Formulas and Hot Ones

Question 1

Price elasticity

Answer 1

ABS(Q1-Q2)/ABS(Q1+Q2) / ABS (P1-P2)/ABS(P1+P2)

It is a division!

Question 2

Constant Growth Dividend Model

Answer 2

Expected dividend per share / (discount rate - dividend growth rate)

discount rate = expected return on equity = rf + B * (RM- rf)

Question 3

After Tax Proceeds from Equipment Disposal

Answer 3

If sale leads to a gain , the difference is multiplied by tax rate and deducted from sales value

Question 4

1. Credibility vs Competence

Answer 4

Credibility (communication):

> Communicate information fairly and objectively

> Provide all relevant impactful information

> Report any delays or deficiencies

> COMMUNICATE PROFESSIONAL LIMITAIONS

Competence (behavior, posture and good output):

• Maintain an appropriate level of professional leadership and expertise enhancing knowledge and skills.
• Perform professional duties in accordance with relevant laws, regulations, and technical standards.
• Provide decision support information and recommendations that are accurate, clear, concise and timely. Recognize and help manage risk.

Question 5

When the company is operating at 100% capacity, the amount charged must cover the variable costs of the item to be produced as well as the contribution that is lost by not producing something else.

Answer 5

• When a manufacturer lacks available production capacity, the differential costs of accepting the order must be considered.
• Now not only variable costs, but also the opportunity costs of redirecting resources must be considered.
  
  • The manufacturer will have to reduce production of existing product lines to fill the special order.
  • This means that the revenue, variable and fixed costs related to reduced production of existing product lines are relevant. HOWEVER, ONLY INCREMENTALLY.
• When the company is operating at 100% capacity, the amount charged must cover the variable costs of the item to be produced as well as the contribution that is lost by not producing something else.

Question 6

Carrying Stock

(Includes what ? and calculations?)

Answer 6

• Storage
• Insurance
• Security
• Taxes
• Depreciation or rent from from facilities
• Interest
• Spoilage and obsolescence
• Opportunity costs of funds invested: Purchase cost * Capital Cost

CARRYING COSTS ARE CALCULATED USING AVG INVENTORY (DIVIDE BY TWO OR INITIAL PLUS END DIVIDED BY 2).

ALSO BE AWARE THAT SAFETY STOCK IS INCLUDED

Question 7

Cosf of fund: common stock, preferred stock, debt

Answer 7

(equals dividend yield but remember to exclude issuance costs from MARKET PRICE)

AND DIVIDENDS ARE NOT TAX DEDUCTIBLE

• Cost of debt = Effective Rate * (1-t)
• Cost of preferred stock (dividend yield ratio) =
  
  • Cash dividend preferred stock / market price of preferred stock
    
    • Cash dividend preferred stock = dividend yield * par value
    • CASH DIVIDEND IS OVER PAR VALUE
• Cost Common stock (dividend yield)
  
  • Cash dividend of common stock / market price of common stock
• Cost of retained earnings is the same as that for common stock, however in practice is usually lower due to absence of issuance costs.

Question 8

DSO

, DIO

, DPO

, OPERATING

, CASH CYCLE

, SECOND FORMULA FOR AVG ACCOUNTS RECEIVABLE

Answer 8

DSO = 360 / AR Turnover

ART = NET CREDIT SALES / AVG ACCOUNTS RECEIVABLE

DIO = 360 / Inventory Turnover

Inventory turnover = COGS / AVG INVENTORY

DPO = 360 / AP Turnover

AP = Net purchases / AVG Payavle

OPERATING CYCLE = DSO + DSI

CASH CYCLE = OPERATING CYCLE - DAYS PRUCHASE IN ACCOUNTS PAYABLE

AVG A/R Oustanding: average collection period * daily net credit sales

Question 9

Lockbox system and Concentration Banking

Answer 9

• Lockbox system is a popular means of speeding up cash receipts
  
  • Customer submit payments to a mailbox rather than firm’s offices.
    
    • Bank personnel remove the envelopes from the mailbox and deposit the checks to the firm’s account directly
  • The bank generally charges a flat fee for this
• Concentration banking is another means of speeding up cash recipits
  
  • Customers submit payments to local branch office >> into local bank account >> firm’s principal bank.

Question 10

Capital Structure

(Best benefit and simple capital structure)

Answer 10

• The capital structure that maximizes the share price is the optimal capital structure. If the share price is at its highest, that means that management has properly balanced the risk and returns in its capital structure and investors value this structure the most.
• A firm with a simple capital structure only has to report a single category of EPS, called Basic EPS (BEPS).

Question 11

Trade Credit and Cost of not taking discount

(cost of not taking discount is very high)

Answer 11

• Spontaneous forms of financing
  
  • Trade credit in the accounts payable is the largest source of credit for small firms. It is created when a firm is offered credit terms by its suppliers.
    
    • Trade credit allows a customer to purchase goods on account (not using cash), receive the goods and pay the supplier at a later date (30,60,90).
      
