Information technology
1.
Business Information System (BIS) allow a business to perform the following functions on data:
a. Distribute, collect, report and transform.
b. Process, report, and store.
c. Initiate, process, distribute, transform, and store.
d. Collect, process, store, transform and distribute.
Explanation
Choice “d” is correct. Business information Systems allow a business to perform the following functions on data:
collect, process, store, transform, and distribute.
Choice ”b” is incorrect. Report is not a function performed on data and store is not the only functions performed
on data by a BIS.
Choice ”c” is incorrect. Report is not a function performed on data and process and store are not the only functions
performed on data by a BIS.
Choice ”d” is incorrect. Data initiation is not a function performed by BIS. Data processing 、distribution、
transformation, and storage are not the only functions performed on data by BIS.
2.
1
3.
Explanation
4.
Explanation
2
5.
Explanation
6.
Which of the following is usually a benefit of using electronic funds transfer for international cash
transactions?
a. Creation of multilingual disaster recovery plans.
b. Reduction in the frequently of data entry errors.
c. Off-site storage of foreign source documents.
d. Improvement in the audit trail for cash transactions.
Explanation
Choice “b” is correct. EFT( electronic funds transfers).either internationals or non-international, will normally result in
reduced data entry errors because the data transfers are system-to –system transfers with less data entry and thus
fewer ”human” errors.
Choice “a” is incorrect. The “creation of multilingual disaster recovery plans” is a pure distracter. Disaster recovery plans
do not have to be multilingual and, even if they are, that does nothing to affect international cash transactions one way
or the other.
Choice “c” is incorrect. Off-site storage of foreign source documents has nothing to do with electronic funds transfer
for international cash transactions. If it is good to store foreign source documents off-sit, it would also be good to store
non foreign, source documents off-site. Either way, where source documents are stored has nothing to do with
electronic funds transfer, either international or non-international.
Choice”d” is incorrect. There is not anything about electronic funds transfer, international or non-international, which
will necessary improve, or necessarily damage, the audit trail for cash transaction.
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7.
Explanation
8.
All following are examples of a decision support system (DSS) except for a:
a. Financial modeling application.
b. Transaction processing system.
c. Database query application.
d. Sensitivity analysis application.
Explanation
Choice “b” is incorrect. Decision support system (DSS) are computer-based information systems that provide interactive
support to managers or others during the decision-making process. Transaction processing systems process data
resulting from business transactions (monthly, historical in nature; not predictive).
Choice “a” is incorrect. A financial modeling application is DSS to assist management in evaluating financing alternatives.
Choice “c” is incorrect. Database query applications are a DSS that read and reorganize data to management’s
specifications but to do not allow alterations of the data.
Choice “d” is incorrect. Sensitivity analysis is a DSS that uses a “what if” technique that asks how a given outcome will
change if the original estimates of the model are changed.
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9.
Which of the following are components of a Business Information System (BIS)?
a. Hardware, software, and reports.
b. Hardware, software, network, people, and data.
c. Software, reports, data, and networks.
d. Queries, data, reports, and people.
Explanation
Choice ”b” is correct. One of the most basic and information technology components of any business is that of the
Software known specifically as the ‘’Business information System.’’ Hardware, software, network, people, and data are
components of BIS.
Choice ”a” is incorrect. Reports are not considered one of the components of BIS. The list in this proposed answer is
also incomplete making ’’b‘’ the best answer.
Choice ”c” is incorrect. Reports are not considered one of the components of BIS. The list in this proposed answer is
also incomplete making ’’b‘’ the best answer.
Choice ”d” is incorrect. Reports are queries are not considered one of the components of BIS. The list in this proposed
answer is also incomplete making ”b” the best.
10.
Explanation
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11.
The performance audit report of an information technology department indicated that the department
lacked a disaster recovery plan. Which of the following steps should management take first to correct this
condition?
a. Bulletproof the information security architecture.
b. Designate a hot site.
c. Designate a cold site.
d. Prepare a statement of responsibilities for tasks included in a disaster recovery plan.
Solution:
Choice "d" is correct. The first step in preparing a disaster recovery plan is to determine the
responsibilities of the various participants in the plan. Prior to that first step, a determination is made of
the kind and extent of recovery that is needed. Once that decision is made, the people responsible for
the recovery can be determined (and those people will normally prepare the plan itself). Like with any
other plan, an unclear designation of responsibilities will normally lead to a lousy plan, and a lousy plan
will lead to a lousy recovery. All plans need to be tested.
Choice "a" is incorrect. The information security architecture has nothing to do with a disaster recovery
plan. Bulletproofing the architecture might be something that is needed (although it is normally not the
"architecture" that is bulletproofed), but not as part of a disaster recovery plan.
Choice "b" is incorrect. A hot site may or may not be in the disaster recovery plan, depending on what
kind of recovery is needed. Recovery is much faster at a hot site than at a cold site, and "fast" recovery is
often needed. With a hot site, hardware is sitting "on the floor" waiting to be configured and used. Of
course, a hot site normally costs more than a cold site. Nothing is free.
Choice "c" is incorrect. A cold site may or may not be in the disaster recovery plan, depending on what
kind of recovery is needed. Recovery is much slower at a cold site than at a hot site because hardware
must be ordered, delivered, received, and configured.
12.
An information technology director collected the names and locations of key vendors, current hardware
configuration, names of team members, and an alternative processing location. What is the director most
likely preparing?
a. Data restoration plan.
b. Disaster recovery plan.
c. System security policy.
d. System hardware policy.
Solution:
Choice "b" is correct. More than likely, the director is preparing a disaster recovery plan.
Choice "a" is incorrect. The names and locations of key vendors, the current hardware configuration,
team members, and an alternate processing location all have nothing to do with a data restoration plan.
Data is restored after the alternative processing location is ready. All of the data being collected is
necessary to get the alternate processing location ready to go.
Choice "c" is incorrect. The names and locations of key vendors, the current hardware configuration,
team members, and an alternate processing location all have nothing to do with a system security policy.
This information is needed for a disaster recovery plan.
Choice "d" is incorrect. The names and locations of key vendors, the current hardware configuration,
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team members, and an alternate processing location all have nothing to do with system hardware policy.
System hardware policy would be a policy on what kind of hardware could and could not be used in an
organization. The more different kinds of hardware (and software) used in an organization, the harder it
is for application systems (and hardware) to "talk" to each other.
13.
Which of the following best defines electronic data interchange (EDI) transactions?
a. Electronic business information is exchanged between two or more businesses.
b. Customers' funds-related transactions are electronically transmitted and processed.
c. Entered sales data are electronically transmitted via a centralized network to a central processor.
d. Products sold on central web servers can be accessed by users any time.
Solution:
Choice "a" is correct. The best definition of EDI is electronic (computer-to-computer) exchange of
business transaction documents (business information). EDI is always between two separate businesses
(not internally).
