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

Multiple Choice

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

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

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

The amount of the sales price above variable costs will contribute to covering fixed costs. Response D: Since a is correct.$14)] more than if it does not accept the offer. 5. Response C: Correct! If the offer is produced with unused capacity. d) all of the above. net income will increase by $12. d) marginal cost. b) sunk cost. c) incremental cost.000. The firm will have $12.000 [3. c) opportunity costs. Response C: Opportunity costs are relevant costs in a make-or-buy decision. Therefore this is the correct answer. 4.Response B: If the offer is produced with unused capacity. the book value of the old equipment is a(n): a) opportunity cost. net income will increase by $12.$14)] more than if it does not accept the offer. relevant costs are: a) manufacturing costs that will be saved. this answer cannot be correct. b) the purchase price of the units.000 [3. not fixed processing costs. c) fixed processing costs. The amount of the sales price above variable costs will contribute to covering fixed costs. fixed costs will not increase. 6. The amount of the sales price above variable costs will contribute to covering fixed costs. fixed costs will not increase. but d is a better answer. d) No correct answer is given. Thus. Response D: Correct! All the costs mentioned above are relevant in a make-or-buy decision. but d is a better answer. Response D: If the offer is produced with unused capacity. Response B: The purchase price of the units are relevant costs in a make-or-buy decision.000 units X ($18 . The firm will have $12. Ans: a Response A: Correct! The decision rule in a sell-or-process-further decision is to process further as long as the incremental revenue from such processing exceeds incremental processing costs. In a decision to retain or replace equipment.000. In a make-or-buy decision. but d is a better answer. . Ans: d Response A: Manufacturing costs that will be saved are relevant costs in a make-or-buy decision.000 units X ($18 .000.$14)] more than if it does not accept the offer. The decision rule in a sell-or-process-further decision is: Process further as long as the incremental revenue from such processing exceeds: a) incremental processing costs. not variable processing costs. The firm will have $12. Response B: The decision rule in a sell-or-process-further decision is to process further as long as the incremental revenue from such processing exceeds incremental processing costs.000 [3. fixed costs will not increase. net income will increase by $12. Thus. b) variable processing costs. Thus. Response C: The decision rule in a sell-or-process-further decision is to process further as long as the incremental revenue from such processing exceeds incremental processing costs.000 units X ($18 .

$15/3 hours = $5 contribution margin per unit of limited resource. In this case. Response D: Net income can either increase or decrease if a segment is eliminated. the book value of the old equipment is a sunk cost. d) The time value of money is considered. 9. Response B: Correct! The contribution margin per unit of limited resource is computed by dividing the contribution margin per unit by the amount of limited resource required to produce the unit. Ans: c Response A: Net income can either increase or decrease if a segment is eliminated. the book value of the old equipment is a sunk cost. b) variable expenses of the eliminated segment will have to be absorbed by other segments c) fixed expenses allocated to the eliminated segment will have to be absorbed by other segments. the book value of the old equipment is a sunk cost. the contribution margin per unit of limited resource is: a) $25. the book value of the old equipment is a sunk cost. Response B: When a segment is eliminated. Ans: b Response A: The contribution margin per unit of limited resource is computed by dividing the contribution margin per unit by the amount of limited resource required to produce the unit.0 machine hours to produce the unit. the fixed costs allocated to that segment will still have to be covered. Response D: In the decision to retain or replace equipment. Response C: Correct! Even though the segment is eliminated. the variable costs of that segment will also be eliminated and will not need to be absorbed by other segments. In this case. $15/3 hours = $5 contribution margin per unit of limited resource. d) No correct answer is given. 8. This is because the book value reflects the original cost less accumulated depreciation and neither of these values are relevant to the decision. This is done by having other segments absorb the fixed costs of the segment to be eliminated. If the contribution margin per unit is $15 and it takes 3. Which of the following is incorrect about the annual rate of return technique? a) The calculation is simple. not a marginal cost. . c) The timing of the net cash flows is not considered.Ans: b Response A: In the decision to retain or replace equipment. not an incremental cost. $15/3 hours = $5 contribution margin per unit of limited resource. 7. Response D: Since b is correct. c) $45. In this case. this answer cannot be correct. Response C: The contribution margin per unit of limited resource is computed by dividing the contribution margin per unit by the amount of limited resource required to produce the unit. Response B: Correct! In the decision to retain or replace equipment. b) $5. not an opportunity cost. d) net income will always decrease. Response C: In the decision to retain or replace equipment. b) The accounting terms used are familiar to management. If an unprofitable segment is eliminated: a) net income will always increase.

Response C: This is an accurate statement about the annual rate of return technique. 10. the return on the project is higher than. the return on the project is higher than the required rate of return. Response B: This is an accurate statement about the annual rate of return technique. the return on the project is higher than. not equal to the required rate of return. Response D: Correct! The time value of money is not considered in the annual rate of return technique. Response D: When the net present value is positive. not less than the required rate of return. A positive net present value means that the: a) project’s rate of return is less than the cutoff rate. . c) project’s rate of return equals the required rate of return. the project is acceptable.Ans: d Response A: This is an accurate statement about the annual rate of return technique. Response B: Correct! When the net present value is positive. Response C: When the net present value is positive. not unacceptable. d) project is unacceptable. Ans: b Response A: When the net present value is positive. b) project’s rate of return exceeds the required rate of return.