      • Trade credits are usually given as 2/10, net 30.
    • Accrued expenses, such as salaries, wages, interest, dividends and tax payables are other sources.
• Costs of not taking discount (annualized)
  
  • Discount % / (1 – Discount %) * Days in year / (Total payment period – discount period)

Question 12

Cash conversion and relationship with rate of return foregone and cost of transaction

Answer 12

The higher the return on a market security the less you want to convert it to cash

The higher the transaction cost the more you want to reduce the number of transactionst to dillute the costs

Question 13

ProjectInvestment CostRate of Return

A$200,00012.5%

B$350,00014.2%

C$570,00016.5%

D$390,00010.6%

The investments will be financed through 40% debt and 60% common equity. Internally generated funds totaling $1,000,000 are available for reinvestment. If the cost of capital is 11%, and Mason strictly follows the residual dividend policy, how much in dividends would the company likely pay?

A. $430,000

B. $650,000

C. $120,000wrong

D. $328,000

Answer 13

Companies following the residual dividend policy use internally generated equity to finance new projects. They pay dividends only out of what is left after all capital requirements have been met, so they declare dividends only if there is enough money left over after all operating and expansion needs are met.

If Mason maintains the 40% debt / 60% equity financing, then 60% of the chosen investments will need to be financed from the $1,000,000 available funds. The investments chosen should provide a rate of return greater than the cost of capital of 11%. The chosen investments should be A, B, and C. The total investment in these projects is $1,120,000. Multiply that by the portion to be financed through the funds available (60%) and you have $672,000. The remaining funds will be available for dividends: $1,000,000 − $672,000 = $328,000.

Question 14

Impact of change of credit terms

Answer 14

• Assessing the impact of a change in credit terms
  
  • Amounts of receivable are an opportunity cost. A key aspect of any change in credit terms is balancing the competitive need to offer credit with the opportunity cost incurred.
  • Increased investment in receivables is calculated with this formula:
    
    • IIR = Incremental variable costs * Incremental average collection period / days in year
  • Cost of change in credit terms is calculated as:
    
    • Change in credit (CC): IIR * opportunity cost of funds (usually anchored in money market instrument)
  • Benefit or loss is:
    
    • Incremental contribution margin (increase in sales * contribution margin ratio)

MINUS CC

The additional cost of each transfer would be $25; collections would be accelerated by 2 days; and the annual interest rate paid by the central bank is 7.2% (0.02% per day). At what amount of dollars transferred would it be economically feasible to use a wire transfer instead of the DTC? Assume a 360-day year.

Question 15

BEP (Units, Dollar and Multi)

Answer 15

BEP Unit: FC / UCM

BEP Dollar : FC / UCMR

UCMR = UCM/SALES

MULTI: CALCULATE INDIVIDUAL UCMR AND CALCULATE AVERAGE UCMR

Variable costing provides the best information for breakeven analysis whether inventories are expected to change or not, because variable costs are segregated from fixed costs

Question 16

Certificates of Deposit (Bank, longer term, insured by Corporation, lower rates) vs Commercial Paper (shorter up to 270 days, large promisory note, not ideal for small business)

CD < CP < Commercial Loan < Trade Credit

Answer 16

CDs and commercial papers are both forms of money market instruments and are issued in the money markets by organizations that wish to raise funds, and are traded by investors who wish to profit from the interest rate fluctuations. However, there are many differences between these two forms of instruments, since CDs are issued as a proof of an investment of funds in the bank by a depositor while commercial papers are issued to an investor as a proof of purchase of the issuer’s debt (purchasing debt means providing funds like a bank gives out a loan). The main difference between the two forms of instruments is the time period of maturity of the two. While a CD is usually for a longer term, a promissory note is for a shorter period. The issuance of a CD, owing to this difference in maturity, entails higher responsibility on the issuer’s part than for a promissory note; t_he CD is insured by the Federal Deposit Insurance Corporation (FDIC) so that the depositor will be reimbursed in the incident that the bank fails to repay the deposit._

An advantage to the issuer of a commercial paper is that since the instrument has a very short maturity it does not require a registration with the Securities and Exchange Commission (SEC), which makes it much less complicated and a cheaper form of obtaining finance

Question 17

Effective Interest Rate

Answer 17

EIR = net interest expense / usable funds

Above the fundamental formula: net interest expense is always calculated on top of the loan amount, and loan amount has to be calculated accordingly

Usable funds can be impacted by the need of compensating balance

Stated rate / (1 - stated rate)

Question 18

Beta and Covariance

Answer 18

The covariance between a security’s return and the return to the market is called the security’s beta.

FORMULA

Correlation coefficient * SD1 * SD2

The risk of a portfolio of stocks will be lower than the average risk of the individual stocks held in the portfolio

C. when the correlation of the individual stocks with one another is less than +1.0.

Question 19

Capital budgeting: What not to include as cash expense?

Answer 19

> Depreciation directly is not included, only depreciation shield and only if the analysis is post-tax.

> Interest expense is not included because is a different process (linked to financing of capital investment) and therefore is different from the budgeting cash flow. Interest cost is also incorporated when the cash flows are discounted to their present value.