Choice "b" is incorrect. It is difficult to determine exactly what the transmission of "customers' funds-related
transactions" means. Does it mean credit card purchases? Does it mean the transfer of funds
between the merchants and the banks to pay for those purchases? In either case, however, it is unlikely
to be EDI; although, this choice is probably the second best answer.
Choice "c" is incorrect. Transmitting entered sales data to a central processor would be internal data
communication. For internal data transfers, there is no reason to bother with all of the format translation
that is necessary with EDI transactions.
Choice "d" is incorrect. It is difficult to determine exactly what this choice means. Does it actually mean
products, or does it mean product information? What users, internal or external? But, regardless of what
the choice really means, access to products and product information is not EDI. EDI is electronic
(computer-to-computer) exchange of business transaction documents (business information) and is
always between two separate businesses (not internally).
14.
Which of the following is a primary function of a database management system?
a. Report customization.
b. Capability to create and modify the database.
c. Financial transactions input.
d. Database access authorizations.
Solution:
Choice "b" is correct. A primary function of a database management system is to provide the capability to
create and modify the database.
Choice "a" is incorrect. A function of a database management system could be report customization if the
database management system has an attached report writer. That function is not, however, primary.
Choice "c" is incorrect. A function of a database management system would seldom be financial
transaction (or any other type of transaction) input. Transaction input and processing would be provided
by an application system using the database management system to store the application data.
Choice "d" is incorrect. A function of many database management systems is to authorize database
access. Many database management systems have security systems built in. This answer is close, but
choice "b" is better.
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15.
To maintain effective segregation of duties within the information technology function, an application
programmer should have which of the following responsibilities?
a. Modify and adapt operating system software.
b. Correct detected data entry errors for the cash disbursement system.
c. Code approved changes to a payroll program.
d. Maintain custody of the billing program code and its documentation.
Solution:
Choice "c" is correct. An application programmer would have the responsibility to code approved
changes to a payroll program. A payroll program is an application program. Note that the changes have
been previously "approved."
Choice "a" is incorrect. An application programmer should never be assigned the responsibility to modify
or adapt operating system software. Few application programmers would have the knowledge and
experience to deal with operating system software anyway, but that would be way too much responsibility
in one person/position.
Choice "b" is incorrect. An application programmer should never be assigned the responsibility to correct
data entry errors for the cash disbursement (or any other) system. Application programmers should not
have access to data (other than for very controlled situations, such as data fixes).
Choice "d" is incorrect. An application programmer should not have custody of billing (or any other
application system) program code. Custody should be with a librarian (either a person or a system), and
application programmers should only have controlled access to the program code. Program
documentation should probably also be secured, but it is nowhere near as important.
16.
A fast-growing service company is developing its information technology internally. What is the first step in the
company's systems development life cycle?
a. Analysis.
b. Implementation.
c. Testing.
d. Design.
Solution:
Choice "a" is correct. This question requires (and can be answered with) some common sense, even if
you don't know what a system development life cycle is. It is more than reasonable to assume that
Analysis precedes everything else (although users sometimes feel, when they do not like the results of a
new system, that no analysis of any kind has been done). Analysis is determining what the new system
should do. It is sometimes called the gathering of system requirements.
Choice "b" is incorrect. Implementation should come at the end, assuming that implementation means
actually putting the new system into operation, which it normally does, and not programming. If
implementation in this question means programming (which it probably does), it would still come after
design and before testing. Either way, it should not be the first step.
Choice "c" is incorrect. Design should come after analysis. It is hard to design a system when you don't
know what the system is supposed to do.
Choice "d" is incorrect. Testing should occur after programming (or before implementation if that is what
implementation means in this question). Either way, it would not be the first step.
8
Economics
1.
2.
The demand curve for a product reflects which of the following?
a. The impact of prices on the amount of product offered.
b. The willingness of producers to offer a product at alternative prices.
c. The impact that price has on the amount of a product purchased.
d. The impact that price has on the purchase amount of two related products.
Explanation
Choice “c” is correct. The requirement is to identify what a demand curve for a product reflects. Answer (c) is correct
because a
demand curve reflects the impact that price has on the amount demanded.
Answers (a), (b), and (d) are incorrect because a demand curve reflects the impact that price has on the demand for
the product.
3.
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Explanation
4.
Explanation
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5.
Explanation
6.
The following information is available for economic activity for year 1:
In billions
Financial transactions
$60
Secondhand sales
50
Consumption by households
40
Investment by businesses
30
Government purchases of goods and services
20
Net exports
10
What amount is the gross domestic product for year 1?
a. $210 billion.
b. $160 billion.
c. $100 billion.
d. $90 billion.
Explanation
Choice “c” is correct. The requirement is to calculate the amount of gross domestic product (GDP). Answer (c) is
correct because
GDP is equal to $100 billion ($40 billion consumption by households + $30 billion investment by businesses + $20
billion government purchases + $10 billion net exports).
Answer (a) is incorrect because it erroneously includes investment transactions and secondhand sales. Answer (b) is
incorrect because it includes investment transactions. Answer (d) is incorrect because it excludes net exports.
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7.
Explanation
8.
Explanation
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9．
The full-employment gross domestic product is $1.3 trillion, and the actual gross domestic product is $1.2 trillion.
The marginal propensity to consume is 0.8. When inflation is ignored, what increase in government expenditures is
necessary to produce full employment?
a. $100 billion
b. $80 billion
c. $20 billion
d. $10 billion
Explanation
Choice “c” is correct. The requirement is to calculate the expenditures necessary to produce full employment.
Answer (c) is correct because the country needs an additional $100 million dollars in gross domestic product (GDP)
to produce full employment.
If the marginal propensity to consume (MPC) is 0.8, the marginal propensity to save (MPS) is 0.2 (1.0 – 0.8). Using the
multiplier we can solve for the needed additional spending as presented below:
× Increase in spending = Increase in GDP
× Increase in spending = $100 billion
Increase in spending = $20 billion
Answer (a), (b), and (d) are incorrect because they represent incorrect computations of the needed increase in
spending.
10.
During which of the following periods will prices generally increase the fastest?
a. Deflation.
b. Recession.
c. Inflation.
d. Hyperinflation.
Explanation
Choice “d” is correct. The requirement is to identify the period in which prices will increase the fastest. Answer (d) is
correct because prices will increase the most in a period of hyperinflation.
Answers (a) and (b) are incorrect because in these periods prices will decrease. Answer (c) is incorrect because prices
will increase but not as fast as during hyperinflation.
11.
Which of the following Federal Reserve policies would increase money supply?
a. Change the multiplier effect.
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b. Increase reserve requirements.
c. Reduce the discount rate.
d. Sell more U.S. Treasury bonds.
Solution:
Choice "c" is correct. If the Fed wanted to increase the money supply, it would reduce the discount rate.
