Learning Points from Practice Exam 1

Question 1

The Carters signed an agreement with an effective Annual Interest Rate of 7.74%. Semi-annual interest payments. What was the stated rate?

Answer 1

Effective annual interest rate = (1 - (stated rate / 2))^2

Question 2

What’s the difference between a forward contract and a futures contract

Answer 2

Forward contract (to sell a foreign currency at a spoecific price for example) tends to be used for larger groups of transactions (large volume of accounts receivable)

Futures contracts are designed for specific transactions rather than large groups of transactions. Futures contract to sell would be appropriate to mitigate the exchange risk associated with a single receivable.

Question 3

A corporation invested 600,000 in a capital project, with 40,000 in installation charges. The project had 12 year useful life, no salvage value, cash flows generated were 150,00 per year. Tax rate is 30%, depreciation is straight line. What are the after tax cash flows per year?

Answer 3

After tax cash flows per year = pre-tax cash flows (net of tax obligations) + tax protection through depreciation

= 150,000 * (1-.3) + (600,000/12 * .3)
=120,000

Question 4

Company wants to buy a 250K piece of equipment. Will cost 20K to install, with a 9 year useful life, and generate 90K per year (pre-tax) cash flows. Assuming a 30% tax rate, what is the payback period?

Answer 4

90,000 * (1-.3) = 63,000 after-tax cash flows
270,000 / 9 * .3 = 9,000 depreciation tax shield per year
=72,000 after tax cash flows per year.
=3.75 years to payback.

Question 5

A company has identified critical success factors and strategic goals that specifically relate to each dimension of its operations. The company has also determined measures that quantify the achievement of the strategic goals. What is this form of regular reporting and evaluation of performance referred to as?

Answer 5

Balanced Scorecard. Balanced scorecards normally classify activities of an organization into major headings and identifies the critical success factors and related strategic goals whose achievement will ensure meeting the requirements of those factors.

The dimensions of the BS are usually: human capital, customer service, internal business processes, and finance.

The answer is not Benchmarking. Benchmarking relates to the determination of standards by looking at an industry practice.

Question 6

How does the high-low method work to give us an estimate of the fixed and variable cost of supplies? Given the following information:
Month: Units produced: Cost:
Jan 167,000 320,000
Feb 182,000 340,000
March 114,000 267,000
April 196,000 368,000

Answer 6

High-low:

April, March

(368,000 - 267,000) / (196,000 - 114,000) = slope of the change (variable costs per unit produced metric)
= 1.2317 VC / unit

FC = plug in VC, pick one of the months:
368,000 = 196,000 * 1.2317 + FC
FC = 126,587

Now you have the entire y=mx+b formula

Question 7

How do we calculate direct labor price variance?

Answer 7

(Actual price of labor - budgeted price of labor) * actual labor hours put in

Question 8

How do we calculate materials efficiency variance?

For example: radios budgeted at 3 materials per radio. 3,000 radios produced. 10,000 units actually consumed in manufacturing. Standard cost of $1.45 per unit

Answer 8

(Materials used in units - materials budgeted in units) * budgeted unit price.

For example. radios budgeted at 3,000 * 3 = 9,000 units needed
10,000 units actually consumed in manufacturing.
1,000 difference (unfavorable) * 1.45 = 1,450 unfavorable.

Question 9

Which of the following is most likely to lead to cost-push inflation?

• Sharp rise in consumer wealth
• Rise in consumer confidence
• Decline in real interest rates
• Sharp rise in nominal wages

Answer 9

Sharp rise in nominal wages.

Cost-push inflation is caused by a shift left in aggregate supply. Only a sharp rise in nominal wages would shift the aggregate supply left.

The other answers would all be examples of “demand-pull inflation”, not cost-push.

Question 10

In an effort to encourage the employment of summer teens, the federales lowered the minimum wage from $7 to $6 per hour. The equilibrium wage for teens is $8. What effect will this change have on teen employment?

Answer 10

No effect on teen employment. The minimum wage is set below the equilibrium wage, so the price floor (minimum wage) will not have any effect on the number of teens that get jobs.

Question 11

Explain whether each of these mergers is horizontal, vertical, circular, or diagonal:

• Financial services industry, scientific research industry
• Textile manufacturer, wholesaler of textiles for company X
• competitors in the same industry
• raw material supplier, producer who uses the raw materials

Answer 11

1) - circular combination. Appear to be in relatively unrelated industries
2) - diagonal combination. some aspects are vertical, but the wholesaler sells a lot more than just their textiles
3) - horizontal combination
4) - vertical merger. This is the definition of vertical

Question 12

Under Sarbox, corporate officers make a number of assertions regarding internal controls. Among those assertions they must make… which of the following describes when internal controls are evaluated :

• Throughout the audit process
• Within 90 days after year end
• Within 90 days prior to the report
• 180 days after PY balance sheet date

Answer 12

-(c) - within 90 days prior to the report. Under Sarbox, internal controls must be evaluated within 90 days prior to the issuer’s report.