Question 20

Differentiate between market risk premium, market return, required risk premium for the security

Answer 20

> Market risk premium: Rm - Rf

> Market return: Rm

> Required risk premium for the security: Ra - Rf = B (Rm - Rf)

Question 21

Price Gouging/ Price Skimming

Answer 21

Price gouging and skimming are both increase in prices, but the first one usually is used after a shock in supply to take advantage and the second one is more linked to higher initial price to recoup RD / advertising high initial costs and is then reduced

Question 22

Greenmail

(aims at outside attack)

vs

Poison Pills

(inside weakening)

Answer 22

Greenmail entails purchasing back a large amount of common stock at a premium from a hostile raider while Poison Pills are provisions in a company’s corporate charger, bylawys or contracts that serve to reduce the value of the firm as a potential takeover target.

Question 23

DOL and DFL: Leverage measures

(one vs multiperiod)

Answer 23

• DOL – Degree of Operating Leverage (REVIEW HARDER)
  
  • Contribution margin / EBIT (=operating income). Reading better: EBIT = CM - FC
  • Multiperiod version of DOL:
    
    • % Delta of EBIT / % Delta in Sales
      
      • Every 1% change in sales generates x% change in EBIT.
      • A firm with high operating leverage necessarily carries a greater degree of risk because fixed costs must be covered regardless of the level of sales. However, such a firm is also able to expand production rapidly in times of higher product demand.
• DFL - Degree of financial leverage
  
  • EBIT/ EBT – more interest the higher the ratio.
  • Multiperiod version of DFL:
    
    • % Delta Net Income / % in EBIT –
      
      • 1% change in EBIT generates x% in NI.
      • A firm with higher financial leverage has a higher risk because debt hast o serviced regardless of the level of earnings.

Question 24

Type of risks: Operational, Financial, Strategic, Hazard

Answer 24

Operational: risk of loss from inadequate or failed internal processes, people and systems

Financial risk (linked only to companies with debt): interest rate, exchange, liquidity and market risk

Strategic risk: global eocnomic risk, political risk, market conditions, brand and changing customer preferences

Hazard risk: risks of natural disaster, impairment of physical assets, death of senior officers

Business risk: risk that a company has lower profits than expected.

Question 25

Relevant Cost

Answer 25

Costs incurred within the relevant range of production may or may not be relevant in a decision-making process. Relevant costs are expected future costs that differ among alternatives. Thus some costs that are incurred within the relevant range of production may be relevant to a decision if they would be different depending on what decision was made. On the other hand, other costs that are incurred within the relevant range of production would not be relevant, if they would be the same no matter which decision was made.

Question 26

Whistlebowing

(allows for…)

Answer 26

Which of the following statements describe the importance of a Whistleblowing Hotline in maintaining an ethical organizational culture?

I.It provides measurable feedback for determining whether employees are following a code of ethics.

II.It creates opportunities to enhance and improve internal controls.

Question 27

4 levels of business’s social responsibility

Answer 27

1. Economic (basic/primary)
2. Legal
3. Ethical
4. Philantropic

Question 28

FCPA

(Scope

Provisions

Faciliation payments)

Answer 28

Accounting provisions:

Scope

Covers all the securities listed in the US (registered with SEC) according to Exchange act of 1934.

Application
> Books and records.

Note: external auditor must still attest to the accuracy of financial statements.

> System of internal control

Anti bribery provisions

> Scope

1. Domestic concern - citizen, natural or resident of the US (whether or not doing business overseas).
2. Issuers (US and Foreign) that have a class of securities traded at US stock exchange or required to file reports to SEC according to Exchange act of 1934.
3. Any person including foreign nationals and foreign non-issuing companies while acting corruptly while in the US.

Application

> None of the subjects may offer or authorize corrupt payments to any foreign official, foreign political party or candidate for political office in a foreign country.

Facilitation payments

> FCPA contains a provision that ALLOWS for facilitation payments. When person is paid to receive a product, service or license that the person was entitled but did not receive without the extra payment. Payments to expedite routine governmental action.

Question 29

SOX (2002)

Scope and Guidance

Answer 29

> SOX applies to all publicly traded companies in the United States

> Requires a code of ethics for senior financial officers (not to all employees) to principal financial officer and comptroller including full, fair, accurate and understandable disclosure in the period reports required to be filled.

Question 30

UKBA ( Scope and Applicaiton)

Answer 30

Scope:

> UK companies doing business overseas

> Foreign companies with operations in the UK. Agent or representative office in the UK is enough to be in the scope.

Application

• Paying bribes (ACTIVE) - NOT ONLY TO FOREIGN OFFICIALS LIKE FCPA
• Receiving bribes (PASSIVE)
• Failing to prevent
• Bribery of foreign nationals
• Conclusion, much more strict and broadly applied then FCPA since it covers passive bribery, commercial bribery and failure to prevent.

Question 31

Rule of Thumb for Ratios

Answer 31

>> RULE OF THUMB FOR RATIOS

If N>D, then decrease in numerator and denominator on the same amount increases ratio. Denominator is stronger.

