corporation has provided you with the following budgeted income statement for one of their
products:
Sales $700,000
DM has just encountered environmental problems with the product and will be forced to drop the
product line altogether. They will be able to eliminate 75% of the fixed expenses. What will be the impact
on operating income of the company?
A) Operating income will decrease by $195,000.
B) Operating income will decrease by $45,000.
C) Operating income will increase by $240,000.
D) Operating income will increase by $55,000.
Answer: B
Explanation: B)
Current operating loss ($30,000)
Unavoidable fixed expenses (75,000)
Excess loss on dropping the product ($45,000)
Diff: 2
LO: 25-3
AACSB: Application
39) Custom Furniture manufactures a small table and a large table. The small table sells for $900, has
variable costs of $560 per table, and takes ten direct labor hours to manufacture. The large table sells for
$1,500, has variable costs of $980, and takes eight direct labor hours to manufacture. Calculate the
contribution margin per direct labor hour for the small table.
A) $29 per direct labor hour
B) $32 per direct labor hour
C) $34 per direct labor hour
D) $36 per direct labor hour
Answer: C
Explanation: C)
Sale price $900
Less: Variable cost 560
Labor hour required for 1 table 10
Contribution margin per direct labor hour $34
Diff: 2
LO: 25-3
AACSB: Application
110
$1,500, has variable costs of $980, and takes eight direct labor hours to manufacture. Calculate the
contribution margin per direct labor hour for the large table.
A) $65 per direct labor hour
B) $66 per direct labor hour
C) $67 per direct labor hour
D) $68 per direct labor hour
Answer: A
Explanation: A)
Sale price $1,500
Less: Variable cost 980
Labor hour required for 1 table 8
Contribution margin per direct labor hour $65
Diff: 2
LO: 25-3
AACSB: Application
41) Which of the following is the key to choose the product type to be maximized, in making product mix
decisions under constraining factors?
A) revenue per unit
B) contribution margin per unit of product
C) contribution margin per unit of the constraining factor
D) gross profit per unit using traditional costing
Answer: C
Diff: 2
LO: 25-3
AACSB: Application
111
$1,500, has variable costs of $980, and takes eight direct labor hours to manufacture. The company has a
maximum of 5,000 direct labor hours per month when operating at full capacity. If there are no
constraints on sales of either of the products, and the company could choose any proportions of product
mix that they wanted, the maximum contribution margin that the company could earn will be:
A) $250,000
B) $425,000
C) $330,000
D) $325,000
Answer: D
Explanation: D) Small Table Large Table
Sale price $900 $1,500
Variable costs (560) (980)
Labor hours per unit 10 8
Contribution margin per labor hour $34 $65
Ranking 2 1

Total 5,000
Large 5,000 625
Small 0 0
Sales of Large tables $937,500

Less: Variable Cost 612,500
Contribution Margin $325,000
Diff: 3
LO: 25-3
AACSB: Application
112
$1,500, has variable costs of $980, and takes eight direct labor hours to manufacture. The company has a
maximum of 5,000 direct labor hours per month when operating at full capacity. If there are no
constraints on sales of either product, and the company could choose any proportions of product mix that
they wanted, what is the optimum product mix to maximize operating income of the company?
A) 400 units of small, 125 units of large
B) zero units of small, 625 units of large
C) 100 units of small, 500 units of large
D) 500 units of small, zero units of large
Answer: B
Explanation: B) Small Table Large Table
Sale price $900 $1,500
Labor hour per unit 10 8
Contribution margin per labor hour $34 $65
Ranking 2 1

Total 5,000
Large 5,000 625
Small 0 0
Diff: 2
LO: 25-3
AACSB: Application
113
A B
Products are made by machine. 4 units of Product A can be made with one machine hour and 2 units of
Product B can be made with one machine hour. The company has a maximum of 3,000 machine hours
available per month. Assume there are no constraints on sales of either product, and the company could
choose any product mix they wish. What is the maximum amount of contribution margin that the
company could earn in a month?
A) $16,000
B) $18,000
C) $48,000
D) $22,000
Answer: C
Explanation: C) A B
Sale price $12.00 $20.00
Ranking 2.00 1.00

Total 3,000
B 3,000 6000
A 0 0
Sales of A $120,000
Less: Variable Cost 72000
Contribution Margin $48,000
Diff: 3
LO: 25-3
AACSB: Application
114
A B
available per month. The company can sell up to 7,000 units of Product A per month, and up to 3,000
units of Product B for the month. What is the maximum amount of contribution margin that the company
could earn in a month given the stated constraints?
A) $10,000
B) $36,000
C) $30,000
D) $40,000
Answer: B
Explanation: B) A B
Sale price $12.00 $20.0
Variable costs (10.00) (12.0)
Ranking 2 1

Total 3,000
B 3,000 1,500
A 6,000 1,500
Contribution Margin $12,000 $24,000

Total Contribution Margin ($12,000 +
$24,000) $36,000
Diff: 3
LO: 25-3
AACSB: Application
115
A B
available per month. The company can sell up to 7,000 units of Product A per month, and up to 3,000
units of Product B for the month. What is the optimum product mix to maximize company's operating
income?
A) 2,000 units of A; 4,000 units of B
B) 6,000 units of A; 3,000 units of B
C) zero units of A; 3,000 units of B
D) 12,000 units of A; zero units of B
Answer: B
Explanation: B) A B
Sale price $12.00 $20.00
Ranking 2.00 1.00

Total 3,000
B 3,000 1,500
A 6,000 1,500
Diff: 3
LO: 25-3
AACSB: Application
116
47) The Badminton Company has 4,000 machine hours available annually to manufacture racquets. The
following information is available for the two different racquets produced by Badminton:
Pro
Unit sales price $300
Unit variable costs $150
Annual demand 2,000 units
Machine time 1.50 hours per unit
Mid
Unit sales price $150
Unit variable costs $60
Annual demand 4,000 units
Machine time 2 hours per unit
How many units of each racquet should be manufactured for the company to maximize its operating
income?
A) 2,000 units of Pro and 1,200 units of Mid
B) 2,000 units of Pro and 500 units of Mid
C) 2,000 units of Pro and 4,000 units of Mid
D) 4,000 units of Mid and 500 units of Pro
Answer: B
Explanation: B) Pro Mid
Sales $300 $150
Variable Cost 150 60
Contribution margin per unit $150 $90
Limiting Factor 1.5 2
Contribution margin per unit per hour $100 $45
No of units Hours required

Pro (2,000 × 1.5) 2000 3000
Mid (1,000 ÷ 2) 500 1000
Diff: 2
LO: 25-3
AACSB: Application
117
1) Doro Fill Company fabricates inexpensive automobiles for sale to 3rd world countries. Each auto
includes one wiring harness, which is currently made in-house. Details of the harness fabrication are as
follows:
Volume 800units per month

Variable cost per unit $7per unit
Fixed costs $15,000per month
A factory in Indonesia has offered to supply Dora Fill with ready-made units for a price of $10 each.
Assume that Doro Fill's fixed costs are unavoidable, and that the company will not be able to use the
excess capacity in any profitable manner. In order to maximize operating income, Doro Fill should not
outsource.
Answer: TRUE
Explanation: In-house Outsource
Variable Cost $5,600 $8,000
Fixed Cost 15,000 15,000
Total cost $20,600 $23,000
As the cost of production in-house is less than outsourcing, the company should produce in house to
maximize operating income.
Diff: 2
LO: 25-4
AACSB: Application
118
2) Doro Fill Company fabricates inexpensive automobiles for sale to 3rd world countries. Each auto
follows:
Volume 800 units per month

Fixed costs $15,000 per month
A factory in Indonesia has offered to supply Dora Fill with ready-made units for a price of $10 each.
Assume that Doro Fill's fixed costs are unavoidable, but the company could use the vacated production
facilities to earn an additional $5,000 of profit per month. In order to maximize operating income, Doro
Fill should outsource.
Answer: TRUE
Less: Rent received _____ 5,000
Total relevant cost $5,600 $3,000
As the relevant cost in outsourcing is less than in-house, the company should outsource to maximize
operating income.
Diff: 2
LO: 25-4
AACSB: Application
3) A company produces 100 microwave ovens per month, each of which includes one electrical circuit.
The company currently manufactures the circuit in-house but is considering outsourcing the circuits at a
contract price of $28 each. Currently, the cost of producing circuits in-house includes variable costs of $26
per circuit and fixed costs of $5,000 per month.
The controller says that they could outsource production of the circuit, if it reduces fixed cost greater than
$200 per month. Is this statement true or false?
Answer: TRUE
Less: Fixed cost reduction _____ $200
Total relevant cost $2,600 $2,600
Diff: 2
LO: 25-4
AACSB: Application
119
4) Marlow Company makes bulk quantities of cleaning fluids. They currently sell 1,200 containers a
month at a price of $23.75 per unit. If they add a new scent, they could charge $25 per unit for the
improved product. It would cost them a total of $800 per month to make that alteration. If they decide to
process further, it will improve their operating income.
Answer: TRUE
Explanation:
Incremental Revenue [( $25 - $23.75) × 1,200] $1,500
Incremental Fixed Cost 800
Incremental Operating Income $700
Diff: 1
LO: 25-4
AACSB: Application
5) When a company is considering the possibility of processing their product further to achieve higher
sales revenues, the rule is as follows: if incremental revenues exceed incremental costs, then further
processing will enhance operational profits.
Answer: TRUE
Diff: 1
LO: 25-4
AACSB: Concept
sales revenues, the rule is as follows: as long as the additional processing generates higher sales revenues,
it is the preferred alternative.
Answer: FALSE
Diff: 1
LO: 25-4
AACSB: Concept
sales revenues, they must carefully study the production costs needed to make the basic product before
processing further in order to come to an informed decision.
Answer: FALSE
Diff: 1
LO: 25-4
AACSB: Concept
120
8) Verdant Avionics makes aircraft instrumentation. Their basic navigation radio requires $120 in variable
costs and requires $3,000 per month in fixed costs. If they process the radio further to enhance its
functionality, it will require an additional $40 per unit of variable costs, and $300 per month in fixed
costs. The marketing manager believes they would be able to boost their price of the radio from $260 to
$280. In making this decision, the amount of additional fixed costs per month is a relevant piece of
information.
Answer: TRUE
Diff: 1
LO: 25-4
AACSB: Concept
9) Wing Company makes a special kind of racing tire. Variable costs are $320, and fixed costs are $35,000
per month. Wing sells 600 units per month at a price of $400. If Wing upgrades the quality of the tire, they
believe they can boost the price to $450. If so, the variable cost will go up to $350 and the fixed costs will
rise by 30%. The CEO wishes to increase his operational income by 20%. If the company decides to
upgrade the product according to the data above, the CEO will reach his goal.
Answer: FALSE
Explanation: No up-
Up-gradation gradation
Revenue $270,000 $240,000
Variable Cost 210,000 192,000
Fixed Cost 45,500 35,000
Operating Income $14,500 $13,000
Increase in operating income [(14,500 - 13,000) ÷ 13,000] × 100 11.5%