A lower discount rate would reduce short-term interest rates, which would encourage more (short-term)
borrowing at the lower interest rate (lower cost means more demand). More borrowing means more
lending and more money in the economy.
Choice "a" is incorrect. The Fed really cannot change the multiplier "effect." It can change the multiplier
by changing the required reserve ratio (which it seldom does), but it cannot change the effect. The
multiplier effect is the effect on the money supply of the multiplier itself. It is due to banks having to keep
only a (small) portion of amounts deposited in reserve.
Choice "b" is incorrect. Increasing reserve requirements would mean less lending because banks would
have to hold a larger portion of amounts deposited in reserve. That would mean a reduced money
supply, not an increased money supply.
Choice "d" is incorrect. Selling more U.S. Treasury bonds would reduce, not increase, the money supply
since the bonds would have to be paid for with money out of the money supply. If the Fed were to buy
U.S. Treasury bonds, that would increase the money supply.
12.
What does the consumer price index measure?
a. Cost of capital.
b. Average household income.
c. Rate of inflation.
d. Prime rate of interest.
Solution:
Choice "c" is correct. The consumer price index is a measure of the inflation rate (the percentage change
of the consumer price index from one period to the next). It is only one measure of inflation; there are
others, such as the producers price index, but the consumer price index is the most widely known and used.
Choice "a" is incorrect. The consumer price index does not measure the cost of capital. The cost of
capital is calculated as the weighted-average cost of capital (WACC).
Choice "b" is incorrect. The consumer price index does not measure average household income.
Choice "d" is incorrect. The consumer price index does not measure the prime rate of interest.
13.
Which of the following characteristics would indicate that an item sold would have a high price elasticity of
demand?
a. The item has many similar substitutes.
b. The cost of the item is low compared to the total budget of the purchasers.
c. The item is considered a necessity.
d. Changes in the price of the item are regulated by governmental agency.
Solution:
Choice "a" is correct. If an item has many similar substitutes, its price elasticity of demand will be high.
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Customers can always switch to a substitute, so a change in price may affect demand substantially.
Choice "b" is incorrect. If the cost of an item is low compared to the total budget of the purchasers, it will
make little difference how much it costs. For a business, for example, the cost of paper clips will probably
not be a significant factor.
Choice "c" is incorrect. If an item is considered a necessity (e.g., insulin to diabetics), the price elasticity
of demand will be relatively low (i.e., inelastic). Purchasers will buy it regardless of the cost, and demand
will not change all that much.
Choice "d" is incorrect. If the price of an item is regulated by a government agency, the demand may not
be highly price elastic because the price may not be able to be changed that much or at all or all that
quickly.
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Capital budgeting
1.
Explanation
2.
When estimating cash flow for use in capital budgeting, depreciation is
a. Included as a cash or other cost.
b. Excluded for all purposes in the computation.
c. Utilized to estimate the salvage value of an investment.
d. Utilized in determining the tax costs or benefit.
Explanation
Choice “d” is correct. The requirement is to identify how depreciation is considered in estimating cash flow.
Answer (d) is correct because depreciation is deductible for tax purposes, and therefore it affects tax costs or
benefit.
Answer (a) is incorrect because depreciation is not a cash cost.
Answer (b) is incorrect because depreciation affects tax costs or benefit.
Answer (c) is incorrect because the salvage value is estimated to determine the depreciation expense.
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3.
A company is considering two projects, which have the following details:
Which project would provide the largest after-tax cash inflow?
a. Project A, because after-tax cash inflow equals $465.
b. Project A, because after-tax cash inflow equals $315.
c. Project B, because after-tax cash inflow equals $635.
d. Project B, because after-tax cash inflow equals $385.
Explanation
Choice “c” is correct. The requirement is to identify the project that would provide the largest after-tax cash inflow.
Answer (c) is correct because Project B’s after-tax cash inflow equals $635 [($1,500 – $700) – ({$1,500 – $700 –
$250}*30%)]. Cash flow for
Project A is equal to $465 [($1,000 – $400) – ({$1,000 – $400 – $150} * 30%)]. Answers (a) and (b) are incorrect
because
Project B’s cash flow is higher than Project A’s cash flow.
Answer (d) is incorrect because Project B’s cash flow equals $635.
4.
Explanation
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5.
A company has a required rate of return of 15% for five potential projects. The company has a maximum of $500,000
available for investment and cannot raise any capital. Details about the five projects are as follows:
The company should choose which of the following projects?
a. Project 1 only.
b. Projects 2, 3, and 4 only.
c. Projects 2, 4, and 5 only.
d. Projects 3, 4, and 5 only.
Explanation
Choice“c”is correct. The requirement is to identify the projects the company should choose for investment.
Answer (c) is correct because projects 2, 4, and 5 have the largest net present value.
Answers (a), (b), and (d) are incorrect because they do not produce the largest net present value.
6.
A company purchased property that it expects to sell for $14,000 next year. The net present value of the investment
is
$1,000. The company is guaranteed an interest rate of 12% by the bank. What amount did the company pay for the
property?
a. $11,500
b. $12,500
c. $13,000
d. $13,500
Explanation
Choice “a” is correct. The requirement is to determine the amount that the company paid for the property.
Answer (a) is correct because the amount paid is $11,500. The present value of the sales price of $14,000 discounted
at 12% for one year is equal to $12,500 ($14,000/1.12). If the net present value of the investment is equal to $1,000,
the purchase price must be equal to $11,500 ($12,500 – $1,000).
Answer (b) is incorrect because this is the present value of the selling price.
Answers (c) and (d) are incorrect because the correct amount is $11,500.
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7.
Explanation
8.
A company is investing in a machine costing $365,000.The following table shows selected financial data for the
company for the next five years:
What is the payback period on this machine?
a. 3.8 years.
b. 4.0 years.
c. 4.4 years.
d. 5.0 years.
Explanation
Choice “a” is correct. The requirement is to calculate the payback period. Answer (a) is correct because the payback
period is equal to 3.8 years ($50,000 + $125,000 + $150,000 + (0.8 $50,000)= $365,000). Answers (b), (c) and (d) are
incorrect because the payback period is 3.8 years.
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9.
A company has an online order processing system. The company is in the process of determining the dollar amount of
loss from user error. The company estimates the probability of occurrence of user error to be 90%, with evenly
distributed losses ranging from $1,000 to $30,000. What is the expected annual loss from user error?
a. $13,050
b. $13,500
c. $13,950
d. $14,400
Explanation
Choice “c” is correct. The requirement is to compute the expected annual loss from user error. Answer (c) is correct
because
the expected loss is equal to $13,950 (($30,000 + $1,000)/2 *90%).
Answers (a), (b), and (d) are incorrect because the expected loss is equal to $13,950.
10.
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11.