Question 32

Special Order Decisions: Opportunity cost of change

Answer 32

Below is a review of your answers, with the incorrectly answered questions first, followed by the correctly answered questions:

3. Question ID: ICMA 10.P2.235 (Topic: Special Order Decisions)

Johnson Company manufactures a variety of shoes and has received a special one-time-only order directly from a wholesaler. Johnson has sufficient idle capacity to accept the special order to manufacture 15,000 pairs of sneakers at a price of $7.50 per pair. Johnson’s normal selling price is $11.50 per pair of sneakers. Variable manufacturing costs are $5.00 per pair and fixed manufacturing costs are $3.00 a pair. Johnson’s variable selling expense (not including shipping-out expense) to obtain an order for its normal line of sneakers is $1.00 per pair. What would the effect on Johnson’s operating income be if the company accepted the special order?

A. Decrease by $60,000.wrong

B. Increase by $52,500.

C. Increase by $22,500.

D. Increase by $37,500.correct

Your Incorrect Answer Explanation for A:

This is the difference between Johnson’s normal selling price of $11.50 per pair and the special order price of $7.50 per pair, multiplied by 15,000 pairs. This answer assumes the company will have a loss equal to the amount of the discount on each pair of sneakers because it could have sold them for $11.50 instead of $7.50. That is not the case, because the company’s facilities would be idle if it does not accept this order. In other words, it cannot sell these sneakers for $11.50. Thus there is no opportunity cost in accepting this order.

Furthermore, the company’s normal fixed costs and normal variable selling costs do not apply to this order.

(1) Fixed manufacturing costs are irrelevant, because they will be the same whether the order is accepted or not accepted.
(2) The variable selling expense for this special order would not be the same as the selling expense for the company’s normal line of sneakers. The question states that the $1.00 variable selling expense does not include shipping-out expense. Other typical variable selling expenses are sales representative’s commissions, advertising, etc. But in this question it is stated that the order was received directly from the wholesaler, so those other selling expenses for the company’s normal line of sneakers would not apply.

Correct Answer Explanation for D:

The incremental contribution margin per pair of sneakers is $7.50 selling price minus $5.00 variable manufacturing cost, or $2.50. Fixed manufacturing costs are irrelevant, because they will be the same whether the order is accepted or not accepted. The variable selling expense for this special order would not be the same as the variable selling expense for the company’s normal line of sneakers. The question states that the $1.00 variable selling expense does not include shipping-out expense. Other typical variable selling expenses are sales representative’s commissions, advertising, etc. But in this question it is stated that the order was received directly from the wholesaler, so those other selling expenses for the company’s normal line of sneakers would not apply.

Therefore, the effect on operating income if the company accepts the special order will be $2.50 × 15,000 pairs, or $37,500.

Show Other Explanations

5. Question ID: ICMA 19.P1.041 (Topic: Disinvestment Decisions)

Superior Tables is a table manufacturer. The company is considering eliminating the Easy Living product line because of losses over the past year. Results for the year just ended for the Easy Living product line are as follows.

Sales (20,000 units)$ 6,000,000

Variable manufacturing costs2,700,000

Fixed manufacturing costs2,400,000

Administrative costs2,000,000

Operating loss($1,100,000)

None of the fixed manufacturing costs can be eliminated, but 25% of the administrative costs are variable and can be eliminated if the product line is eliminated. Based on the information above, should the Easy Living product line be eliminated?

A. Yes, because eliminating the product line would increase the operating income by
$1,500,000 from the saved administrative costs.

B. Yes, because eliminating the product line would increase the operating income by
$1,100,000.

C. No, because eliminating the product line would only save $500,000 of administrative costs still resulting in an overall loss.wrong

D. No, because eliminating the product line would increase the operating loss by ($2,800,000).correct

Your Incorrect Answer Explanation for C:

While Superior Tables should not eliminate the product line, this is not the reason that they should make that decision.

Correct Answer Explanation for D:

If Superior Tables were to illuminate the Easy Living product line, they would lose all of the revenue from that product line. This is $6,000,000. They would also avoid $2,700,000 of variable costs. Additionally, they would avoid $500,000 of administrative costs.

Adding all of these together, superior tables would have a $2,800,000 lower operating income if the eliminated the Easy Living product line.

Show Other Explanations

7. Question ID: CMA 1273 4.4 (Topic: CVP Analysis)

Which of the following would decrease unit contribution margin the most?

A. A 15% decrease in variable expenses.

B. A 15% decrease in selling price.correct

C. A 15% increase in variable expenses.wrong

D. A 15% decrease in fixed expenses.

Your Incorrect Answer Explanation for C:

Assuming the selling price is greater than variable costs, a 15% increase in variable costs would not have as great an impact on the contribution margin as a 15% decrease in selling price.

Correct Answer Explanation for B:

Assuming that the selling price is greater than variable costs, a 15% decrease in selling price would have the greatest impact on the unit contribution margin.

Show Other Explanations

Explanation for A:

Decreasing variable expenses will increase the contribution margin.

Explanation for D:

Changing fixed expenses will have no effect on the contribution margin.

8. Question ID: ICMA 10.P2.277 (Topic: Pricing Strategy)

Which one of the following is not a characteristic of market-based pricing?