Diff: 2
LO: 25-4
AACSB: Application
10) ________ refer to the value forgone in order to make one particular investment instead of another.
A) Opportunity costs
B) Sunk costs
C) Relevant costs
D) Irrelevant costs
Answer: A
Diff: 1
LO: 25-4
AACSB: Concept
121
11) Valuable Electronics uses a standard part in the manufacture of different types of radios
manufactured by it The total cost of producing 25,000 parts is $95,000, which includes fixed costs of
$40,000 and variable costs of $55,000. The company can buy the part from an outside supplier for $3 per
unit, and avoid 20% of the fixed costs. Assume that free factory space can be used to manufacture another
product that can earn profit of $15,000. If Valuable outsources, what will be the effect on operating
income?
C) decrease of $8,000
D) increase of $5,000
Answer: A
Explanation: A) In-house Outsource
Avoidable Fixed Cost (8,000)
Profit from another product (15,000)
Total Cost $55,000 $52,000
Increase in operating income ($55,000 - $52,000) $3,000

Diff: 2
LO: 25-4
AACSB: Application
12) Gnome Company is trying to decide whether to continue to manufacture a particular component or to
buy the component from a supplier. Which of the following is relevant to this decision?
A) the potential uses of the facilities that are currently used to manufacture the component
B) the insurance on the manufacturing facility which will continue regardless of the decision
C) allocated corporate fixed costs which would have to be allocated to other products if the component is
no longer manufactured
D) the cost of the equipment that is currently being used to manufacture the component
Answer: A
Diff: 2
LO: 25-4
AACSB: Application
13) Shasta Company is trying to decide whether to continue to manufacture a particular component or to
buy the component from an outside supplier. Which of the following is irrelevant with respect to this
decision?
A) the quality of the component purchased from the outside supplier
B) the outside supplier's ability to deliver the component on a timely basis
C) the alternative uses of the facilities being used to currently manufacture the component
D) the unavoidable fixed manufacturing costs associated with the manufacture of the component
Answer: D
Diff: 2
LO: 25-4
AACSB: Application
122
14) Which of the following phrases most accurately describe opportunity cost?
A) the cost incurred to gain the opportunity to make a sale
B) the benefit gained by choosing a certain course of action
C) the benefit given up by not choosing an alternative course of action
D) costs which have been incurred in the past
Answer: C
Diff: 1
LO: 25-4
AACSB: Concept
15) The benefit foregone by not choosing an alternative course of action is referred to as a(n):
A) opportunity cost.
B) sunk cost.
C) variable cost.
D) incremental cost
Answer: A
Diff: 1
LO: 25-4
AACSB: Concept
123
16) CM Manufacturing has provided the following unit costs pertaining to a component they
manufacture and use in the production of one of their main products:
Direct materials $420

Direct labor (variable) 110
Variable manufacturing overhead 90
Fixed manufacturing overhead 35
A supplier has offered to provide the component to CM manufacturing for $630 per unit. If CM
Manufacturing acquire the component from the supplier, they could use the released facilities to
manufacture a product which would generate contribution margin of $20,000 annually. Assuming that
CM Manufacturing needs 3,000 components annually and the fixed manufacturing overhead is
unavoidable, what would be the impact on operating income if the company outsources?
A) Operating income would go down by $10,000.
B) Operating income would go up by $20,000.
C) Operating income would go down by $18,000.
D) Operating income would go up by $26,000.
Answer: A
Explanation: A)
Direct material $420
Direct labor 110
total variable manufacturing cost $620
Cost per unit if outsourced 630
Loss per unit if outsourced $10
Annual requirement units 3,000
Total loss if outsourced(3,000 × $10) $30,000
Annual saving in fixed cost 20,000
Net loss on outsourcing $10,000
Diff: 2
LO: 25-4
AACSB: Application
124
17) A chemical company spent $530,000 to produce 150,000 gallons of a chemical, which can be sold for
$5.20 per gallon. The chemical can be further processed into a weed killer which can be sold for $7.20 per
gallon; it will cost $270,000 to process the chemical into a weed killer. Which of the following is true?
A) To maximize operating income, the company should continue to sell the chemical as is.
B) If the company decides to process further, it will increase operating income by $280,000.
C) If the company decides to process further, it will increase operating income by $30,000.
D) If the company decides to process further, it will decrease operating income by $150,000.
Answer: C
Explanation: C) As is Process further
Sale value $780,000 $1,080,000
Less: Cost incurred (530,000) (800,000)
Operating Income $250,000 $280,000
Increase in operating income on account of further processing $30,000 ($280,000 - $250,000).

Diff: 2
LO: 25-4
AACSB: Application
18) Lightening Semiconductors produces 400,000 hi-tech computer chips per month. Each chip uses a
component which Lightening makes in-house. The variable costs to make the component are $1.20 per
unit, and the fixed costs run $1,200,000 per month. The company has been approached by a foreign
producer who can supply the component, ready-made and with acceptable quality standards for $1.10
each. The fixed costs are unavoidable, and Lightening would have no other use for the facilities currently
employed in making the component. What is the effect on operating income, if the company decides to
outsource?
A) There would be no effect on operating income.
B) Lightening Semiconductors could save $1,200,000 per month in costs.
C) Lightening Semiconductors could save $40,000 per month in costs.
D) Lightening Semiconductor's costs would go up by $10,000 per month.
Answer: C
Explanation: C)
In-house (400,000 × $1.20) $480,000
Outsource (400,000 × $1.10) 440,000
Savings in cost if outsourced $40,000
Diff: 1
LO: 25-4
AACSB: Application
125
19) Lightening Semiconductors produces 400,000 hi-tech computer chips per month. Each chip uses a
component which Lightening makes in-house. The variable costs to make the component are $1.20 per
unit, and the fixed costs run $1,200,000 per month. The company has been approached by a foreign
producer who can supply the component, ready-made and with acceptable quality standards for $1.10
each. If the company chooses to outsource, it could reduce the fixed costs by 40%. The company does not
have any other use for the facilities currently employed in making the component. What is the effect on
operating income, if the company decides to outsource?
A) There would be no effect on operating income.
B) Operating income would go up by $520,000.
C) Operating income would go up by $440,000.
D) Operating income would go down by $80,000.
Answer: B
Explanation: B)
In-house(400,000 × $1.20) $480,000
Less: Purchase cost(400,000 × $1.10) 440,000
Savings in cost on account of outsourcing $40,000
Savings in fixed cost ($1,200,000 × 40%) 480,000
Total savings $520,000
Diff: 2
LO: 25-4
AACSB: Application
20) Fin Company fabricates inexpensive automobiles for sale to 3rd world countries. Each auto includes
one wiring harness, which is currently made in-house. Details of the harness fabrication are as follows:
Volume 1,200.00 units per month

Variable cost per unit $12.50 per unit
Fixed costs $20,000.00 per month
A factory in Indonesia has offered to supply Fin Company with ready-made units for a price of $15 each.
Assume that Fin's fixed costs are unavoidable, and that Fin will not be able to use the excess capacity in
any profitable manner. What will be the impact on Fin's monthly operating income, if Fin decides to
outsource?
A) It will go up by $3,000.
B) It will go down by $20,000.
C) It will go up by $20,000.
D) It will go down by $3,000.
Answer: D
Explanation: D) Relevant cost
Purchase cost (1,200 × $15) $18,000
In-house(1,200 × $12.50) 15,000
Reduction in operating income $3,000
Diff: 2
LO: 25-4
AACSB: Application
126
21) Dong Fang Company fabricates inexpensive automobiles for sale to 3rd world countries. Each auto
follows:

A factory in Indonesia has offered to supply Dong Fang with ready-made units for a price of $14 each.
Assume that Dong Fang's fixed costs could be reduced by $5,000 if they outsource, and that Dong Fang
will not be able to use the excess capacity in any profitable manner. What will be the impact on Dong
Fang's monthly operating income, if Dong Fang decides to outsource?
D) It will go down by $400.
Answer: D
Explanation: D) Cost incurred
Saving in variable cost (900 × $8) $7,200
Saving in fixed cost 5,000
Less: Purchase cost (900 × $14) (12,600)
Loss on cost on account of outsourcing ($400)
Diff: 2
LO: 25-4
AACSB: Application
127
22) Dong Fang Company fabricates inexpensive automobiles for sale to 3rd world countries. Each auto
follows:

A factory in Indonesia has offered to supply Dong Fang with ready-made units for a price of $14 each.
Assume that Dong Fang's fixed costs are unavoidable, but that Dong could use the vacated production
facilities to earn an additional $7,500 of profit per month. What will be the impact on Dong Fang's
monthly operating income, if Dong Fang decides to outsource?
D) It will go down by $400.
Answer: A
Explanation: A)
Earnings from vacant production facilities 7,500
Less: Purchase cost (900 × $14) 12,600
Diff: 2
LO: 25-4
AACSB: Application
The company currently manufactures circuit in-house but is considering outsourcing the circuits at a
Assume the company could not reduce any fixed costs by outsourcing, and that there is no alternative use
for the facilities presently being used to make circuits. How will it affect monthly operating income, if the
company outsources?
A) Operating income will go up by $4,800.
B) Operating income will go down by $2,800.
C) Operating income will go down by $200.
D) Operating income will stay the same.
Answer: C
Explanation: C) Cost Incurred
In-house (100 × $26) $2,600
Loss of operating income on account of outsourcing ($200)
Diff: 2
LO: 25-4
AACSB: Application
128
Assume the company could cut fixed costs in half by outsourcing, and that there is no alternative use for
the facilities presently being used to make circuits. How will it affect monthly operating income, if the
company outsources?
D) Operating income will stay the same.
Answer: A
Explanation: A) Cost incurred
Saving in fixed costs ($5,000 ∕ 2) 2,500
Increase in operating income on account of outsourcing $2,300
Diff: 2
LO: 25-4
AACSB: Application
Assume the company could eliminate all fixed costs by outsourcing, and that there is no alternative use
for the facilities presently being used to make circuits. How will it affect monthly operating income, if the
company outsources?
D) Operating income will go up by $4,800.
Answer: D
Explanation: D) Cost incurred
Saving in fixed costs 5,000
Less: Purchase cost (100 × $28) (2,800)
Diff: 2
LO: 25-4
AACSB: Application
129
Assume the fixed costs are unavoidable, but that company could employ the vacated premises to earn
rental income of $700 per month. How will it affect monthly operating income, if the company
outsources?
A) Operating income will go up by $500.
Answer: A
Explanation: A) Cost incurred
Rental Income 700
Increase in operating income on account of outsourcing $500
Diff: 2
LO: 25-4
AACSB: Application
27) Seven Seas Company manufactures 100 luxury yachts per month. Included in each yacht is a compact
media center. Seven Seas manufactures media center in-house, but is considering the possibility of
outsourcing that function, in order to close down some of their facilities and reduce the administrative
costs. At present, the variable cost per unit is $275 and the fixed costs are $39,000 per month. Assuming
that if they outsource, and the fixed costs could be eliminated entirely, at what contract rate would
outsourcing pay off for Seven Seas? Round to nearest whole dollar.
A) at any rate lower than $844 per unit
B) at any rate lower than $796 per unit
C) at any rate lower than $775 per unit
D) at any rate lower than $665 per unit
Answer: D
Explanation: D)
Saving in Variable Cost (100 × $275) $27,500
Saving in Fixed Cost 39,000
Total savings on outsourcing $66,500
No. of Yachts manufactured per month 100
Contract rate ($66,500 ÷ 100) $665
Diff: 3
LO: 25-4
AACSB: Application
130
outsourcing that function, in order to close down some of their facilities and reduce the administrative
costs. At present, the variable cost per unit is $275 and the fixed costs are $39,000 per month. Assume that
if they outsource, fixed costs could be reduced by 40%. The production manager advised the company to
contract with a foreign supplier which offered a contract rate of $420 per unit. If they outsource, how
would that affect operational income?
A) Operating income would improve by $1,100.
B) Operating income would improve by $4,000.
C) Operating income would decline by $14,500.
D) Operating income would remain the same.
Answer: A
Explanation: A)
Saving in variable cost(100 × $275) $27,500
Saving in fixed cost ($39,000 × 40%) 15,600
Diff: 2
LO: 25-4
AACSB: Application
outsourcing that function. At present, the variable cost per unit is $275, and the fixed costs are $39,000 per
month. If they outsource, fixed costs could be reduced by half, and the vacant facilities could be rented
out to earn $1,000 per month of rental income. At what contract rate would outsourcing pay off for Seven
Seas?
A) $480 per unit
B) $499 per unit
C) $388 per unit
D) $295 per unit
Answer: A
Explanation: A)
Saving in fixed cost ($39,000 × 50%) 19,500
Rent from vacant facilities 1,000
Total Savings $48,000
No. of Yachts manufactured per month 100
Contract rate ($48,000 ÷ 100) $480
Diff: 2
LO: 25-4
AACSB: Application
131
outsourcing that function. At present, the variable cost per unit is $275, and the fixed costs are $39,000 per
month. The CEO wishes to boost operational income by $5,000. He has an offer from a foreign producer
to provide the media centers at a contract rate of $300 per unit. The required saving in fixed cost in order
to achieve his objective would be:
A) $4,250.
B) $2,000.
C) $7,500.
D) $19,500.
Answer: C
Explanation: C)
Variable cost (100 × $275) $27,500
Purchase cost (100 × $300) 30,000
Loss on outsourcing $2,500
Add: Target increase in operating income 5,000
Required saving in fixed cost $7,500
Diff: 2
LO: 25-4
AACSB: Application
31) Carlo Company makes bulk quantities of cleaning fluids. They currently sell 1,000 containers a month
at a price of $22 per unit. If they added a disinfectant, they could charge $25 per unit for the improved
product. It would cost them a total of $3,800 per month to make that alteration. What would be the effect
on operating income?
A) It would decline by $1,200.
B) It would increase by $3,000.
C) It would increase by $400.
D) It would decline by $800.
Answer: D
Explanation: D) Sell as is Process further
Sales $22,000 $25,000
Less: Additional Cost ______ 3,800
Operating income will decline by $800 ($22,000 - $21,200) if it's further processed.
Diff: 1
LO: 25-4
AACSB: Application
132
32) Carlo Company makes bulk quantities of cleaning fluids. They currently sell 1,000 containers a month
at a price of $22 per unit. If they added a newer scent, they could charge $22.75 per unit for the improved
product. It would cost them a total of $700 per month to make that alteration. What would be the effect
on operating income?
A) It would decline by $120.
B) It would increase by $300.
C) It would increase by $50.
D) It would decline by $800.
Answer: C
Explanation: C) Sell as is Process further
Sales $22,000 $22,750
Less: Additional Cost ______ 700
Operating income will improve by $50 ($22,050 - $22,000) if it's further processed.
Diff: 1
LO: 25-4
AACSB: Application
33) When a company is considering the option of processing their product further to achieve higher sales
revenues, they must ignore:
A) how much additional costs are necessary to process further.
B) how much incremental revenue can be earned if processed further.
C) how much cost is required to produce the basic product, before processing further.
D) will the additional processing produce any environmental toxins.
Answer: C
Diff: 1
LO: 25-4
AACSB: Concept
133
34) Nordic Avionics makes aircraft instrumentation. Their basic navigation radio requires $80 in variable
functionality, it will require an additional $25 per unit of variable costs, but no change to the fixed costs.
The marketing manager believes that they would be able to boost their price of the radio from $260 to
$280. If they do so, how would the change affect operating income?
A) It would remain the same.
B) It would go up by $25 per unit.
C) It would go up by $20 per unit.
D) It would go down by $5 per unit.
Answer: D
Explanation: D) Sell as is Process further
Sales $260 $280
Less: Variable cost 80 80
Less: Variable cost for further processing ____ 25
Decline in operating income ($180 - $175) $5
Diff: 1
LO: 25-4
AACSB: Application
functionality, it will require an additional $25 per unit of variable costs, plus an increase in fixed costs of
$800 per month. The marketing manager believes that they would be able to boost their price of the radio
from $260 to $300. Nordic sells 30 radios per month. If they decide to process further, what would the
impact be on monthly operating income?
A) It would increase by $1,050.
B) It would increase by $250.
C) It would decrease by $350.
D) It would decrease by $750.
Answer: C
Explanation: C) Sell as is Process further
Sales $7,800 $9,000
Less: Variable cost 2,400 2,400
Less: Variable cost for further processing 750
Less: Increase in fixed cost 800
Contribution margin $5,400 $5,050
Decrease in operating income $350

Diff: 2
LO: 25-4
AACSB: Application
134
costs and requires $2,000 per month in fixed costs. Nordic sells 30 radios per month. If they process the
radio further to enhance its functionality, it will require an additional $25 per unit of variable costs, plus
an increase in fixed costs of $800 per month. The current price of the radio is $260. The marketing
manager is sure that they can charge a higher price for the improved version. At what price level would
the new, improved radio begin to improve operational earnings? Round to nearest whole dollar.
A) at a price of higher than $312
B) at a price of $309 or higher
C) at a price of lower than $420
D) at a price of $295 or higher
Answer: A
Explanation: A)
Incremental variable cost $750.00
Add: increase in fixed cost 800.00
Total incremental cost $1,550.00
Incremental cost per unit ($1,550 ÷ 30) $51.67
Add: Current selling price 260.00
Price to be charged $312.00
Diff: 3
LO: 25-4
AACSB: Application
costs and requires $2,000 per month in fixed costs. Nordic sells 30 radios per month. If they process the
radio further to enhance its functionality, it will require an additional $25 per unit of variable costs, plus
an increase in fixed costs of $800 per month. The current price of the radio is $260. The CEO wishes to
improve operating income by $1,000 per month by selling the enhanced version of the radio. In order to
hit his target, the price to be charged for the enhanced product is:
A) $212 per unit
B) $345 per unit
C) $440 per unit
D) $367 per unit
Answer: B
Explanation: B)
Incremental variable cost $750
Add: increase in fixed cost 800
Add: Target operating income 1,000
$2,550
Incremental cost per unit $85
Add: Current selling price 260
Price to be charged $345
Diff: 3
LO: 25-4
AACSB: Application
135
38) A company produces 1,000 packs of chicken feed per month. Sales price is $4 per pack. Variable cost
is $1.50 per unit, and fixed costs are $1,800 per month. Management is considering adding a vitamin
supplement to improve the value of the product. The variable cost will go up from $1.50 to $1.90 per unit,
but there will be no change in fixed costs. The company will price the new product at $4.25 to compete
with other producers. How will this affect operating income?
A) Operating income will go down by $150 per month.
B) Operating income will go up by $250 per month.
C) Operating income will go down by $400 per month.
D) Operating income will remain unchanged.
Answer: A
Explanation: A) Sell as is Further processing
Sales $4,000 $4,250
Less: Variable Cost 1,500 1,900
Less: Fixed Cost 1,800 1,800
Operating income $700 $550
Decline in operating income $150
Diff: 2
LO: 25-4
AACSB: Application
and fixed costs will go up by 20%. The company will price the new product at $5 per pack. How will this
affect operating income?
A) Operating income will go down by $150 per month.
B) Operating income will remain unchanged.
C) Operating income will go down by $400 per month.
D) Operating income will go up by $240 per month.
Answer: D
Explanation: D) Sell as is Further processing
Sales $4,000 $5,000
Operating income $700 $940
Increase in operating income ($940 - $700) $240

Diff: 2
LO: 25-4
AACSB: Application
136
and fixed costs will go up by 20%. At what price for the new product will the two alternatives (sell as is or
process further) produce the same operating income? Round to nearest cent.
A) $5
B) $4.76
C) $3.99
D) $4.40
Answer: B
Explanation: B) Sell as is further process
Variable cost $1,500 1900.00
Fixed cost 1,800 2160.00
Total cost $3,300 $4,060.00
Sales 4,000
Operating income $700 700.00
Sales $4,760.00
Selling price ($4,760 ÷ 1,000) $4.76
Diff: 3
LO: 25-4
AACSB: Application
and fixed costs will go up by 20%. The CEO wants to price the new product at a level which will bring
operating income up to $1,000 per month. What price is to be charged?
A) $5.00
B) $5.06
C) $4.99
D) $4.76
Answer: B
Explanation: B)
Incremental variable cost $1,900.00
Add: fixed cost 2,160.00
Add: Target operating income 1,000.00
$5,060.00
No. of packs 1,000.00
Cost per unit ($5,060 ÷ 1,000) $5.06
Diff: 3
LO: 25-4
AACSB: Application
137
42) Victory Company makes a special kind of racing tire. Variable costs are $220, and fixed costs are
$30,000 per month. Victory sells 500 units per month at a price of $300. If Victory upgrades the quality of
the tire, they believe that they can boost the price up to $325. If so, the variable cost will go up to $230 and
the fixed costs will remain the same. If Victory decides to upgrade, how will it affect operating income?
A) Operating income will go down by $1,250.
C) Operating income will go up by $12,500.
Answer: D
Explanation: D) Sales as is Further processing
Sales $150,000 $162,500
Contribution margin per unit $40,000 $47,500