Which of the following rates is most commonly compared to the internal rate of return to evaluate whether
to make an investment?
a. Short-term rate on U.S. Treasury bonds.
b. Prime rate of interest.
c. Weighted-average cost of capital.
d. Long-term rate on U.S. Treasury bonds.
Solution:
Choice "c" is correct. The weighted-average cost of capital is frequently used as the hurdle rate within
capital budgeting techniques. Investments that provide a return that exceeds the weighted-average cost
of capital should continuously add to the value of the firm.
Choice "a" is incorrect. The short-term rate on U.S. Treasury bonds represents the risk-free rate of return
and would not be appropriate for use as a hurdle rate, in most instances.
Choice "b" is incorrect. The prime rate of interest represents the rate offered by banks to their most credit
worthy debtors. The prime rate of return would not necessarily consider the risk-specific return required
for a particular company's IRR and would not be appropriate as a hurdle rate.
Choice "d" is incorrect. The long-term rate on U.S. Treasury bonds represents a risk-free rate of return
and would not necessarily consider the risk-specific return required for a particular company's IRR and
would not be appropriate as a hurdle rate.
12.
Which of the following statements about investment decision models is true?
a. The discounted payback rate takes into account cash flows for all periods.
b. The payback rule ignores all cash flows after the end of the payback period.
c. The net present value model says to accept investment opportunities when their rates of return exceed
the company's incremental borrowing rate.
d. The internal rate of return rule is to accept the investment if the opportunity cost of capital is greater
than the internal rate of return.
Solution:
Choice "b" is correct. The payback period computation ignores cash flows after the initial investment has
been recovered. The payback method focuses on liquidity and the time it takes to recover the initial
investment.
Choice "a" is incorrect. The discounted payback period considers the time value of money but, like any
other payback method, it ignores cash flows after the initial investment has been recovered.
Choice "c" is incorrect. The net present value method measures amount of return and not rate. Although
a positive net present value would confirm that the entity's investment exceeds the hurdle rat established
by management, it neither measure the rate specifically nor assumes a hurdle rate equal to the
incremental borrowing rate.
Choice "d" is incorrect. When using the internal rate of return, the analyst recommends acceptance of the
investment in the event that the IRR is greater than the hurdle rate established by management.
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13.
Platinum Co. has a receivable due in 30 days for 30,000 euros. The treasurer is concerned that the value
of the euro relative to the dollar will drop before the payment is received. What should Platinum do to
reduce this risk?
a. Buy 30,000 euros now.
b. Enter into an interest rate swap contract for 30 days.
c. Enter into a forward contract to sell 30,000 euros in 30 days.
d. Platinum cannot effectively reduce this risk.
Solution:
Choice "c" is correct. Since Platinum is going to receive euros in 30 days, it will want to lock in the price
of euros now. The way to do that is to enter into a forward contract (referred to in the text as a forward
hedge) to sell euros in 30 days. The price will be fixed now, but the transaction will not occur until the end
of the 30 day period. A futures contract might be able to be used also. Note that, with the fixed price,
Platinum will not be hurt if the price of euros in terms of dollars falls, but it will also not benefit if the price
of euros in terms of dollars rises. In this question, the treasurer was concerned about the price of euros
dropping.
Choice "a" is incorrect. Buying 30,000 euros now will not reduce the risk of a drop in the value of the
euro. In fact, the risk will double since the company will have 60,000 euros in 30 days.
Choice "b" is incorrect. Buying an interest rate swap will do nothing to reduce the risk of a drop in the
value of the euro. Interest rate swaps might reduce the risk of changes in interest rates. Swaps are not
used for single transactions anyway.
Choice "d" is incorrect. Platinum can reduce the risk of a drop in the value of the euro by using the
appropriate hedge. Hedges are often used to reduce currency risk.
22
Working capital management
1.
Explanation
2.
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Explanation:
3.
Three suppliers offer Ruby Co. different credit terms. Bandy Co. offers terms of 1.5/15, net 30. Carryl Co. Offers terms
of 1/10, net 30. Platt Co. offers terms of 2/10, net 60. Ruby Co. would have to borrow from a bank at an annual rate
of 10% to take any cash discounts. Based on a 360-day year, which of the following options would be most attractive
for Ruby Co.?
a. Purchase from Platt Co., pay in 60 days, and do notnot borrow from the bank.
b. Purchase from Bandy Co., pay in 15 days, and borrow from the bank.
c. Purchase from Carryl Co., pay in 10 days, and borrow from the bank.
d. Purchase from Bandy Co., pay in 30 days, and do notnot borrow from the bank.
Explanation:
Choice “b” is correct. The requirement is to determine the most attractive terms. Answer (b) is correct because the
most attractive option would be to purchase from Brandy, pay in 15 days, and borrow from the bank. The nominal
annual benefit of taking Brandy’s terms is equal to 36.5% (1.5%/(100% - 1.5%) *360 days/(30days – 15 days)). Answer
(a) is incorrect because the nominal annual cost of not taking Platt’s terms is equal to 14.7% ((2%/(100% - 2%)) *(360
days /(60 days – 10 days))), which is less than the benefit from taking Brandy’s terms. Answer (c) is incorrect because
the nominal annual cost of not taking Carryl’s terms is equal to 18.2% (1%/(100% - 1%) *360 days /(30 days – 10
days)) which is less than the benefit from taking Brandy’s terms. Answer (d) is incorrect because the company would
benefit from taking Brandy’s discount terms.
4.
A company has equity of $9,000. Long-term debt is $1,900. Net working capital, other than cash, is $2,500. Fixed
assets are $2,200. What amount of cash does the company have?
a. 7,400
b. $6,800
c. $6,200
d. $2,400
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Explanation:
(c)
The requirement is to calculate the amount of cash.
Answer (c) is correct because the amount of cash is equal to $6,200 ($9,000 (equity) + $1,900 (long-term debt) –
$2,200
(fixed assets) – $2,500 (net working capital other than cash).
Answers (a), (b), and (d) are incorrect because cash is equal to $6,200.
5.
A company purchases inventory on terms of net 30 days and resells to its customers on terms of net 15 days. The
inventory conversion period averages 60 days. What is the company’s cash conversion cycle?
a. 15 days
b. 45 days
c. 75 days
d. 105 days
Explanation:
(b)
The requirement is to determine the cash conversion cycle. Answer (b) is correct because the cash conversion cycle
is equal to the inventory conversion period plus the receivables conversion period minus the payables deferral
period (45 days = 60 days + 15 days – 30 days). Answer (a) is incorrect because the cash conversion cycle is equal to
45 days.
Answers (c) and (d) are incorrect because the cash conversion cycle is equal to 45 days.
6.