A. It is used by companies facing stiff competition.

B. It starts with a target selling price and target profit.wrong

C. It has a customer-driven external focus.

D. It is used by companies facing minimal competition.correct

Your Incorrect Answer Explanation for B:

When market-based pricing is used, the company establishes a target price, which is a price based on knowledge of customer perception of the value of the product or service and what customers are willing to pay, as well as knowledge of competitors’ responses. The target price then determines what the target cost per unit needs to be in order to earn the target operating income per unit. The target cost per unit must then be the target price minus the target operating income per unit, and the company has to figure out how to provide the product or service at that cost. So this is a true statement.

Correct Answer Explanation for D:

This is not a true statement. Companies operating in competitive markets, such as oil and gas, use market-based pricing in order to be competitive. Companies facing minimal competition do not need to use market-based pricing. In fact, there would probably not be any market prices in a market with little competition.

Show Other Explanations

11. Question ID: CMA 692 4.25 (Topic: Make or Buy Decisions)

Laurel Corporation has its own cafeteria with the following annual costs:

Food$100,000

Labor75,000

Overhead 110,000

Total$285,000

The overhead is 40% fixed. Of the fixed overhead, $25,000 is the salary of the cafeteria supervisor. The remainder of the fixed overhead has been allocated from total company overhead. Assuming the cafeteria supervisor will remain and the Laurel will continue to pay his/her salary, the maximum cost Laurel will be willing to pay an outside firm to service the cafeteria is

A. $241,000.correct

B. $285,000.

C. $175,000.wrong

D. $219,000.

Your Incorrect Answer Explanation for C:

This is incorrect since the $175,000 includes only food and labor. It does not include the avoidable portion of overhead costs.

Correct Answer Explanation for A:

In order to find the most Laurel would be willing to pay an outside company, we need to look at avoidable variable costs only, since all of the fixed costs are unavoidable. Total avoidable cost is $241,000 ($100,000 food + $75,000 labor + 66,000 of avoidable variable overhead).

Show Other Explanations

14. Question ID: CMA 687 4.13 (Topic: Profit Point Analysis)

Donnelly Corporation manufactures and sells T-shirts imprinted with college names and slogans. Last year, the shirts sold for $7.50 each, and the variable cost to manufacture them was $2.25 per unit. The company needed to sell 20,000 shirts to break even. The net income last year was $5,040. Donnelly’s expectations for the coming year include the following:

The sales price of the T-shirts will be $9

Variable cost to manufacture will increase by one-third

Fixed costs will increase by 10%

The income tax rate of 40% will be unchanged

If Donnelly Corporation wishes to earn $22,500 in net income for the coming year, the company’s sales volume in dollars must be

A. $213,750

B. $257,625

C. $229,500correct

D. Some amount other than those given.wrong

Your Incorrect Answer Explanation for D:

The correct answer is given.

Correct Answer Explanation for C:

This question is asking for the sales revenue given a requirement for an after-tax net income of $22,500. To solve it, we need to use the version of the breakeven formula for determining the sales revenue required to result in a specific dollar amount of profit.

Target Sales Revenue = (FC + Target Pretax Income) / Contribution Margin Ratio

In order to use this formula, we need to calculate three things: (1) the amount of fixed cost in the coming year, (2) the amount of desired net income before tax for the coming year, and (3) the contribution margin ratio for the coming year.

(1) We are told that fixed cost for the coming year will be 10% higher than the previous year’s fixed cost. So we need to find what the fixed cost was for last year. We know the break-even point in units for last year (20,000) and we know the unit contribution margin for last year ($7.50 − $2.25 = $5.25). So we can find the fixed cost for last year by using the Break-Even Point in Units formula and solving for FC: FC / Unit Contribution Margin = BEP in Units.

FC / 5.25 = 20,000
Solving for FC, we get FC = $105,000

Since fixed cost for the coming year will be 10% higher than last year, fixed cost for the coming year will be $105,000 × 1.10, which is $115,500.

(2) The formula to find before-tax net income when we know the after-tax net income is After-Tax NI / (1 − tax rate). Therefore, the desired before tax net income is $22,500 / (1 − 0.40), which is $37,500.
(3) We are told that variable cost to manufacture will increase by one-third. Variable cost last year was $2.25 per unit. Therefore, variable cost in the coming year will increase by 1/3 of $2.25, which is $0.75, so variable cost will be $3 per unit. We are told that the sales price will be $9. Therefore, the Contribution Margin Ratio will be $6 / $9, which is 2/3 or 0.666667.

Now, we can calculate the Target Sales Revenue, because we have the fixed cost, the target pretax income, and the contribution margin ratio for the coming year.

Target Sales Revenue = ($115,500 + $37,500) / 0.666667 = $229,500.

Show Other Explanations

16. Question ID: CMA 691 4.11 (Topic: CVP Analysis)

If inventories are expected to change, the type of costing that provides the best information for breakeven analysis is

A. joint costing.

B. job order costing.wrong

C. absorption (full) costing.

D. variable (direct) costing.correct

Your Incorrect Answer Explanation for B:

To use breakeven analysis, variable costs need to be segregated from fixed costs. Variable costs are not segregated from fixed costs in job order costing.