Diff: 2
LO: 25-4
AACSB: Application
$30,000 per month. Victor sells 500 units per month at a price of $300. If Victory upgrades the quality of
the tire, they believe they can boost the price up to $325. If so, the variable cost will go up to $230 and the
fixed costs will rise by 40%. If Victory decides to upgrade, how will it affect operating income?
Answer: B
Explanation: B) Sales as is Further processing
Sales $150,000 $162,500
Decrease in operating income $4,500

Diff: 2
LO: 25-4
AACSB: Application
138
$30,000 per month. Victor sells 500 units per month at a price of $300. If Victory upgrades the quality of
the tire, they believe they can boost the price up to $340. If so, the variable cost will go up to $230 and the
fixed costs will rise by 50%. If Victory decides to upgrade, how will it affect operating income?
D) Operating income remains the same.
Answer: D
Explanation: D) Sales as is Further processing
Sales $150,000 $170,000
Diff: 2
LO: 25-4
AACSB: Application
$30,000 per month. Victory sells 500 units per month at a price of $300. If Victory upgrades the quality of
the tire, they believe that they can boost the price. If so, the variable cost will go up to $230 and the fixed
costs will rise by 50%. The CEO wishes to increase his operational income by 25%. What price level
would give the desired results?
A) $330 per unit
B) $370 per unit
C) $320 per unit
D) $345 per unit
Answer: D
Explanation: D)
Sales $150,000
Less: Variable cost 110,000
Less: Fixed Cost 30,000
Target operating income($10,000 × 125 ÷ 100) $12,500

Add: Increased variable cost 115,000
Add: Increased fixed cost 45,000
Total cost $172,500
No. of units manufactured per month 500
Price to be charged ($172,500 ÷ 500) $345
Diff: 2
LO: 25-4
AACSB: Application
139
46) Valuable Electronics uses a standard part in the manufacture of different types of radios
manufactured by it. The total cost of producing 25,000 parts is $95,000, which includes fixed costs of
$40,000 and variable costs of $55,000. The company can buy the part from an outside supplier for $3 per
unit, and avoid 20% of the fixed costs.
If Valuable Electronics decides to outsource the production of the part, how will it impact its operating
income?
Answer: B
Explanation: B) In-house Outsource

Avoidable Fixed Cost _______ 8,000
Total Cost $55,000 $67,000
Reduction in operating income

($67,000 - $55,000) $12,000
Diff: 1
LO: 25-4
AACSB: Application
47) Brio Company produces a part that is used in the manufacture of one of its products. The unit
manufacturing costs of this part, assuming a production level of 6,000 units, are as follows:
Direct materials $5
Direct labor (variable cost) 6
Fixed manufacturing overhead 4
Total cost $18
Fine Company has offered to sell 6,000 units of the same part to Brio Company for $17.50 per unit.
Assuming the company has no other use for its facilities and that the fixed manufacturing costs are
unavoidable. What should Brio Company do?
Answer: Produce in-house
Explanation:
Direct labor 6.00
Variable manufacturing overhead 3.00
Total variable manufacturing cost $14.00
Cost per unit if outsourced 17.50
Loss per unit if outsourced ($3.50)
Diff: 2
LO: 25-4
AACSB: Application
140
48) Enthusiastic Products is deciding whether to outsource production of a certain component that is
included in all of its products. It currently costs Enthusiastic Products $1.20 to make each component in-
house. If Enthusiastic Products outsources, it can buy the component ready-made for $0.90 each, and can
shut down the production facilities it is currently using to manufacture the component, and save $20,000
a year in fixed costs. Annual requirement for the component is 12,000 units. What is the effect of
outsourcing?
Answer:
Variable cost per unit $1.20
cost per unit if outsourced (0.90)
Net saving $0.30
No of units 12,000.00
Total net saving $3600.00
Saving in fixed cost $20,000.00
Total saving if outsourced $23,600.00
Diff: 2
LO: 25-4
AACSB: Application
141
Chapter 26 Capital Investment Decisions
1) An operational asset used for a long period of time is known as a capital asset.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
2) The acquisition or construction of a capital asset is known as a capital investment.

Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
3) A post-audit in capital budgeting is a comparison of actual results of capital investments with the
projected results.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
4) Capital rationing is a process adopted when a company has limited resources, and it must find ways to
reduce operating expenses in all of its divisions and units.
Answer: FALSE
Diff: 1
LO: 26-1
AACSB: Concept
5) Two methods of analyzing potential capital investments—payback and accounting rate of return—
ignore the time value of money.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
142
6) The accounting rate of return method uses accrual-based accounting income.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
7) To determine the investment's net cash inflows, the inflows are netted against the investment's initial
cash outflow.
Answer: FALSE
Diff: 1
LO: 26-1
AACSB: Concept
8) The payback period and accounting rate of return (ARR) methods are suitable to investments with a
short time span.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
9) The payback method and the accounting rate of return method are often used to perform an initial
screening of investments, rather than a detailed, in-depth analysis.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
10) Most capital budgeting methods focus on cash flows rather than book income.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
11) Payback provides management with valuable information about the time period within which the
cash invested will be recouped.
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
143
12) Net present value and internal rate of return consider the time value of money, so they are
appropriate for longer-term capital investments
Answer: TRUE
Diff: 1
LO: 26-1
AACSB: Concept
13) Which of the following best describes a post-audit in capital budgeting?

A) an audit of an operating unit of a company
B) an audit performed after financial statements have been issued
C) an analysis of an investment's cash flows prior to committing to the initial investment
D) a comparison of actual results of capital investments with projected results
Answer: D
Diff: 1
LO: 26-1
AACSB: Concept
14) Which of the following best describes the term "capital rationing"?
A) a method of determining the period within which the cash invested is recouped
B) a process of ranking and choosing among alternative capital investments based on the availability of
funds
C) a method which shows the effect of the investment on the company's accrual-based income
D) a process of controlling operating costs when adequate funds are not available
Answer: B
Diff: 1
LO: 26-1
AACSB: Concept
15) The last step in the capital budgeting process is control which compares the actual results with the
projected results. These comparisons are known as:
A) cash inflows.
B) post-audits.
C) ranks.
D) cash outflows
Answer: B
Diff: 1
LO: 26-1
AACSB: Concept
144
16) Which of the following describes the word "capital budgeting"?
A) It involves budgeting for yearly operational expenses.
B) It involves preparing the sales budget for the coming year.
C) It involves deciding among various long-term investment decisions.
D) It involves analyzing various alternatives of financing available to a company.
Answer: C
Diff: 1
LO: 26-1
AACSB: Concept
17) Which of the following is a capital budgeting method?

A) return on assets
B) net present value
C) inventory turnover
D) return on equity
Answer: B
Diff: 1
LO: 26-1
AACSB: Concept
18) Which of the following is a capital budgeting method that is used to screen potential investments?
A) return on assets
B) acid test ratio
C) accounting rate of return
D) debt-to-equity ratio
Answer: C
Diff: 1
LO: 26-1
AACSB: Concept
19) Which of the following two methods are typically used for initial screening of investments, rather
than for detailed, in-depth analysis?
A) payback and accounting rate of return
B) net present value and payback
C) internal rate of return and net present value
D) accounting rate of return and net present value
Answer: A
Diff: 1
LO: 26-1
AACSB: Concept
145
20) Which of the following is true of projecting future cash flows of an investment?
A) Information on cash flow will also include non-cash transactions like depreciation.
B) Cash inflows and cash outflows are treated separately, rather than being netted together.
C) Cash flows are projected by accounting personnel without considering input from other business
functions.
D) The initial investment is always treated separately from all other cash flows.
Answer: D
Diff: 2
LO: 26-1
AACSB: Concept
21) Capital budgeting is:

A) the process of planning the investment in long-term assets.
B) preparing the budget for operating expenses.
C) the process of evaluating the profitability of a business.
D) the process of making pricing decisions for products.
Answer: A
Diff: 1
LO: 26-1
AACSB: Concept
1) The accounting rate of return method and the payback method are often used as preliminary screening
measures, but are insufficient to fully evaluate a capital investment.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
2) All else being equal, investments with longer payback periods are preferable.
Answer: FALSE
Diff: 1
LO: 26-2
AACSB: Concept
3) Net cash inflows from a capital investment arise from an increase in revenues, a decrease in expenses,
or both.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
146
4) A major criticism of the payback method is that it focuses only on time to recover the investment, and
ignores profitability.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
5) The payback considers only those cash flows that occur during the payback period and ignores any
cash flows that occur after that period.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
6) The payback method can only be used when the net cash inflows from a capital investment are the
same for each period.
Answer: FALSE
Diff: 1
LO: 26-2
AACSB: Concept
7) The accounting rate of return method of analyzing a potential capital investment considers the time
value of money.
Answer: FALSE
Diff: 2
LO: 26-2
AACSB: Concept
8) The payback method is the most thorough and comprehensive way to choose the best investment
among alternatives, than any other capital budgeting methods.
Answer: FALSE
Diff: 2
LO: 26-2
AACSB: Concept
9) The payback method uses discounted cash flows to make investment decisions.
Answer: FALSE
Diff: 2
LO: 26-2
AACSB: Concept
147
10) The payback method ignores cash flows that an asset generates, whereas the accounting rate of return
includes them.
Answer: FALSE
Diff: 1
LO: 26-2
AACSB: Concept
11) The accounting rate of return method focuses on net operating income instead of net cash inflow
generated by an asset.
Answer: TRUE
Diff: 2
LO: 26-2
AACSB: Concept
12) The accounting rate of return is also known as average rate of return or annual rate of return.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
13) The accounting rate of return method evaluates the lifetime return of an asset, whereas return on
investment evaluates an annual return.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
14) The accounting rate of return is calculated by dividing the average annual operating income by the
average amount invested.
Answer: TRUE
Diff: 1
LO: 26-2
AACSB: Concept
148
15) Which of the following is a capital budgeting method that ignores the time value of money?
A) payback
B) internal rate of return
C) return on assets
D) net present value
Answer: A
Diff: 1
LO: 26-2
AACSB: Concept
16) Which capital budgeting method uses accrual accounting, rather than net cash flows, as a basis for
calculations?
A) payback
B) accounting rate of return
C) net present value
D) internal rate of return
Answer: B
Diff: 2
LO: 26-2
AACSB: Concept
17) Flip Flop company is considering investing in production-management software that costs $600,000,
has $60,000 residual value, and should lead to cost savings of $150,000 per year for its five-year life.
Calculate the average amount invested in the asset that should be used for calculating the accounting rate
of return?
A) $660,000
B) $600,000
C) $330,000
D) $60,000
Answer: C
Diff: 1
LO: 26-2
AACSB: Application
149
18) Cortes Company is considering three investment opportunities with the following payback periods:
Project X Project Y Project Z

Payback period 3 years 2.5 years 2.8 years
Use the decision rule for payback to rank the projects from most desirable to least desirable, all else being
equal.
A) Y, Z, X
B) X, Y, Z
C) Z, Y, X
D) Y, X, Z
Answer: A
Diff: 1
LO: 26-2
AACSB: Application
19) Newman Automobiles Manufacturing is considering two alternative investment proposals with the
following data:
Proposal X Proposal Y
Investment $10,000,000 $500,000
Useful life 5 years 5 years
Estimated annual net cash inflows for 5 years $2,000,000 $95,000
Residual value $50,000 $20,000
Depreciation method Straight-line Straight-line
Required rate of return 12% 10%
Calculate the payback period for Proposal X.