Mein Co.’s sales totaled $300,000 for the current year. Mein’s cost of goods sold was $150,000. Mein’s accounts
receivable balance was $20,000 on January 1 and $30,000 on December 31. What was Mein’s accounts receivable
turnover rate for the current year?
a. 6 times.
b. 10 times.
c. 12 times.
d. 15 times.
Explanation:
(c)
The requirement is to calculate the accounts receivable turnover rate. Answer (c) is correct because the accounts
receivable turnover rate is equal to 12 times ($300,000 sales/ (($30,000 + $20,000)/2). Answers (a), (b), and (d) are
incorrect because the accounts receivable turnover rate is equal to 12 times.
7.
The following information pertains to material X that is used by Sage Co.:
Annual usage in units 20,000
Working days per year
250
Safety stock in units
800
25
Normal lead time in working days 30
Units of material X will be required evenly throughout the year. The order point is
a. 800
b. 1,600
c. 2,400
d. 3,200
Explanation:
(dd)
The requirement is to determine the order point for material X. When safety stock is maintained, the order point is
computed as follows:
Daily demand is eighty units (20,000 units ÷ 250 days). Therefore, the order point is 3,200 units [(80 × 30) + 800].
8.
Ral Co. sells 20,000 radios evenly throughout the year. The cost of carrying one unit in inventory for one year is $8,
and the purchase order cost per order is $32. What is the economic order quantity?
a. 625
b. 400
c. 283
d. 200
Explanation:
(bb) The requirement is to calculate the economic order quantity (EOQ). The EOQ formula is
In the above equation, a = cost of placing one order, D = annual demand in units, and k = cost of carrying one unit in
inventory for one year. Substituting the given information, the equation becomes
9.
Newman Products has received proposals from several banks to establish a lockbox system to speed up receipts.
Newman receives an average of 700 checks per day averaging $1,800 each, and its cost of short-term funds is 7% per
year. Assuming that all proposals will produce equivalent processing results and using a 360-day year, which one of
the following proposals is optimal for Newman?
a. A $0.50 fee per check.
b. A flat fee of $125,000 per year.
c. A fee of 0.03% of the amount collected.
d. A compensating balance of $1,750,000.
26
Explanation:
(dd)
The requirement is to determine the optimal agreement for a lockbox system. The number of checks issued during
the year is determined by multiplying 700 times 360 days, which results in a total of 252,000 checks. The total
amount of collections is equal to $453,600,000 (252,000 checks × $1,800 per check). Answer (d) is correct because it
results in the lowest cost of $122,500 ($1,750,000 × 7%), which is the cost of maintaining the compensating balance.
Answer (a) is incorrect because it results in a cost of $126,000 ($.50 × 252,000 checks). Answer (b) is incorrect
because it results in a cost of $125,000. Answer (c) is incorrect because it results in a fee of $136,080 (3% ×
$453,600,000).
10.
Which of the following describes the appropriate formula for days’ sales outstanding?
Explanation:
(bb)
The requirement is to identify the formula for days’ sales in accounts receivable. Answer (b) is correct because days’
sales in receivables provides an overall measure of the accumulation of receivables. It is calculated by dividing the
balance of receivables by sales per day.
Answers (a), (c), and (d) are incorrect because they do not accurately illustrate the formula.
11
When a firm finances each asset with a financial instrument of the same approximate maturity as the life of
the asset, it is applying:
1. Return maximization.
2. Operating leverage.
3. Working capital management.
4. Financial leverage.
Explanation
Choice "3" is correct. Appropriate working capital management matches the maturity life of each asset with the
length of the financial instrument used to finance that asset.
Choice "1" is incorrect. Return maximization seeks to obtain the optimal return rate by asset utilization. It is not
necessarily related to the maturity of the asset.
Choice "4" is incorrect. Financial leverage is the amount of debt used to finance an asset. Higher leverage
equals more debt. It is unrelated to the maturity life of an asset.
Choice "2" is incorrect. Operating leverage is the degree that fixed costs are used in the production process.
Operating leverage is unrelated to the methods used to finance assets.
27
12.A company has the following information in its financial records:
What is the company's receivable turnover ratio?
a. 6.0
b. 7.1
c. 7.5
d. 8.0
Solution:
Choice "c" is correct. Accounts receivable turnover is computed as the ratio of sales to average accounts
receivable. There is a lot of distracting data in the fact pattern, but on a limited amount of relevant
information:
Choice "a" is incorrect. The proposed solution incorrectly divides net income by average accounts
receivable, instead of sales.
Choice "b" is incorrect. The proposed solution incorrectly divides sales by beginning accounts receivable,
instead of average accounts receivable.
Choice "d" is incorrect. The proposed solution incorrectly divides sales by ending accounts receivable,
instead of average accounts receivable.
13.
The CFO of a company is concerned about the company's accounts receivable turnover ratio. The
company currently offers customers terms of 3/10, net 30. Which of the following strategies would most
likely improve the company's accounts receivable turnover ratio?
a. Pledging the accounts receivable to a finance company.
b. Changing customer terms to 1/10, net 30.
c. Entering into a factoring agreement with a finance company.
d. Changing customer terms to 3/20, net 30.
28
Explanation
Choice "c" is correct. The accounts receivable turnover ratio is expressed as Sales ÷ Accounts
Receivable. A reduction in accounts receivable would serve to improve (increase) the turnover ratio.
Factoring (selling) receivables would serve to reduce the amount of accounts receivable (indicating more
rapid collections) thereby increasing (improving) the company's accounts receivable.
Choice "a" is incorrect. Pledging accounts receivable does not impact either sales or accounts
receivable. There would be no improvement in the accounts receivable turnover ratio.
Choice "b" is incorrect. Changing the customer terms from 3/10, net 30 to 1/10, net 30 would actually
reduce discount incentives to pay timely. Accounts receivable would likely remain the same or be higher.
There would be no improvement in the company's accounts receivable turnover ratio.
Choice "d" is incorrect. Changing the customer terms from 3/10, net 30 to 3/20, net 30 would actually
reduce incentives to pay timely by increasing the amount of time in which the customer could capitalize
on the discount. Accounts receivable would likely remain the same or be higher. There would be no
improvement in the company's accounts receivable turnover ratio.
29
Capital Structure and Cost of Capital
1.
When calculating a company’s cost of common stock, an analyst evaluates the following four components: risk-free
rate, stock’s beta coefficient, rate of return on the market portfolio, and required rate of return on the company’s
stock. Which of
the following measurement models is being used?
a. Constant growth.
b. Weighted marginal cost of capital.
c. Capital asset pricing.
d. Overall cost of capital.
Explanation:
Choice “c” is correct. The requirement is to identify the type of valuation model that is being used. Answer (c) is
correct because the capital asset pricing model is calculated using the risk free interest rate, the stock’s beta
coefficient, and the estimated return on the market to calculate the cost of equity. Answers (a), (b), and (d) are
incorrect because the factors are used in the capital asset pricing model.