Question 13

Which of these is “systematic” risk, which of these is “unsystematic” risk:

• Diversifiable risk
• Non-diversifiable risk
• Market risk
• Firm-specific risk

Answer 13

“Systematic”:

• Non-diversifiable risk.
• Market risk

“Unsystematic”:

• Diversifiable risk.
• Firm-specific, “non-market” risk.

Question 14

A firm with a higher degree of operating leverage than it’s industry competitors is said to have:

• firm is more profitable
• firm uses a significant amount of debt financing
• Firm has higher variable costs
• Firm’s profits are more sensitive to changes in sales volume

Answer 14

Operating leverage = the presence of fixed costs in operations… which allows for small changes in sales to be amplified in producing a larger relative change in profits. So…

The answer is: (d) - firm’s profits are more sensitive to changes in sales volume

Question 15

When using the EOQ formula to determine a company’s optimal inventory order amount, which of the following factors is not necessary to be known?

• Cost per purchase order
• Insurance costs
• Annual sales revenue
• Carrying cost per unit

Answer 15

-(c) - annual sales revenue

The formula for EOQ is:

Square root of: (2 * annual units sold * cost per order / carrying cost per unit)

Question 16

(Question 10, MC part 2) -
A bond with a face value of 10,000 is maturing in two years. It has an annual interest rate of 6 percent (coupon rate). Market interest rate at time of issuance is 5%. What is the bond’s price at the time of issuance?

Answer 16

Price = Net Value of the payments for the bond

Year 1 payment = 6% * 10,000 = 600. TVM this gives you 600 / (1+.05) = $571.
Year 2 payment = 6% * 10,000, + 10,000 principal repaid. = 10,600 total payment. TVM this gives you 10,600 / (1.05 * 1.05) = $9,614

Total sum of the TVM’ed payments = 571+9614 = 10,185

Question 17

Heartland Farms is using the internal rate of return method as part of its consideration of the purchase of a new piece of equipment. Heartland has a 7% hurdle rate, net capital investment of 250,000. After-tax cash flows are uneven, they will come at beginning of first year, end of second year (108,900), and end of third year (98,900). PV factors at 7% are given. What is the necessary after-tax cash flow in year 1 to achieve a 7% IRR?

Answer 17

Using the PV factors at 7% (discounting so that the NPV of your investnemtn = 250,000 at 7% time value of money)… calculate what’s missing from the omitted year-1 cash flow in order to get you to the 250,000.

Y2 cash flow = 108,900 * (.8734 factor) = 95,113
Y3 cash flow = 98,900 * (.8163 factor) = 80,732

Y1 cash flow therefore must have been 250,000 - 95,113 - 80,732 = 74,155

Question 18

Company uses a cost system to value its inventory.

• Pays workers $30/hr, overhead application $20/hr.
• Beginning DM inventory 5,000; WIP inventory 15,000.
• Company purchased 30,000 in DM in the month.
• Recorded 7,000 direct service hours in May.
• End DM inventory 7,000; WIP inventory 17,000

*What were the Company’s current manufacturing costs for the month?

Answer 18

*Current manufacturing costs are different from Cost of Goods Manufactured (which hits the finished goods portion only)

Current manufacturing costs encompasses all costs that go into work in process (cost of materials used, + direct labor, + overhead). Do not worry about changes in “work in process” when you’re asked to give current manufacturing costs.

When you’re asked for COGM, you must do the additional step of beginning and ending WIP to calculate the difference in COGM going out (and subsequently into finished goods)

Question 19

Company makes two goods, X and Y.

• Produced 300 units of X, 600 units of Y
• Selling price of X and Y are unknown at split-off. Joint costs at split-off are 18,000.
• Final selling price of X=50, Y = 25, further processing costs X=5000, Y=10000.

*What amount of Joint Costs should be allocated to X and Y when using the Net Realizable Value approach?

Answer 19

NRV X = 300 produced * $50 per = 15,000…
minus 5,000 additional to process = 10,000.

NRV Y = 600 produced * $25 per = 15,000…
minus 10,000 additional separable costs 5,000…

X NRV = 10,000 / 15,000 total… = 66%
Y NRV = 5,000 / 15,000 total… = 33%.

Allocate 66% * 18,000 costs = 12,000 to X.
Allocate 33% * 18,000 costs = 6,000 to Y.

Question 20

DIO is 35 days. DSO is 20 days. DPO is 30 days. What is the company’s cash conversion cycle?