A) 5 years
B) 4 years
C) 8 years
D) 10 years
Answer: A
Explanation: A)
Payback = Amount invested ÷ Expected annual net cash inflow
Payback for Proposal X = $10,000,000 ÷ $2,000,000 per year = 5 years
Diff: 2
LO: 26-2
AACSB: Application
150
20) Newman Automobiles Manufacturing is considering two alternative investment proposals with the
following data:
Investment $10,000,000 $500,000
Estimated annual net cash inflows for 5 years $2,000,000 $95,000
Residual value $50,000 $20,000
Calculate accounting rate of return for Proposal Y.

A) 8.95%
B) 10.21%
C) 7.50%
D) 6.57%
Answer: C
Explanation: C) Calculation of accounting rate of return:
Proposal Y
Total net cash inflows during operating life of the $475,000
asset ($95,000 per year × 5 years)
Less: Total depreciation during operating life of the
asset ($400,000 - $0) 400,000
Total operating income during operating life 75,000
Divide by: Asset's operating life in years ÷5
Average annual operating income from asset $15,000
Average amount invested [($400,000 + 0) ÷ 2] $200,000
ARR of Proposal Y = Average annual operating income ÷ Average amount invested

ARR = $15,000 ÷ $200,000 = 7.5% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
151
21) The following details are provided by a manufacturing company.
Product line
Investment $1,000,000
Useful life 12 years
Estimated annual net cash inflows for first year $400,000
Estimated annual net cash inflows for second year $350,000
Estimated annual net cash inflows for next ten years $300,000
Residual value $50,000
Depreciation method Straight-line
Required rate of return 12%
Calculate the payback period for the investment.

A) 2.5 years
B) 2.83 year
C) 3.0 years
D) 3.5 years
Answer: B
Explanation: B) Payback = 2 years + [($1,000,000 - $750,000)] ÷ $300,000 = 2.83 years or 2 years 10 months.
Diff: 2
LO: 26-2
AACSB: Application
22) Logy Inc. is evaluating two possible investments in depreciable plant assets. The company uses the
straight-line method of depreciation. The following information is available:
Investment A Investment B
Initial capital investment $100,000 $150,000
Estimated useful life 10 years 10 years
Estimated residual value 0 $20,000
Estimated annual net cash inflow for 10 years $20,000 $40,000
Calculate the payback period for Investment A.

A) 3 years
B) 4 years
C) 1 year
D) 5 years
Answer: D
Explanation: D) Payback for Investment A = $100,000/$20,000 = 5 years.
Diff: 2
LO: 26-2
AACSB: Application
152
23) Logy Inc. is evaluating two possible investments in depreciable plant assets. The company uses the
straight-line method of depreciation. The following information is available:
Investment A Investment B
Initial capital investment $100,000 $150,000
Estimated useful life 10 years 10 years
Estimated residual value 0 $20,000
Estimated annual net cash inflow for 10 years $20,000 $40,000
Calculate the payback period for Investment B.

A) 3 years
B) 2 years
C) 4 years
D) 5 years
Answer: A
Explanation: A) Payback for Investment B = $150,000/$50,000 = 3 years
Diff: 2
LO: 26-2
AACSB: Application
153
24) Dartis Company is considering investing in a specialized equipment costing $600,000. The equipment
has a useful life of 5 years and a residual value of $60,000. Depreciation is calculated using the straight-
line method. The expected net cash inflows from the investment are given below.
Year 1 $200,000
2 150,000
3 160,000
4 95,000
5 75,000
$680,000
What is the accounting rate of return on the investment?

A) 7.95%
B) 8.78%
C) 8.48%
D) 9.25%
Answer: C
Explanation: C)
Calculation of accounting rate of return:
Total net cash inflows during operating life of the asset $680,000
asset ($600,000 - $60,000) 540,000
Average amount invested [($600,000 + $60,000) ÷ 2] $330,000
ARR of Equipment = Average annual operating income ÷ Average amount invested

ARR = $28,000 ÷ $330,000 = 8.48% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
154
25) Landmark Company is considering an investment in new equipment costing $500,000. The equipment
will be depreciated on a straight-line basis over a five-year life and is expected to generate net cash
inflows of $120,000 the first year, $140,000 the second year, and $150,000 every year thereafter until the
fifth year. What is the payback period for this investment? The residual value is zero.
A) 4.5 years
B) 3.6 years
C) 2.9 years
D) 3.2 years
Answer: B
Explanation: B)
Net cash outflows Net cash inflows
Year Amount invested Annual Accumulated
0 500,000
1 $120,000 $120,000
2 140,000 260,000
3 150,000 410,000
4 150,000 560,000
5 150,000 710,000
Payback = 3 years + [($500,000 - $410,000) ÷ $150,000] = 3.6 years

Diff: 2
LO: 26-2
AACSB: Application
26) Software Hub is deciding whether to purchase new accounting software. The cost of the software
package is $55,000, and its expected life is 10 years. The payback for this investment is four years.
Assuming equal yearly cash flows, what are the expected annual net cash savings from the new software?
(Assume the investment has zero salvage value.)
A) $5,500
B) $37,800
C) $13,750
D) $220,000
Answer: C
Explanation: C) Expected annual net cash savings from the software = $55,000 ÷ 4 years = $13,750
Diff: 2
LO: 26-2
AACSB: Application
155
27) Paramount Company is considering purchasing new equipment costing $700,000. The company's
management has estimated that the equipment will generate cash flows as follows:
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
Residual value is zero. What is the payback period?

A) 4.5 years
B) 3.2 years
C) 3.5 years
D) 3.8 years
Answer: B
Explanation: B)
Net cash outflows Net cash inflows
Year Amount invested Annual Accumulated
0 700,000
1 $200,000 $200,000
2 200,000 400,000
3 250,000 650,000
4 250,000 900,000
5 150,000 1,050,000
Payback = 3 years + [($700,000 - $650,000) ÷ $250,000] = 3.2 years

Diff: 2
LO: 26-2
AACSB: Application
28) Caliber Company is considering the purchase of a new machine costing $800,000. The company's
management is estimating that the new machine will generate additional cash flows of $180,000 a year for
ten years and have a salvage value of $50,000 at the end of ten years. What is the machine's payback
period?
A) 4.44 years
B) 6.77 years
C) 3.33 years
D) 5.33 years
Answer: A
Explanation: A) Payback period =$800,000/$180,000 = 4.44 years
Diff: 2
LO: 26-2
AACSB: Application
156
29) Nylan Company is considering an investment in new equipment costing $850,000. The equipment
will be depreciated on a straight-line basis over a five-year life and is expected to have a salvage value of
$50,000. The equipment is expected to generate net cash inflows of $1,000,000 in total during the five
years life. What is the accounting rate of return associated with the equipment investment?
A) 9.99%
B) 8.89%
C) 7.56%
D) 9.32%
Answer: B
Explanation: B)
Total net cash inflows during operating life of the asset $1,000,000
asset ($850,000 - $50,000) 800,000

ARR = $40,000 ÷ $450,000 = 8.89% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
157
30) Clapton Corporation is considering an investment in new equipment costing $900,000. The equipment
will be depreciated on a straight-line basis over a ten-year life and is expected to have a salvage value of
$90,000. The equipment is expected to generate net cash flows of $140,000 for each of the first five years
and $100,000 for each of the last five years. What is the accounting rate of return associated with the
equipment investment?
A) 8.89%
B) 9.23%
C) 8.52%
D) 7.88%
Answer: D
Explanation: D)
Total net cash inflows during operating life of the
asset [($140,000 × 5) + ($100,000 × 5)] $1,200,000
asset ($900,000 - $90,000) 810,000
Divide by: Asset's operating life in years ÷ 10

ARR = $39,000 ÷ $495,000 = 7.88% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
158
31) A company is evaluating three possible investments. Following information is provided by the
company.
Project A Project B Project C

Investment $200,000 $50,000 $200,000
Salvage value 0 5,000 10,000
Net cash flows:
Year 1 50,000 25,000 80,000
Year 2 50,000 16,000 50,000
Year 3 50,000 12,000 60,000
Year 4 50,000 9,000 20,000
Year 5 50,000 0 0
What is the payback period for Project A? (Assume that the company uses the straight-line depreciation
method.)
A) 3.0 years
B) 2.0 years
C) 4.0 years
D) 5.0 years
Answer: C
Explanation: C) Payback = $200,000 ÷ $50,000 = 4 years
Diff: 1
LO: 26-2
AACSB: Application
159
32) A company is evaluating three possible investments. Each uses straight-line method of depreciation.
Following information is provided by the company.

Investment $200,000 $50,000 $200,000
Net cash flows:
Year 1 50,000 25,000 80,000
Year 2 50,000 16,000 50,000
Year 3 50,000 12,000 60,000
Year 4 50,000 9,000 20,000
Year 5 50,000 0 0
What is the accounting rate of return for Project B?

A) 15.08%
B) 10.214%
C) 15.45%
D) 14.54%
Answer: C
Explanation: C)
asset ($25,000 + $16,000 + $12,000 +$9,000)
asset ($50,000 - $5,000) 45,000
ARR of Project B = Average annual operating income ÷ Average amount invested

ARR = $4,250 ÷ $27,500 = 15.45% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
160
33) A company is evaluating three possible investments. Each uses straight-line method of depreciation.
Following information is provided by the company.

Investment 200,000 $50,000 $200,000
Net cash flows:
Year 1 50,000 25,000 80,000
Year 2 50,000 16,000 50,000
Year 3 50,000 12,000 60,000
Year 4 50,000 9,000 20,000
Year 5 50,000 0 0
What is the accounting rate of return for Project C?