Correct Answer Explanation for D:

Variable costing provides the best information for breakeven analysis whether inventories are expected to change or not, because variable costs are segregated from fixed costs. To use the formula for the breakeven point in CVP analysis, fixed costs need to be separated from variable costs.

Show Other Explanations

17. Question ID: ICMA 13.P2.048 (Topic: Other Decisions using CVP)

Leslie Corporation manufactures classroom desk chairs and tables. In the present market, the company can sell as many units of product as it can manufacture, but it is constrained by its availability of machine-hour capacity. Sales price and cost information for each unit of product are shown below.

Desk
ChairsTables

Sales price$75 $180

Variable costs 60 155

Contribution margin$15 $ 25

Producing a desk chair requires 1½ machine hours; producing a table requires 2½ machine hours. Which product, if any, is most profitable given the machine-hour constraints?

A. Desk chairs.wrong

B. Tables.

C. Both products are equally profitable.correct

D. There is not enough data to identify the most profitable product.

Your Incorrect Answer Explanation for A:

The product with the higher contribution margin per unit of the constrained resource is the most profitable. The contribution margin per machine hour for desks is not higher than it is for tables.

Correct Answer Explanation for C:

The product with the higher contribution margin per unit of the constrained resource is the most profitable. The contribution margin per unit for desk chairs is $15 and desk chairs require 1.5 machine hours each, so the contribution margin per machine hour for desk chairs is $15 ÷ 1.5, or $10. The contribution margin per unit for tables is $25 and tables require 2.5 machine hours each, so the contribution margin per machine hour for tables is $25 ÷ 2.5, or $10. Therefore, desk chairs and tables are equally profitable, given the machine-hour constraint.

Show Other Explanations

20. Question ID: IIA 18.3.003 (Topic: Product Life Cycle Pricing)

Which of the following is not characteristic of a mature industry environment?

A. Competitive interdependence.wrong

B. Falling demand.correct

C. Consolidation.

D. Strategic focus on deterring entry of new competitors into the marketplace.

Your Incorrect Answer Explanation for A:

Competitive interdependence is characteristic of a mature industry environment.

Correct Answer Explanation for B:

Falling demand is characteristic of a declining industry, not a mature industry.

Show Other Explanations

Explanation for C:

Consolidation is characteristic of a mature industry environment.

Explanation for D:

Strategic focus on deterring entry of new competitors into the marketplace is characteristic of a mature industry environment.

22. Question ID: CIA 1186 IV.10 (Topic: Profit Point Analysis)

A company has just completed the final development of its only product, general recombinant bacteria, which can be programmed to kill most insects before dying themselves. The product has taken 3 years and $6,000,000 to develop. The following costs are expected to be incurred on a monthly basis for the normal production level of 1,000,000 pounds of the new product:

Direct materials$ 300,000

Direct labor1,250,000

Variable factory overhead450,000

Fixed factory overhead2,000,000

Variable selling, general, and adm. expenses900,000

Fixed selling, general, and adm. expenses1,500,000

Total:$6,400,000

At a sales price of $5.90 per pound, the sales in pounds necessary to ensure a $3,000,000 profit the first year would be (to the nearest thousand pounds):

A. 15,000,000 pounds.correct

B. 13,017,000 pounds.

C. 14,000,000 pounds.wrong

D. 25,600,000 pounds.

Your Incorrect Answer Explanation for C:

This is the breakeven volume, not the volume required to earn a $3,000,000 profit. The required profit should be included as another fixed cost in the calculation.

Correct Answer Explanation for A:

The cost information given is for one month’s production. The unit contribution margin is $3 per pound, calculated as follows:

Selling price per pound$5.90

Less: Variable costs per lb, based on 1,000,000 lbs:

Direct materials: $300,000 ÷ 1,000,000 lbs0.30

Direct labor: $1,250,000 ÷ 1,000,000 lbs1.25

Variable factory overhead: $450,000 ÷ 1,000,000 lbs0.45

Variable selling, general, and adm. expense: $900,000 ÷ 1,000,000 lbs 0.90

Contribution margin per pound$3.00

Fixed factory overhead for one month is $2,000,000, and fixed selling, general and administrative expense for one month is $1,500,000.

Since the company’s income tax rate is not given, we can assume the question is asking for before-tax profit.

The required profit given is for a year, whereas the costs given are for one month. Therefore, we must adjust either the fixed costs or the required profit amount so they are both for the same duration. Since the question asks for an annual sales volume, we will adjust the costs by multiplying them by 12. Fixed factory overhead for one year is $24,000,000 and fixed selling, general and administrative expense is $18,000,000.

The formula to find the required number of units to sell to earn a specific profit is:

(Fixed Costs + Required Profit) / Contribution Margin Per Unit

($24,000,000 + $18,000,000 + $3,000,000) / $3 = 15,000,000 pounds

Show Other Explanations

25. Question ID: ICMA 10.P2.241 (Topic: Special Order Decisions)

Gardener Company currently is using its full capacity of 25,000 machine hours to manufacture product XR-2000. LJB Corporation placed an order with Gardener for the manufacture of 1,000 units of KT-6500. LJB would normally manufacture this component. However, due to a fire at its plant, LJB needs to purchase these units to continue manufacturing other products. This is a one time special order. The following reflects unit cost data, and selling prices.