Answer 20

DIO + DSO - DPO = cash conversion.

35 + 20 - 30 = 25.

Question 21

Company has sales of 1,500,000; asset turnover of 3; residual income of 10,000; hurdle rate of 8%. What is the ROI?

Answer 21

ROI = net income / investment (total assets)

Total assets = back calculate. Asset turnover = sales / average assets (investments). Assets will = 500,000 (1,500,000 / 3).

Net income = Hurdle income + Residual income
Hurdle income = Assets * hurdle rate = 500,000 * 8%
Residual income = 10,000
Net income = 40,000 + 10,000 = 50,000

Net income / investment = ROI
50,000 / 500,000 = 10%

Question 22

Company develops a product with $8 of variable costs (includes direct materials, labor, and “distribution”). 120,000 in fixed costs associated with this product.

Fixed charge of 20,000 will be allocated as well.

Selling price is $14 per unit. What’s the breakeven point in units?

Answer 22

CM = $14 - $8 (of VC per unit) = $6

Fixed costs to break: 120,000
(ignore the 20,000 that are also allocated. It will be incurred as a corporate cost in ANY EVENT)…

120,000 / 6 = 20,000. Easy.

Question 23

A company has excess manufacturing capacity.
They receive a special order request.  
It will incur the following costs:
Fixed costs: 21,000
Variable costs: 33,000

Fixed costs include: 3,700 of normal in-house design costs
Other costs include: 7,750 for external designers needed for this special project.

What is the total amount to be included for the minimum acceptable price for this job?

Answer 23

Only include the “incremental” costs associated with the order:

33,000 VC
7,750 external designers
= 40,750.

Do NOT include fixed costs that were already there, because (A) there is idle capacity and (B) this is a special order request in the idle capacity.

Question 24

Government is concerned with “full employment.” How would you best define the term “full employment?”

Answer 24

Level of employment when there is no cyclical unemployment

Question 25

What system represents an organizational commitment to “customer focused performance” that emphasizes both quality and continuous improvement?

Answer 25

Total Quality Management.

Both quality and continuous improvement. Customer-focused performance.

Question 26

Choose which of the systems (EIS, BIS, MIS, TPS) are described by each of the following situations:

• Processes and records the daily transactions necessary to conduct the business
• Provides management and other end users with reports
• Assists executives in making daily business decisions
• Helps executives monitor business conditions in general, and assists in strategic planning

Answer 26

• TPS (transaction processing system)
• MIS (management Information System)
• BIS (Business Information System)
• EIS (Executive Information System)*

*More high level than a business information system. It is one type of business information system, but not involved in daily business decisions.

Question 27

What are the differences between a hot site, a warm site, and a cold site?

Answer 27

All used in the event of disaster recovery for continuing operations in the event of destruction of not only program and data files, but also processing capability.

Hot site = complete equipped to take over data processing. Ready to go

Warm site = Already equipped with proper hardware, to replicate the primary data center.

Cold site = Equipped with all of the electrical connections and other physical requirements for data processing, but does not have the actual equipment.

Question 28

What control will we use? Duplicate purchase orders are created and entered into the system

Answer 28

Input control. Prenumbered forms should be implemented

Question 29

What control will we use? Vendor invoice is paid immediately after receipt:

Answer 29

Processing control. Controls should be implemented to perform a three-way match of information.

Question 30

What control will we use? Sales order database does not prevent the entry of wrong inventory numbers on sales orders

Answer 30

Input control. Validation controls need to be implemented.

Question 31

What control will we use? Creation of a fake employee by HR personnel:

Answer 31

Output control (can’t stop it at the beginning - have to check it after it’s been created). Reconciliation of database totals with data maintained outside the system (good for catching fraud).

Question 32

What control will we use? The purchase order is not required to have all fields completed prior to submission of PO:

Answer 32

Input control (not processing). As the data is being entered...
Edit checks should be implemented.

Question 33

What control will we use? Substitution of fake invoice by employee:

Answer 33

Processing control (as we’re processing the payment, we’re not gonna pay this). Hash and batch totals should be implemented.

Hash totals add up numbers that don’t need to be added up (digits in an invoice)
Fake invoices can be bucked.

Question 34

Which of the following costing methods will yield the lowest inventory value?

• absorption
• hybrid
• process
• variable

Answer 34

Variable costing will yield the lowest inventory value, because the rest of the methods will assign some portion of fixed costs to the inventory (with its variable costs). Variable costing will not assign any fixed costs to inventory

Question 35

What are Porter’s Five Forces?

Answer 35

• Threat of new competition
• Threat of substitutes (Goods or services)
• Bargaining power of customers
• Bargaining power of suppliers
• Intensity of competition