A) 15%
B) 12%
C) 18%
D) 10%
Answer: B
Explanation: B)
asset ($80,000 + $50,000 + $60,000 +$20,000)
asset ($200,000 - $50,000) 150,000
ARR of Project C = Average annual operating income ÷ Average amount invested

ARR = $15,000 ÷ $125,000 = 12% (Rounded)
Diff: 3
LO: 26-2
AACSB: Application
34) Which of the following capital budgeting methods uses accrual accounting information?
A) payback
B) accounting rate of return
C) net present value
D) internal rate of return
Answer: B
Diff: 1
LO: 26-2
AACSB: Concept
161
1) The fact that invested cash earns income over time is called the time value of money.
Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
2) An annuity refers to a series of equal cash flows received or paid annually.

Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
3) All else being equal, the shorter the investment period, the higher the total amount of interest earned.
Answer: FALSE
Diff: 1
LO: 26-3
AACSB: Concept
4) Compound interest means that interest is calculated only on the principal amount.
Answer: FALSE
Diff: 1
LO: 26-3
AACSB: Concept
5) Compound interest assumes that all interest earned will be reinvested at the same rate of interest at
which the investment was originally made.
Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
6) The only difference between present value and future value is the amount of interest that is earned in
the intervening time span.
Answer: TRUE
Diff: 1
LO: 26-3
AACSB: Concept
162
7) Paramount Company is considering purchasing new equipment costing $700,000. The management
has estimated that the equipment will generate cash flows as follows:
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
Present value of $1:
6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621
The company's required rate of return is 8%. Using the factors in the table, calculate the present value of
the cash inflows. (Round all calculations to the nearest whole dollar)
A) $890,000
B) $750,000
C) $850,000
D) $841,000
Answer: D
Explanation: D)
Calculation of present value of cash inflows:
Cash inflows PV factors at 8% Present value

$200,000 0.926 $185,200
200,000 0.857 171,400
250,000 0.794 198,500
250,000 0.735 183,750
150,000 0.681 102,150
$841,000
Diff: 3
LO: 26-3
AACSB: Application
163
8) Paramount Company is considering purchasing new equipment costing $700,000. Company's
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621
The company's required rate of return is 9%. Using the factors in the table, calculate the present value of
the cash flows.
A) $850,000
B) $819,300
C) $820,500
D) $852,000
Answer: B
Explanation: B)
Calculation of present value of cash inflows:
Cash Inflows PV factors at 9% Present Value

$200,000 0.917 $183,400
200,000 0.842 168,400
250,000 0.772 193,000
250,000 0.708 177,000
150,000 0.650 97,500
$819,300
Diff: 3
LO: 26-3
AACSB: Application
164
9) Paramount Company is considering purchasing new equipment costing $700,000. Company's
Year 1 $200,000
2 200,000
3 250,000
4 250,000
5 150,000
The company's required rate of return is 10%. Using the factors in the table below, calculate the present
value of the cash inflows. Present value of $1:
6% 7% 8% 9% 10%
1 0.943 0.935 0.926 0.917 0.909
2 0.89 0.873 0.857 0.842 0.826
3 0.84 0.816 0.794 0.772 0.751
4 0.792 0.763 0.735 0.708 0.683
5 0.747 0.713 0.681 0.65 0.621
A) $765,000
B) $768,921
C) $798,650
D) $780,000
Answer: C
Explanation: C)
Cash Inflows PV factors at 10% Present Value
$200,000 0.909 $181,800
200,000 0.826 165200
250,000 0.751 187750
250,000 0.683 170750
150,000 0.621 93150
$798,650
Diff: 3
LO: 26-3
AACSB: Application
10) Which of the following describes the term time value of money?
A) Money can be used only at certain times and only for certain purposes.
B) Money loses its purchasing power over time through inflation.
C) Wasted time can result in wasted money.
D) Value of a dollar received today will be higher than that received after some time.
Answer: D
Diff: 1
LO: 26-3
AACSB: Concept
165
11) Which of the following most accurately describes the term annuity?
A) an investment which produces increasing cash flows overtime
B) an installment loan with amortizing principal payments
C) a stream of equal installments of cash flows made at equal time intervals
D) a term life insurance policy
Answer: C
Diff: 1
LO: 26-3
AACSB: Concept
12) Lara is going to receive $10,000 a year at the end of each of the next five years from her insurer to meet
her education cost. Using a discount rate of 14%, the present value of the receipts can be stated as:
A) PV = $10,000 (Annuity FV factor, i = 14%, n = 5).
B) PV = $10,000 (PV factor, i = 14%, n = 5).
C) PV = $10,000 (Annuity PV factor, i = 14%, n = 5).
D) PV = $10,000 (FV factor, i = 14%, n = 5).
Answer: C
Diff: 1
LO: 26-3
AACSB: Application
166
13) If $10,000 is invested annually in an account with 7% interest compounded yearly, what will the
balance of the account be after six years? Refer to the following Future Value table:
Future value of annuity of $1:
5% 6% 7% 8%
1 1 1 1 1
2 2.05 2.06 2.07 2.08
3 3.153 3.184 3.215 3.246
4 4.31 4.375 4.44 4.506
5 5.526 5.637 5.751 5.867
6 6.802 6.975 7.153 7.336
7 8.142 8.394 8.654 8.923
A) $79,050
B) $71,530
C) $18,020
D) $83,290
Answer: B
Explanation: B)
Balance in the account after six years:
Net Cash Annuity

Time Inflow FV Factor Future Value
1-6 years Cash flow $10,000 7.153 $71,530
Diff: 1
LO: 26-3
AACSB: Application
167
14) If $15,000 is invested annually in an account with 9% interest compounding yearly, what will the
balance of the account be after five years? Refer to the following Future Value table:
Future value of annuity of $1:
7% 8% 9%
1 0.935 0.926 0.917
2 1.808 1.783 1.759
3 2.624 2.577 2.531
4 3.387 3.312 3.24
5 4.1 3.993 3.89
6 4.767 4.623 4.486
7 5.389 5.206 5.033
A) $26,180
B) $26,211
C) $58,350
D) $25,125
Answer: C
Explanation: C) Balance in the account after five years:
Net cash Annuity

Time inflow FV Factor Future Value
1-5 years Cash flow $15,000 3.89 $58,350
Diff: 1
LO: 26-3
AACSB: Application
168
15) John wins the lottery and has the following three payout options for after-tax prize money:
1. $150,000 per year at the end of each of the next six years
2. $300,000 (lump sum) now
3. $500,000 (lump sum) six years from now
The required rate of return is 9%. What is the present value if he selects the first option? Round to nearest
whole dollar.
Present value of annuity of $1:
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
7 5.206 5.033 4.868
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
7 0.583 0.547 0.513
A) $750,000
B) $672,900
C) $450,000
D) $450,050
Answer: B
Explanation: B) Present value of lottery receipt under first option:
Net cash Annuity

Time inflow PV Factor Present Value
1-6 years Cash flow $150,000 4.486 $672,900
Diff: 1
LO: 26-3
AACSB: Application
169
2. $300,000 (lump sum) now
The required rate of return is 9%. What is the present value if he selects the second option? Round to
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
7 0.583 0.547 0.513
A) $650,000
B) $100,000
C) $400,000
D) $300,000
Answer: D
Diff: 1
LO: 26-3
AACSB: Application
170
2. $300,000 (lump sum) now
The required rate of return is 9%. What is the present value if he selects the third option? Round to
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
7 0.583 0.547 0.513
A) $250,000
B) $230,000
C) $238,400
D) $298,000
Answer: D
Explanation: D) Present value of lottery receipt under third option:
Net Cash Annuity

Time Inflow PV Factor Present Value
6th year Cash flow $500,000 0.596 $298,000
Diff: 1
LO: 26-3
AACSB: Application
171
18) Nylan Manufacturing is considering two alternative investment proposals with the following details:
Investment $720,000 $500,000
Estimated annual net cash inflows $150,000 $90,000
Residual value $50,000 $0
Discount rate 10% 9%
What is the total present value of future cash inflows from Proposal Y?
8% 9% 10%
1 0.926 $0.92 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
A) $266,750
B) $291,600
C) $290,000
D) $250,000
Answer: B
Explanation: B) Present value of future cash inflows from proposal Y:
Net cash Annuity

1-4 years Cash flow $90,000 3.24 $291,600
Diff: 2
LO: 26-3
AACSB: Application
172
173
19) Nylan Manufacturing is considering two alternative investment proposals with the following details:
Investment $720,000 $500,000
Estimated annual net cash inflows $150,000 $90,000
Residual value $50,000 $0
Discount rate 10% 9%
What is the total present value of future cash inflows from Proposal X?
8% 9% 10%
1 0.926 $0.92 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
8% 9% 10%
1 0.926 0.917 0.909
2 0.857 0.842 0.826
3 0.794 0.772 0.751
4 0.735 0.708 0.683
5 0.681 0.65 0.621
6 0.63 0.596 0.564
A) $742,340
B) $650,070
C) $568,650
D) $599,700
Answer: D
Explanation: D) Present value of cash inflows from Proposal X:
Net cash Annuity Present

Time inflow PV Factor Value
1-5 years Present value of annuity $150,000 3.791 $568,650
5th year Present value of residual value 50,000 0.621 31,050
Total present value of cash flows $599,700
Diff: 1
LO: 26-3
AACSB: Application
174
20) Arriyana has just received an inheritance of $100,000, and she would like to put it into an investment
portfolio for 20 years. Which of the following would be useful to calculate the value of the investment at
the end of 20 years?
A) Present Value of $1
B) Present Value of an Annuity of $1
C) Future Value of $1
D) Future Value of an Annuity of $1
Answer: C
Diff: 1
LO: 26-3
AACSB: Concept
21) Zane has received a prize which entitles him to receive annual payments of $10,000 for the next 10
years. Which of the following is to be referred to in order to calculate the total value of the prize today?
A) Present Value of $1
B) Present Value of an Annuity of $1
C) Future Value of $1
D) Future Value of an Annuity of $1
Answer: B
Diff: 1
LO: 26-3
AACSB: Concept
175
22) James has just won the lottery after purchasing one $10 lottery ticket. The state offers him the
following three payout options for after-tax prize money:
2. $300,000 (lump sum) now
Calculate the present value of each scenario using an 8% discount rate. Round to nearest whole dollar.
7% 8% 9%
1 0.935 0.926 0.917
2 1.808 1.783 1.759
3 2.624 2.577 2.531
4 3.387 3.312 3.24
5 4.1 3.993 3.89
6 4.767 4.623 4.486
7% 8% 9%
1 0.935 0.926 0.917
2 0.873 0.857 0.842
3 0.816 0.794 0.772
4 0.763 0.735 0.708
5 0.713 0.681 0.65
6 0.666 0.63 0.596
Answer:
Scenario 1: Present value of lottery receipt:
Net cash Annuity