KT-6500XR-2000

Material $ 27 $ 24

Direct labor 12 10

Variable overhead 6 5

Fixed overhead 48 40

Variable selling & administrative 5 4

Fixed selling & administrative 12 10

Normal selling price $125 $105

Machine hours required 3 4

What is the minimum unit price that Gardener should charge LJB to manufacture 1,000 units of KT-6500?

A. $96.50.correct

B. $93.00.wrong

C. $125.00.

D. $110.00.

Your Incorrect Answer Explanation for B:

This is the material, direct labor, variable overhead and fixed overhead cost of one unit of KT-6500 (27 + 12 + 6 + 48). The fixed overhead cost should not be included, while variable selling and administrative costs plus an opportunity cost for the units of XR-2000 that cannot be manufactured need to be included.

Correct Answer Explanation for A:

Because Gardner is at full capacity manufacturing only XR-2000, they would need to pull machine hours away from XR-2000 to produce KT-6500. Therefore, the minimum price they should charge would be equal to the variable cost of KT-6500 plus the contribution margin lost on the sacrificed units of XR-2000.

The variable costs for KT-6500 are $50 ($27 material + $12 direct labor + $6 variable overhead + $5 variable selling & administrative). The total variable cost for 1,000 units would be $50,000.

The contribution margin on the sacrificed units of XR-2000 is an opportunity cost that needs to be included. Each unit of KT-6500 requires 3 hours of machine time, so for 1,000 units, Gardner would have to pull 3,000 hours away from producing XR-2000. 3,000 hours divided by the 4 hours used to produce 1 unit of XR-2000 means Gardner would be giving up 750 units of XR-2000. Contribution margin is calculated as sales minus variable costs. For XR-2000, the selling price is $105 and variable costs are $43 ($24 material + $10 direct labor + $5 variable overhead + $4 variable selling & administrative), which is a $62 contribution margin per unit. 750 units at a contribution margin of $62 per unit is $46,500 that would be given up in order to produce the KT-6500 for this order.

$50,000 of total variable cost for 1,000 units of KT-6500 + $46,500 of lost contribution margin for XR-2000 equals $96,500 total cost, or $96.50 per unit. Therefore, $96.50 per unit is the minimum price that Gardener should charge.

Question 33

Market based-pricing

and

Cost Pricing

Answer 33

Market Based Pricing

When market-based pricing is used, the company establishes a target price, which is a price based on

1) knowledge of customer perception of the value of the product
2) knowledge of competitor responses

Cost-based Pricing

Starts with cost determination followed by setting a price that will recover the value chain costs and provide a desired return on investment (cost plus target rate of return).

When there is significant product differentiation, like auto industry, both cost based and market based pricing approaches are combined

A SITUATION INVOLVING A JOB COSTING SYSTEM (MADE TO ORDER PRODUCT OPPOSES STANDARD PRODUCT) WOULD BE MOST CONDUCTIVE TO THE USE OF A COST BASED PRICING APPROACH.

Question 34

Constraint and CM

Answer 34

When there is a constraint ( labor hours, machine hours, beds occupied, computer time used) the manager should direct limited resources towards those products or services that produces the MOST CONTRIBUTION MARGIN PER UNIT OF CONSTRAINT

DO NOT USE CONTRIBUTION MARGIN RATIO.

Question 35

Value of Stock Right when trading ex-rights vs when trading on-rights

Answer 35

Ex rights price: (Value of stock ex-rights - subscription rights) / (number of rights needed)

On rights: (value of stock with rights - subcription price) / (number of rights + 1)

number of rights needed: existing shares / new shares issued.

Market price - onrighs price = exrights price

Question 36

Teleology, Utilitarianism, Relativism and Deontology

Answer 36

Deontology: focuses on the motivation of the decision maker, not on the consequences of the decision

Utilitarianism: focuses on the consequences that will bring the greatest food for the greatest number of people

Teleology: morally right if the consequences produces desired results

Relativism: what is right or wrong depends on the consensus of the group

Question 37

Make or Buy Decisions

(Important factors)

Answer 37

Compare variable cost per unit to manufacture vs variable cost per unit to purchase.

Then check if there are any opportunity costs or differencialr relevant fixed costs.

Usually cost for purchase is higher than the cost of making.

Question 38

Earnings Quality

vs

Earnings Power

Answer 38

• Earnings quality (affected by consistency and used of certain accounting principles) 1) the company’s business environment, (2) its selection and application of accounting principles, and (3) the character of its management. More conservative, better earnings quality.
• Earnings power is the capacity of a firm’s operation to produce cash inflows, and definitely helps to fund payment of fixed changes, long term debt and future dividends.

Question 39

Maturity Matching Considerations

Answer 39

The maturity matching approach to financing current assets (also called the hedging or the self-liquidating approach) matches assets to be financed with financing having the same maturity.