2. The cost of debt most frequently is measured as
a. Actual interest rate.
b. Actual interest rate adjusted for inflation.
c. Actual interest rate plus a risk premium.
d. Actual interest rate minus tax savings.
Explanation:
Answer (d) is correct.
The requirement is to identify the most frequent measure of the cost of debt. Answer (d) is correct because the most
frequent measure is the after-tax interest rate.
Answer (a) is incorrect because the actual rate ignores the tax benefit of the debt. Answers (b) and (c) are incorrect
because these are not common measures of the cost of debt.
3.
30
Explanation：
4.
c. Decreased interest rate risk
d. Increased interest rate risk
Explanation:
Increased credit risk
Decreased credit risk
5.
31
Explanation:
6.
Management of Kelly, Inc. uses CAPM to calculate the estimated cost of common equity. Which of the following
would reduce the firm’s estimated cost of common equity?
a. A reduction in the risk-free rate.
b. An increase in the firm’s beta.
c. An increase in expected inflation.
d. An increase in the risk-free interest rate.
Explanation:
(aa)
The requirement is to identify the factor that affects the calculation of the cost of equity using CAPM.
Answer (a) is correct because a reduction in the risk-free rate would reduce the required return demanded by
stockholders.
Answers (b), (c), and (d) are incorrect because an increase in these items would cause the estimated cost of common
equity to increase.
7. In general, it is more expensive for a company to finance with equity than with debt because
a. Long-term bonds have a maturity date and must, therefore, be repaid in the future.
b. Investors are exposed to greater risk with equity capital.
c. The interest on debt is a legal obligation.
d. Equity capital is in greater demand than debt capital.
Explanation:
(b)
The requirement is to identify the reason why it is more expensive to finance with equity than with debt.
Answer (b) is correct because equity holders are subject to more risk than debt holders. Therefore, they require a
higher rate of return.
32
8. Which of the following is notnot a characteristic of the capital asset pricing model for estimating the cost of equity?
a. The model is simple to understand and implement.
b. The model can be applied to all fi rms.
c. The model does not rely on any dividend assumptions or growth of dividends.
d. It is based upon the stock’s actual market price.
Explanation:
(dd)
The requirement is to identify the item that does notnot describe a characteristic of the capital asset pricing model.
Answer (d) is correct because CAPM does not include the stock’s market price in its computation. Answers (a), (b),
and (c) are incorrect because they are all characteristics of CAPM model.
9. Management of Terra Corp. is attempting to estimate the firm’s cost of equity capital. Assuming that the firm has
a constant growth rate of 5%, a forecasted dividend of $2.11, and a stock price of $23.12, what is the estimated cost
of common equity using the dividend-yield-plus-growth approach?
a. 9.1%
b. 14.1%
c. 15.6%
d. 12.3%
Explanation:
(bb)
The requirement is to apply the dividend-yield-plus- growth approach to calculate the cost of common equity.
The formula for estimated cost of common equity is equal to the expected dividend divided by the stock price plus
the growth rate. Therefore, the correct answer is (b) because the estimated cost of equity is 14.1% [(2.11/23.13) +
5%].
10.
If nominal interest rates increase substantially but expected future earnings and dividend growth for a firm over the
long run are not expected to change, the firm’s stock price will
a. Increase.
b. Decrease.
c. Stay constant.
d. Change, but in no determinable direction.
Explanation:
(bb)
The requirement is to identify the impact of an increase in nominal interest rates on a company’s share price.
Answer (b) is correct because an increase in the nominal interest rate would mean that investors would expect a
higher return on all investments. If the stock earnings and dividend growth is unchanged, the stock price will
decrease.
11.The benefit of debt financing over equity financing are likely to be highest in which of the following situations?
a. High marginal tax rates and few non-interest tax benefits
b. Low marginal tax rates and few non-interest tax benefits
c. High marginal tax rates and many non-interest tax benefits
d. Low marginal tax rates and many non-interest tax benefits
33
Explanation
Choice “a” is correct. The benefits of debt financing over equity financing are likely to be highest if marginal tax rates
are high ( because interest on debt is deductible for tax purposes) and if there are few noninterest tax benefits ( because
there is little or no reason to depart from debt financing).
12. DQZ Telecom is considering a project for the coming year, which will cost $50 million. DQZ plans to use the
following combination of debt and equity to finance the investment.
Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and inflation costs of 2% of par.
Use $35 million of funds generated from(retained) earnings.
The equity market is expected to earn 12%. US treasury bonds are currently yielding 5%. The beta coefficient for DQZ
is estimated to be 0.60. DQZ is subject to an effective corporate income tax rate of 40%. Assume that the after-tax cost
of debt is 7% and the cost of equity is 12%. Determine the weighted average cost of capital.
a. 10.50 percent b. 8.50 percent c. 9.50 percent d. 6.3 percent
Debt
Equity
Total
13.
Which of the following is an advantage of debt financing?
a. Interest and principal obligations must be paid regardless of the economic position of the firm.
b. Debt agreements contain covenants.
c. The obligation is generally fixed in terms of interest and principal payments.
d. Excessive debt increases the risk of equity holders and therefore depresses share prices.
Explanation
Answer (c) is correct.
The requirement is to identify the advantages/ disadvantages of debt versus equity financing. Answer (c) is correct
because the fixed obligation of interest and principal is
an advantage to debt financing. Answers (a), (b), and (d) are incorrect because they are all disadvantages of debt
financing.
Explanation
Answer (d) is correct. The requirement is to identify the most frequent measure of the cost of debt. Answer (d) is
correct because the most frequent measure is the after-tax interest rate. Answer (a)
is incorrect because the actual rate ignores the tax benefit of the debt. Answers (b) and (c) are incorrect because
these are not common measures of the cost of debt.
34
Cost Measurement Method and Techniques
1.
On January 1 Maples had two jobs in process: #506 with assigned costs of $10,500 and #507 with assigned costs of
$14,250. During January three new jobs, #508 through #510, were started and three jobs, #506, #507, and #508,
were completed. Materials and labor costs added during January were as follows:
Manufacturing overhead is assigned at the rate of 200 percent of labor. What is the January cost of goods
manufactured and
transferred from work-in-process?
a. $25,300
b. $35,850
c. $42,950
d. $50,050
Explanation:
Choice “d” is correct. The requirement is to determine the cost of goods manufactured and transferred from workin-process. Answer (d) is correct because the amount of costs transferred is equal to $50,050 as calculated below:
Answers (a), (b), and (c) are incorrect because they are computations of the costs transferred.
2.
Based on the following data, what is the gross profit for the company?
a. $200,000
35
b. $400,000
c. $600,000
d. $900,000
Explanation:
Choice "c" is correct. The gross profit for the company is $600,000 computed as follows:
Note that significant irrelevant information was provided in the problem. Some of the information (e.g., the raw
materials purchases, indirect costs and WIP) relate to data used to develop the relevant cost of goods manufactured.
