Chapter 5
At the break-even point, what does total contribution margin equal?
Fixed expenses.
What type of cost has already been incurred and cannot be changed by a current decision?
Sunk cost.
Which capital-budgeting method focuses on incremental net operating income instead of cash flows?
Simple rate of return.
A product sells for $75 and has variable expenses of $45 per unit. What is the contribution margin ratio?
40%
$75 − $45 = $30 CM
$30 ÷ $75 = 40%
A supplier offers a lower price than the relevant cost of making a part, but management is worried about poor quality and late deliveries. What type of factors should management also consider?
Qualitative factors.
A $210,000 investment generates equal annual cash inflows of $60,000. What is the payback period?
3.5 years.
$210,000 ÷ $60,000 = 3.5
A company has a very small margin of safety. What does this tell you about its current sales level?
Sales are close to the break-even point.
Explanation: A small margin of safety means there is only a small gap between current sales and break-even sales. Therefore, sales would only need to decrease slightly before the company begins operating at a loss
A product can be sold at split-off for $54,000 or processed further and sold for $72,000. Additional processing costs $13,000. What should the company do?
Process further.
Incremental revenue = $72,000 − $54,000 = $18,000
$18,000 − $13,000 = $5,000 advantage.
What does a positive net present value indicate about a project's return relative to the required rate of return?
The project's return exceeds the required rate.
Fixed expenses are $126,000. Selling price is $60 and variable expense is $39 per unit. How many units must be sold to earn a $42,000 target profit?
8,000 units
CM/unit = $60 − $39 = $21
($126,000 + $42,000) ÷ $21 = 8,000
Product A has CM of $45 and requires 5 machine minutes. Product B has CM of $32 and requires 2 minutes. Which should receive priority?
Product B.
A = $45 ÷ 5 = $9/min
B = $32 ÷ 2 = $16/min
A project requires a $280,000 investment. The present value of future cash inflows is $301,000. What is the profitability index?
1.075
$301,000 ÷ $280,000 = 1.075
A company has contribution margin of $180,000 and NOI of $45,000. If sales increase by 12%, by what percentage should NOI increase?
48%
DOL = $180,000 ÷ $45,000 = 4
4 × 12% = 48%
A segment earns $84,000 of contribution margin. If dropped, $63,000 of fixed expenses would be avoided. What is the effect on total NOI, and should the segment be dropped?
NOI decreases by $21,000, so keep the segment.
$63,000 saved − $84,000 CM lost = $(21,000)
A project costs $190,000. Its discounted cash inflows are $54,600, $58,100, and $67,500. What is the NPV, and should the project be accepted?
NPV = $(9,800), reject.
Total PV = $180,200
$180,200 − $190,000 = $(9,800)