1. Worst case scenario is to finance long term assets with current debt due to renewal implications linked to interest forward curve and not having current assets available for so.
2. Second worst case is to finance short term assets with long term debt because probably you will still with iddle unplanned amount on your account.

Question 40

Income Available to Common Sharehoders

Answer 40

+ Net Income

(MINUS)

preferred dividends declared for non-cumulative preferred stock (or cumulative preferred dividends earned). Remember that dividends are paid at par value.

Question 41

Stock Dividends and Stock Splits

Answer 41

IMPORTANT THAT IS WEIGHTED SHARES OF STOCKS, AND HAVE TO BE WEIGHTED BY THE TIME OF ISSUANCE/AVAILABILITY. BE AWARE THAT STOCK DIVIDEND AND STOCK SPLITS ARE ASSUMED TO BE OUTSTANDING AS OF THE BEGINNING OF THE EARLIEST ACCOUNT PERIOD (so it impacts back in the beginning)

Question 42

Tricks

(months to years conversion)

(risk premiums (required vs market), market risk)

( The problem says that sale of the special order items will not require any additional selling effort)

(problem specifically talks about end of year inventory requiring EOI calculation and use as denominator for inventory turnover)

year end dividends do not need to be adjusted for next year growth

cost to remove equipment is an operational expense that has to be adjusted after tax (1-t) )

Question 43

Book Value of Common Stock

Answer 43

Book value of common equity that includes:

1. Common stock
2. Retained earnings
3. Paid in capital

Question 44

Common Size vs Common Base

Answer 44

Common size (vertical) = linked to same years revenue

Common base (horizontal) = linked to base year revenue

Question 45

Venture Capitals

Answer 45

A. Initial private placement for the majority of issues.

B. The use of common stock for most placements.wrong

C. A lack of liquidity for a period of time (just after investment is made)

Question 46

Bill of Lading

vs

Package Slip

Answer 46

Bill of lading = used to transfer responsibility for goods between the seller of goods and a common carrier.

Packing slip: is sent with the goods giving a listing of the qts of items in the shipment.

Question 47

Spin off vs Equity Carve Out

Answer 47

Spin off: does not raise capital for the original company, only the spun off part. while Equity Carve out does.

Question 48

CAPM and Tbill

Answer 48

The t-bill is the best estimate for CAPM because is the closest to a risk-free rate

Question 49

Financial Leverage Ratio,

Times Interest Earned,

ROA and ROE

Answer 49

> Total assets / total equity

> EBIT / Interest Expense

> ROA = ROE * (1 - D/E)

Question 50

Heding implies on what type of risk response?

(Reducing

Exploiting

Avoiding

Transferring or Sharing)

Answer 50

Transferring or sharing (transferring is done with HEDGING).

Question 51

Purchasing Receivables

and Discount

Answer 51

When receivables are purchased, the interest paid is calculated multiplying the discount rate times the sales and not times the receivable. The receivable is used only used on the denominator.

Question 52

Contract Liability is the same as…

Answer 52

Deferred or unearned revenue

Question 53

P/E also known as…

Answer 53

Earnings Multiple, to increase it we have to reduce earnings/ reduce risk

Question 54

Silo Approach

Answer 54

Contrast to the portfolio view of risk, since it evaluates risks as individual, standalone evnts

Question 55

Sustainability Goal

Answer 55

Sustainability is providing for the needs of the present generation while preserving the environment so that future generations will also be able to meet their needs.

Question 56

Norms for Current and Acid Ratio

Answer 56

Current Ratio : 2 - 1

Quick Ratio : 1 - 1

Close to norm is good

Question 57

Imputed Cost

Answer 57

An imputed cost is a cost that has to be inferred because it does not represent an actual payment made or expense booked.

Type of OPPORTUNITY COST, NOT VISIBLE.

Question 58

Debt consideration for D/E and WACC

Answer 58

When calculating debt to equity or other solvency ratios, always use total liabilities (excluding equity) - current an non-current liabilities

When calculating WACC use only relevant long term debt, because is based on funds available for growth of which current liabilities are not strategic for that purpose

Question 59

Bailout Payback Method

Answer 59

Incorporates the salvage value at various points of the calculation since it might make sense to sell it instead of keeping the project. Therefore it measures the risk if the project is terminated.

Question 60

DEPS and Convertible bonds

Answer 60

In order to calculate DEPS, we need to assume that the bonds had been converted at the beginning of the year and calculate what the EPS Effect would have been if this had happened. ALSO TAKE INTO ACCOUNT THE REDUCE ON INTEREST PAYMENTS ADJUSTED FOR TAX,.

Question 61

VaR

Answer 61

Value at Risk (VaR) measures the potential (OR MAXIMUM) loss in value of a risky asset or event over a defined period for a given confidence interval. It is based on the assumption that the possible outcome of the event is represented by a normal distribution (bell curve). With a normal distribution, we know that 95% of the results will lie within 1.96 standard deviations of the mean, and that 99% of the results will lie within 2.57 standard deviations of the mean. Using this information, we can predict what the range of results will be with a measured level of confidence.