Other information (e.g., marketing and administrative expenses) relate to computation of operating income rather
than gross profit.
Choices "a", "b", and "d" are incorrect per computations above.
3.
Under Pick Co.’s job order costing system manufacturing overhead is applied to work in process using a
predetermined annual overhead rate. During January 2014, Pick’s transactions included the following:
Pick had neither beginning nor ending work in process inventory. What was the cost of jobs completed in January
2014?
a. 302,000
b. 310,000
c. 322,000
d. 330,000
Explanation:
Choice "b" is correct. The requirement is to determine the cost of jobs completed in January 2014. In a job order
costing system,
manufacturing overhead cannot be traced to specific jobs. Instead, overhead is accumulated in an overhead control
account and applied to work performed based on some predetermined overhead rate. The difference between
actual and applied overhead is normally either allocated to work in process, finished goods, and cost of goods sold or
written off to cost of goods sold. In this case the cost of jobs completed is being determined for January only. Underor over applied overhead is not usually considered on a monthly basis. Therefore, the cost of jobs completed should
include allocated overhead only. The amount of indirect materials issued to production has already been included in
overhead applied. These costs do not need to be considered again in determining the cost of jobs completed. The
cost of jobs completed can be computed as follows:
36
4.
Explanation:
37
5.Which of the following choices shows the proper treatment of sales commissions and abnormal spoilage charges
when calculating a manufactured good’s inventoriable cost?
Sales commissions
Abnormal spoilage
a.
Include
Include
b.
Include
Exclude
c.
Exclude
Include
d.
Exclude
Exclude
Explanation:
Choice “d” is correct. The requirement is to identify the proper treatment of the costs. Answer (d) is correct because
both costs are excluded from inventoriable costs. Inventoriable costs include only the normal costs of manufacture
of the goods. Answer (a) is incorrect because commissions are a selling expense and abnormal spoilage is expensed
in the period and is not part of inventoriable costs. Answer (b) is incorrect because commissions are a selling
expense. Answer (c) is incorrect because abnormal spoilage is expensed in the period and is not part of inventoriable
costs.
6.
Kimbeth Manufacturing uses a process cost system to manufacture Dust Density Sensors for the mining industry. The
following information pertains to operations for the month of May 2012:
Units
Beginning work in process inventory, May 1
16,000
Started in production during May
100,000
Completed production during May
92,000
Ending work in process inventory, May 31
24,000
The beginning inventory was 60% complete for materials and 20% complete for conversion costs. The ending
inventory was 90% complete for materials and 40% complete for conversion costs.
Costs pertaining to the month of May are as follows:
The beginning inventory costs are: materials,$54,560;direct labor, $20,320; and factory overhead, $15,240.
Costs incurred during May are: materials used,$468,000; direct labor, $182,880; and factory overhead, $391,160.
Using the weighted-average method, the equivalent unit cost of materials for May is
a. 4.12
b. 4.50
c. 4.60
d. 5.03
Explanation:
Choice “c” is correct.
The requirement is to calculate the equivalent unit cost of materials for the month using the weighted-average method.
This amount is calculated as follows:
38
7.
A manufacturing company has several product lines. Traditionally, it has allocated manufacturing overhead costs
between product lines based on total machine hours for each product line. Under a new activity-based costing
system, which of the following overhead costs would be most likely to have a new cost driver assigned to it?
a. Electricity expense.
b. Repair and maintenance expense.
c. Employee benefits expense.
d. Depreciation expense.
Explanation:
Choice “c” is correct. The requirement is to identify the overhead cost that would be most likely to have a driver other
than machine hours. Answer (c) is correct because employee benefits expense is least likely to be driven by machine
hours. Answers (a), (b) and (d) are incorrect because they all are related to the use of machinery.
8.
The New Wave Co. is considering a new method for allocating overhead to its two products, regular and premium
coffee beans. Currently New Wave is using the traditional method to allocate overhead, in which the cost driver is direct
labor costs. However, it is interested in using two different drivers: machine hours (MH) for separating and roasting
beans, and pounds of coffee for packing and shipping. Machine hours for the current month are 700 hours, direct labor
cost per pound of coffee is $1.25, and direct materials cost per pound of coffee is $1.50. There are 1,000 pounds of
coffee packed and shipped for the current month. The following data are also available:
What is the total cost per pound for the premium coffee using the new activity-based costing method?
a. $5.00
b. $5.75
c. $7.75
d. $9.75
Explanation:
Choice "d" is correct. Activity based costing is a cost assignment concept that uses activity level as the fundamental
cost object. Total cost per unit would be equal to the overhead allocated in accordance with the activity based cost
object associated with each activity and the direct cost per unit.
39
9.
Limitations of an activity-based costing system include which of the following?
a. Control of overhead costs is enhanced.
b. Activity-based costing systems are less
less reliable.
c. The expense of obtaining cost data is relatively high.
d. It eliminates arbitrary assignment of overhead costs.
Explanation:
Choice "c" is correct. Activity based costs anticipates increased cost pools and increased allocation bases. The
determination of the amounts that go in these pools and their related cost drivers will likely be more costly than
traditional systems. Increased costs of ABC represent a limitation of the system.
Choice "a" is incorrect. Improved control over overhead costs is a benefit, not a limitation of activity based costing
Choice "b" is incorrect. Activity based costing systems tend to produce more accurate and more reliable information
that traditional cost allocation systems.
Choice "d" is incorrect. Activity based costing attempts to trace costs to activities that consume resources and thereby
eliminate the arbitrary assignment of overhead costs. The enhanced traceability of costs is a benefit and not a limitation
of ABC.
10.
The accountant for Champion Brake, Inc. applies overhead based on machine hours. The budgeted overhead and
machine hours for the year are $260,000 and 16,000, respectively. The actual overhead and machine hours incurred
were $275,000 and 20,000. The cost of goods sold and inventory data compiled for the year is as follows:
What is the amount of over/under applied overhead for the year?
a. $15,000
b. $50,000
c. $65,000
d. $67,000
40
Explanation:
Choice “b” is correct. The requirement is to compute the amount of over/ under applied overhead for the year.
Answer (b) is correct because the amount of over applied overhead is $50,000. Overhead is applied at a rate of
$16.25 per machine hour($260,000 budgeted overhead . 16,000 budgeted machine hours). Therefore, $325,000
overhead was applied ($16.25 application rate . 20,000 actual hours), and the over applied overhead is equal to
$50,000 ($325,000 applied overhead – $275,000 actual overhead).
Answers (a), (c), and (d) are incorrect because they are incorrect computations of the over applied overhead.
11.
Which of the following costs would decrease if production levels were increased within the relevant
range?
a. Total fixed costs.
b. Variable costs per unit.
c. Total variable costs.
d. Fixed costs per unit.