1-6 years Cash flow $50,000 4.623 $231,150
Scenario 2: Present value of lottery receipt = $300,000
Scenario 3: Present value of lottery receipt:
Net cash
6th year Cash flow $400,000 0.63 $252,000
Diff: 2
LO: 26-3
AACSB: Application
176
1) Net present value is defined as the difference between the present value of the project's net cash
inflows and the cost of investment.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
2) Management's minimum desired rate of return on a capital investment is known as the return on
investment.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
3) The residual value is discounted as a single lump sum because it will be received only once at the end
of life of the asset.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
4) When the internal rate of return is the same as the required rate of return, the net present value of an
investment will be positive.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
5) The NPV method of evaluating capital investments suggests that a project with positive net cash
inflows that exceed the cost of the investment should be accepted.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
177
6) When calculating the net present value of future cash flows, dollars that are received in earlier years
are worth more than dollars received in later years.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
7) The internal rate of return (IRR) is the rate of return, based on discounted cash flows, that a company
can expect to earn by investing in a capital asset.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
8) The benefit foregone by not choosing an alternative course of action is known as an opportunity cost.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
9) Out of all methods of evaluating capital investments, the discounted cash flow methods are superior
because they consider both the time value of money and the profitability of the investment.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
10) When evaluating a potential investment, managers should use more than one measure for making a
sound investment decision.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
11) When a company is evaluating an investment proposal with high risk, a low discount rate should be
used, and vice versa.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
178
12) Compound interest used in discounted cash flow calculations assumes that companies will reinvest
future cash flows whenever they are received.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
13) If an investment project's IRR is higher than the company's required rate of return, the company
should reject the investment.
Answer: FALSE
Diff: 1
LO: 26-4
AACSB: Concept
14) Discounted cash flow methods consider the time value of money while evaluating an investment
proposal.
Answer: TRUE
Diff: 1
LO: 26-4
AACSB: Concept
15) Which of the following is true of discounted cash flow methods like NPV and IRR?
A) They use simple interest calculations.
B) They use net income amounts rather than cash flows.
C) They focus on the payback period.
D) They consider discounted cash flows.
Answer: D
Diff: 1
LO: 26-4
AACSB: Concept
16) Which of the following is true of discounted cash flow methods like NPV and IRR?
A) They use simple interest calculations.
B) They assume that cash flows will be reinvested when received.
C) They focus on the payback period.
D) They comply with the requirements of GAAP.
Answer: B
Diff: 1
LO: 26-4
AACSB: Concept
179
17) Cash flows used in NPV and IRR analysis ignore:
A) future increased sales.
B) future cost savings.
C) depreciation expense.
D) residual value.
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
18) Which of the following situations suggests the acceptance of an investment proposal?
A) The present value of the net cash inflows exceeds the initial investment.
B) The IRR is lower than the hurdle rate.
C) The cash inflows are lesser than the initial investment.
D) The investment will have a residual value.
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
19) The term net present value means the difference between:
A) the total net income of the project and the initial investment.
B) the initial investment and the residual value.
C) the future value of the cash flows and the present value of the cash flows.
D) the present value of the net cash inflows and the investment's cost.
Answer: D
Diff: 2
LO: 26-4
AACSB: Concept
20) Which of the following most accurately describes the discount rate used in NPV analysis?
A) the rate of inflation
B) the rate of interest earned on a savings account
C) the required rate of return or the hurdle rate
D) the rate of interest charged for debt financing of an investment
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
180
21) Gamma Company is considering an investment of $500,000 in a land development project. It will
yield cash flows of $200,000 for 5 years. The company uses a discount rate of 9%. What is the net present
value of the investment?
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
A) $230,000
B) $278,000
C) $330,000
D) $200,000
Answer: B
Explanation: B)
1-5 years Cash flow $200,000 3.89 $778,000
0 Initial investment (500,000)
Net present value $278,000
Diff: 2
LO: 26-4
AACSB: Application
181
22) Gamma Company is considering an investment proposal that would require an initial outlay of
$800,000, and would yield yearly cash flows of $200,000 for 9 years. The company uses a discount rate of
10%. What is the NPV of the investment?
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
7 5.206 5.033 4.868
8 5.747 5.535 5.335
9 6.247 5.995 5.759
A) $350,000
B) $400,000
C) $351,800
D) $250,000
Answer: C
Explanation: C)
1-9 years Cash flow $200,000 5.759 $1,151,800
0 Initial Investment (800,000)
Net present value $351,800
Diff: 2
LO: 26-4
AACSB: Application
182
23) A company is considering an iron ore extraction project which requires an initial investment of
$500,000 and will yield annual cash flows of $150,000 for 4 years. The company's hurdle rate is 9%. What
is the NPV of the project?
8% 9% 10%
1 0.926 0.917 0.909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
4 3.312 3.24 3.17
5 3.993 3.89 3.791
6 4.623 4.486 4.355
7 5.206 5.033 4.868
8 5.747 5.535 5.335
9 6.247 5.995 5.759
10 6.71 6.418 6.145
A) positive $14,000
B) negative $100,000
C) positive $100,000
D) negative $14,000
Answer: D
Explanation: D)
1-4 years Cash flow 150,000 3.24 $486,000
Net present value ($14,000)
Diff: 2
LO: 26-4
AACSB: Application
24) Which of the following would be the best basis on whether to accept an investment opportunity or
not?
A) if it has positive total cash inflows
B) if it has a payback period in less than 10 years
C) if the investment's rate of return is higher than the company's current year required rate of return
D) if the net present value is positive
Answer: D
Diff: 1
LO: 26-4
AACSB: Concept
183
25) Following details are provided by Dopler Company.
Initial investment $2,000,000

Discount rate 12%
Yearly cash flows
1 $200,000
2 $400,000
3 $400,000
4 $400,000
5 $200,000
Refer to the following table for PV factors:
10% 11% 12% 13%

1 0.909 0.901 0.893 0.885
2 0.826 0.812 0.797 0.783
3 0.751 0.731 0.712 0.693
4 0.683 0.659 0.636 0.613
5 0.621 0.593 0.567 0.543
Calculate the NPV of the project.

A) $950,000 negative
B) $850,000 negative
C) $1,005,000 positive
D) $250,000 positive
Answer: B
Explanation: B)
Net cash Annuity
Present value of each year's inflow
1 $200,000 0.893 $178,600
2 400,000 0.797 318,800
3 400,000 0.712 284,800
4 00,000 0.636 254,400
5 00,000 0.567 113,400
Total PV of cash inflows $1,150,000
0 Total Investment (2,000,000)
Net present value of the project ($850,000)
Diff: 2
LO: 26-4
AACSB: Concept
184
26) Following details are provided by VPN Company.

Discount rate 15%
Yearly cash flows
1 $1,250,000
2 $1,350,000
3 $2,400,000
4 $1,150,000
Refer to the following table for PV factors:

13% 14% 15%
1 0.885 0.877 0.87
2 0.783 0.769 0.756
3 0.693 0.675 0.658
4 0.613 0.592 0.572
What is the NPV of the project?

A) $654,900 negative
B) $590,000 positive
C) $615,455 positive
D) $590,850 negative
Answer: A
Explanation: A)
Net cash Annuity
Present value of each year's inflow
1 $1,250,000 0.87 $1,087,500
2 1,350,000 0.756 1,020,600
3 2,400,000 0.658 1,579,200
4 1,150,000 0.572 657,800
Total PV of cash inflows $4,345,100
0 Total Investment 5,000,000
Net present value of the project ($654,900)
Diff: 2
LO: 26-4
AACSB: Application
185
27) When comparing several investments with the same initial outlay, the decision should be made on the
basis of:
A) highest total cash inflows.
B) longest payback period.
C) highest NPV.
D) highest ARR.
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
28) Under conditions of limited resources, when a company is comparing several investments with
different amounts of initial outlay, the decision should be made on the basis of:
A) highest total cash inflows.
B) shortest payback period.
C) highest profitability index.
D) highest NPV.
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
29) Which of the following best describes the profitability index?

A) an index of projects based on their net income
B) the ratio of present value of net cash inflows to initial investment
C) the ratio of total cash inflows to initial investment
D) an array of possible investment outcomes at different discount rates
Answer: B
Diff: 1
LO: 26-4
AACSB: Concept
186
30) A company seeking investment opportunities has collected the following information.
Project A Project B Project C Project D

Initial investment $400,000 $250,000 $150,000 $270,000
PV of cash inflows $570,000 $295,000 $210,000 $282,000
Payback period (years) 3.6 3.0 4.75 3.5
NPV of project $170,000 $45,000 $60,000 $12,000
Profitability index 1.43 1.18 1.40 1.04
If the company makes a decision based on the NPV, the most preferable project would be:
A) Project A.
B) Project B.
C) Project C.
D) Project D.
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
31) The following details are provided by Dopler Company:

NPV of project $150,000 $180,000 $250,000 ($110,000)
Calculate the profitability index for Project A.

A) 0.98
B) 1.08
C) 1.36
D) 1.66
Answer: C
Explanation: C)
Calculation of Profitability Index:
Project A
Present value of cash inflows $570,000
Initial Investment 420,000
Profitability Index($570,000 ÷ $420,000) 1.36
Diff: 2
LO: 26-4
AACSB: Application
187

NPV of project $150,000 $180,000 $250,000 ($110,000)
What is the profitability index for Project B?

A) 1.98
B) 1.38
C) 1.26
D) 1.90
Answer: D
Explanation: D) Project B
Initial Investment 200,000
Profitability Index ($380,000 ÷ $200,000) 1.90
Diff: 2
LO: 26-4
AACSB: Application

NPV of project $150,000 $180,000 $250,000 ($110,000)
What is the profitability index for Project C?

A) 1.45
B) 1.38
C) 1.26
D) 1.23
Answer: A
Explanation: A) Project C
Initial investment 550,000
Profitability index ($800,000 ÷ $550,000) 1.45
Diff: 2
LO: 26-4
AACSB: Application
188

NPV of project $150,000 $180,000 $250,000 ($110,000)
Which project has the highest profitability index?

A) Project A
B) Project B
C) Project C
D) Project D
Answer: B
Explanation: B)
Present value of cash inflows $570,000 $380,000 $800,000 $390,000
Profitability index 1.36 1.90 1.45 0.78
Diff: 3
LO: 26-4
AACSB: Application
35) Which of the following best describes the term sensitivity analysis?
A) setting the budgets of an investment
B) analyzing the effect of an investment on workers' morale
C) evaluating different investment options
D) testing the results of an investment analysis with varying assumptions
Answer: D
Diff: 1
LO: 26-4
AACSB: Concept/Application
36) Which of the following is the rate of return, based on discounted cash flows, that a company can
expect to earn by investing in a capital asset?
A) accounting rate of return (ARR)
B) bank interest rate
C) internal rate of return (IRR)
Answer: C
Diff: 1
LO: 26-4
AACSB: Concept
189
37) Which of the following best describes the internal rate of return?
A) discount rate at which the cost of the investment equals the present value of the net cash inflows from
the investment
B) discount rate that is used to evaluate funds borrowed from a lender for profitability
C) the ratio of average annual income to average amount invested
D) the rate at which the profitability of an investment increases
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
38) At the internal rate of return (IRR), the present value of cash inflows will be equal to:
A) initial investment.
B) residual value.
C) average operating income.
D) profit from the project.
Answer: A
Diff: 1
LO: 26-4
AACSB: Concept
190
39) A company is considering an iron ore extraction project which requires an initial investment of
$1,000,000 and will yield annual cash flows of $350,263 for 4 years. The company's hurdle rate is 9%.
Calculate IRR.
A) 15%
B) 18%
C) 12%
D) 10%
Answer: A
Explanation: A) Calculation of IRR:

Present value of cash inflows 350,263
Annuity PV factor ($1,000,000 ÷ $350,263) 2.855
Net cash Annuity

1-4 years Cash flow $350,263 2.855 $1,000,000
0 Initial Investment 1,000,000
Net present value 0
15%
1 0.87
2 1.626
3 2.283
4 2.855
At IRR, NPV = 0
Diff: 2
LO: 26-4
AACSB: Application
191
40) Nobell Company is evaluating an investment of $1,000,000 which will yield net cash inflows of
$142,369 per year for 10 years with no residual value. What is the internal rate of return?
5% 6% 7% 8%
1 0.952 0.943 0.935 0.926
2 1.859 1.833 1.808 1.783
3 2.723 2.673 2.624 2.577
4 3.546 3.465 3.387 3.312
5 4.329 4.212 4.1 3.993
6 5.076 4.917 4.767 4.623
7 5.786 5.582 5.389 5.206
8 6.463 6.21 5.971 5.747
9 7.108 6.802 6.515 6.247
10 7.722 7.36 7.024 6.71
A) 6%
B) 7%
C) 8%
D) 9%
Answer: B
Explanation: B)
Present value of cash inflows 142,369
Annuity PV factor ($1,000,000 ÷ $142,369) 7.024

1-10 years Cash flow 142,369 7.024 $1,000,000
0 Initial Investment 1,000,000
Net present value 0
Diff: 2
LO: 26-4
AACSB: Application
192
41) Gamma Company is considering an investment opportunity with the following expected net cash
inflows: Year 1, $250,000; Year 2, $350,000; Year 3, $395,000. The company uses a discount rate of 12% and
the initial investment is $750,000.
The following table is available:

Present Value of $1:
10% 12% 14% 15%

1 0.909 0.893 0.877 0.870
2 0.826 0.797 0.769 0.756
3 0.751 0.712 0.675 0.658
4 0.683 0.636 0.592 0.572
5 0.621 0.567 0.519 0.497
The IRR of the project will be:

A) less than 12%.
B) between 12% and 13%.
C) between 14% and 15%.
D) more than 12%.
Answer: C
Explanation: C)
At 10% $250,000 0.909 $227,250
$350,000 0.826 289,100
$395,000 0.751 296,645
(750,000)
Net Present Value 62,995
At 14% $250,000 0.877 219,250

$350,000 0.769 269,150
$395,000 0.675 266,625
(750,000)
Net Present Value 5,025
At 15% $250,000 0.87 217,500

$350,000 0.756 264,600
$395,000 0.658 259,910
(750,000)
Net Present Value ($7,990)
Diff: 3
LO: 26-4
AACSB: Application
193
42) Gladeer Company is evaluating an investment that will cost $520,000 and will yield cash flows of
$300,000 in the first year, $200,000 in the second year, and $100,000 in the third and final year. Use the
tables below and determine the internal rate of return.
8% 9% 10% 11%
1 0.926 0.917 0.909 0.901
2 0.857 0.842 0.826 0.812
3 0.794 0.772 0.751 0.731
4 0.735 0.708 0.683 0.659
5 0.681 0.65 0.621 0.593
The IRR of the project will be:

A) between 9% and 10%.
B) less than 8%
C) less than 9%, more than 8%
D) more than 10%
Answer: A
Explanation: A) At 8% $300,000 0.926 $277,800
$200,000 0.857 171,400
$100,000 0.794 79,400
(520,000)
Net Present Value $8,600
At 9% $300,000 0.917 $275,100

$200,000 0.842 168,400
$100,000 0.772 77,200
(520,000)
Net Present Value $700
At 10% $300,000 0.909 $272,700

$200,000 0.826 165,200
$100,000 0.751 75,100
(520,000)
Diff: 3
LO: 26-4
AACSB: Application
194
43) Canbera Company is considering investing $450,000 in telecommunications equipment which would
have an estimated life of 5 years with zero residual value. The cash flows are as shown below:
Year 1 $120,000
2 $235,000
3 $140,000
4 $98,000
The present value of $1 factors are given below:
10% 12% 13% 14%

1 0.909 0.893 0.885 0.877
2 0.826 0.797 0.783 0.769
3 0.751 0.712 0.693 0.675
4 0.683 0.636 0.613 0.592
5 0.621 0.567 0.543 0.519
The IRR of the project would be:

A) between 12% and 13%
B) more than 13%
C) less than 10%
D) between 8% and 10%
Answer: A
Explanation: A) At 10%$120,000 0.909 $109,080
$235,000 0.826 194,110
$140,000 0.751 105,140
$98,000 0.683 66,934
(450,000)
At 12% $120,000 0.893 $107,160

$235,000 0.797 187,295
$140,000 0.712 99,680
$98,000 0.636 62,328
(450,000)
At 13% $120,000 0.885 $106,200

$235,000 0.783 184,005
$140,000 0.693 97,020
$98,000 0.613 60,074
(450,000)
Diff: 3
LO: 26-4
AACSB: Application
195
44) Gamma Company is considering an investment opportunity with the following expected net cash
inflows: Year 1, $250,000; Year 2, $350,000; Year 3, $395,000. Residual value of the investment would be
$50,000. The company uses a discount rate of 12% and the initial investment is $400,000. Calculate the
NPV of the investment.
11% 12% 13% 14%

1 0.901 0.893 0.885 0.877
2 0.812 0.797 0.783 0.769
3 0.731 0.712 0.693 0.675
4 0.659 0.636 0.613 0.592
5 0.593 0.567 0.543 0.519
Answer: Net cash Present

Time inflow PV factor Value
Present value of each year's cash flow
1 $250,000 0.893 $223,250
2 350,000 0.797 278,950
3 395,000 0.712 281,240
3 Present value of residual value 50,000 0.712 35,600
Net Present value $419,040
Diff: 3
LO: 26-4
AACSB: Application
196
45) Gamma Company is considering an investment opportunity with the expected net cash inflows of
$300,000 for four years. Residual value of the investment would be $70,000. The company uses a discount
rate of 14% and the initial investment is $290,000. Calculate the NPV of the investment.
12% 13% 14% 15%

1 0.893 0.885 0.877 0.87
2 1.69 1.668 1.647 1.626
3 2.402 2.361 2.322 2.283
4 3.037 2.974 2.914 2.855
5 3.605 3.517 3.433 3.352
12% 13% 14% 15%

1 0.893 0.885 0.877 0.87
2 0.797 0.783 0.769 0.756
3 0.712 0.693 0.675 0.658
4 0.636 0.613 0.592 0.572
5 0.567 0.543 0.519 0.497
Answer: Net cash Annuity Present

1-4 years Present value of annuity $300,000 2.914 $874,200
4th year Present value of residual value 70,000 0.592 41,440
0 Initial Investment 290,000
Net Present value $625,640
Diff: 3
LO: 26-4
AACSB: Application
197

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Horngren's Accounting, 10e, Global Edition (Nobles/Mattison/Matsumura)

Chapter 24 Cost Allocation and Responsibility Accounting

Learning Objective 24-1

15) An activity-based costing system is developed in four steps.

Activity Allocation Base Cost Allocation Rate $

What is the cost of materials handling per ceiling fan?

Activity Allocation Base Cost Allocation Rate $

What is the cost of machining per ceiling fan?

Activity Allocation Base Cost Allocation Rate $

What is the cost of assembling per ceiling fan?

Activity Allocation Base Cost Allocation Rate $

What is the total manufacturing cost per ceiling fan?

Estimated Indirect Estimated Quantity of

Activities Allocated Costs Allocation Base

Northeast Office Midwest Office

Activities Allocated Costs Allocation Base

Northeast Office Midwest Office

Activities Allocated Costs Allocation Base

Northeast Office Midwest Office

Activities Allocated Costs Allocation Base

Northeast Office Midwest Office

What is the cost per letter for the correspondence activity?

Activities Allocated Costs Allocation Base

Northeast Office Midwest Office

Activities Allocated Costs Allocation Base

Northeast Office Midwest Office

Activities Allocated Costs Allocation Base

Northeast Office Midwest Office

34) Which of the following statements is true?

Total cost Total units Cost Driver

Direct material $28.00

37) The activity-based costing system improves the allocation of:

Materials management—allocated by number of purchase orders

The activity rates are as follows:

Materials management $12.00 Per purchase order

Computation of overhead cost of the order:*

Per unit Standard Heavy

Price per unit 350.00 370.00

Activities: Estimated Cost

Cost of Cost Quantity of Cost Driver

Calculation of production cost of Standard Bearings (per unit):

Calculation of gross profit:

13) Which of the following is a disadvantage of decentralization?

17) The term goal congruence refers to the:

18) The payroll department of a manufacturing company is most likely to be a(n):

4) A lag indicator is a performance measure that forecasts future performance.

17) A high rate of employee turnover indicates that:

21) The goal of the balanced scorecard is to:

9) Performance report of a profit center includes both revenues and expenses.

15) Which of the following statements is true of performance reporting?

4) To adequately evaluate an investment center's financial performance, summary performance measures

Boat Division Trailer Division

Income from operations $200,000

Calculate return on investment based on the information given above.

Boat Division Trailer Division

16) Which of the following is an expanded form of calculating return on investment?

Agriculture Division Industrial Division

Agriculture Division Industrial Division

Calculate the residual income for the Agriculture division.

8) Opportunity cost means:

Learning Objective 25-1

8) Fixed costs that do not differ between two alternatives are:

11) Which of following statements is true of short-term decision making?