Explanation
Choice "d" is correct. In the relevant range, fixed costs are constant in total, but decrease per unit as
production levels increase.
Choice "a" is incorrect. Although total fixed costs are constant in total in the relevant range, the call of the
question relates to per-unit fixed costs. Fixed costs per unit decrease as production levels increase.
Choice "b" is incorrect. Variable costs per unit remain unchanged in the relevant range, but increase in
total as unit volume increases.
Choice "c" is incorrect. Total variable costs increase as total unit volume increases in the relevant range.
12.
Merry Co. has two major categories of factory overhead: material handling and quality control. The costs
expected for these categories for the coming year are as follows:
Material handling
$120,000
Quality inspection
200,000
The plant currently applies overhead based on direct labor hours. The estimated direct labor hours are
80,000 per year. The plant manager is asked to submit a bid and assembles the following data on a
proposed job:
Direct materials
$4,000
Direct labor (2,000 hours) 6,000
What amount is the estimated product cost on the proposed job?
a. $8,000
b. $10,000
c. $14,000
d. $18,000
Explanation
Choice "d" is correct. The estimated product cost is equal to the sum of prime costs and applied
overhead or 18,000.
41
Prime costs are the sum of direct labor and direct material:
Applied overhead is equal to the overhead rate times the estimated hours:
Choice "a" is incorrect. The proposed solution incorrectly anticipates that the product cost is equal to only
applied overhead, exclusive of prime costs.
Choice "b" is incorrect. The proposed solution incorrectly anticipates that the product cost is equal to only
prime costs, exclusive of applied overhead.
Choice "c" is incorrect. The proposed solution incorrectly anticipates that the product cost is equal to the
sum of only direct labor and applied overhead, exclusive of direct material.
13.
Which of the following is not a basic approach to allocating costs for costing inventory in joint-cost
situations?
a. Sales value at split-off.
b. Flexible budget amounts.
c. Physical measures such as weights or volume.
d. Constant gross margin percentage net realizable value method.
Explanation
Choice "b" is correct. Joint costs will most likely be allocated based upon relative unit volume, relative
sales value at split off, or net realizable value. Flexible budget amounts are not used to allocate joint costs
Choice "a" is incorrect. Sales value at split-off is a recognized method of allocating joint costs.
Choice "c" is incorrect. Physical measures, such as weights or volume, are a recognized method of allocating joint
costs.
Choice "d" is incorrect. Constant gross margin percentage net realizable value method is a recognized method of
allocating joint costs.
42
Budgeting and Variance Analysis
1.
Mien Co. is budgeting sales of 53,000 units of product Nous for October 2014. The manufacture of one unit of Nous
requires four kilos of chemical Loire. During October 2014, Mien plans to reduce the inventory of Loire by 50,000
kilos and increase the finished goods inventory of Nous by 6,000 units. There is no Nous work in process inventory.
How many kilos of Loire is Mien budgeting to purchase in
October 2014?
a. 138,000
b. 162,000
c. 186,000
d. 238,000
Explanation:
(cc)
The requirement is to determine the number of kilos of chemical Loire that Mien is planning to purchase in October.
The first step is to prepare a production budget for product
Nous.
Next, a purchases budget for raw material Loire should be prepared.
Note that the production needs for Loire equal the number of units of Nous to be produced times the number of
kilos of Loire needed per unit (4).
2. The master budget
a. Shows forecasted and actual results.
b. Reflects controllable costs only.
c. Can be used to determine manufacturing cost variances.
d. Contains the operating budget.
Explanation:
(dd)
The requirement is to identify a characteristic of the master budget.
Answer (d) is correct because the master budget is a comprehensive budget that includes both the operating and
financial budgets. Answer (a) is incorrect because the master budget does not show actual results.
Answer (b) is incorrect because the master budget shows all costs, controllable and uncontrollable.
Answer (c) is incorrect because the master budget is not structured for the computation of variances.
3.Rolling Wheels purchases bicycle components in the month prior to assembling them into bicycles. Assembly is
scheduled one month prior to budgeted sales. Rolling pays 75% of component costs in the month of purchase and
25% of the costs in the following month. Component cost included in budgeted cost of sales are
43
What is Rolling’s budgeted cash payment for components in
May?
a. $5,750
b. $6,750
c. $7,750
d. $8,000
Explanation:
(cc)
Calculation of the cash payments for components in May is shown below.
Payments for June sales $1,750 ($7,000 × 25%)
Payment for July sales $6,000 ($8,000 × 75%)
Total cash payments $7,750
Answer (a) is incorrect because parts are ordered two months prior to sales. Therefore, costs of components for
sales of June and July should be considered.
Answer (b) is incorrect because parts are ordered two months prior to sales. Therefore, costs of components for
sales of June and July should be considered.
Answer (d) is incorrect because parts are ordered two months prior to sales. Therefore, costs of components for
sales of June and July should be considered.
4. A 2014 cash budget is being prepared for the purchase of Toyi, a merchandise item. Budgeted data are
Purchases will be made in twelve equal monthly amounts and paid for in the following month. What is the 2014
budgeted cash payment for purchases of Toyi?
a. $295,000
b. $300,000
c. $306,000
d. $312,000
Explanation:
(cc) The requirement is to determine budgeted cash disbursements for purchases for 2014. The solutions approach is
to use T-accounts to trace the flow of budgeted costs through the accounts.
44
5. The standard direct material cost to produce a unit of Lem is four meters of material at $2.50 per meter. During
May 2014, 4,200 meters of material costing $10,080 were purchased and used to produce 1,000 units of Lem. What
was the material price variance for May 2014?
a. $400 favorable.
b. $420 favorable.
c. $ 80 unfavorable.
d. $480 unfavorable.
Explanation:
(bb)
The requirement is to determine Lem’s material price variance for May. The direct materials price variance is the
difference between actual unit prices and standard unit prices multiplied by the actual quantity, as shown below.
45
The $420 price variance is favorable because the actual purchase price of the material was lower than the standard
price. Since the material was purchased for only $2.40 per meter ($10,080 cost ÷ 4,200m), Lem saved $.10 per meter
compared to the standard price, for a total price savings of $420 (4,200m × $.10/m). Note that the standard quantity
of materials is ignored in order to isolate these price differences; differences in quantity are addressed by the
materials usage variance.
6. Carr Co. had an unfavorable materials usage variance of $900. What amounts of this variance should be charged to
each department?
Explanation:
(aa)
The materials usage variance measures the actualactual amount of materials usedused versus the standard amount that
should
have been used given the level of output. Normally the only department with controls over usage of materials is the
manufacturing department. The purchasing department normally controls the cost of materials purchased,
and not
the amounts used (materials price variance). The warehouse department has little or no controlpurchased,
over the materials
used.
7. Yola Co. manufactures one product with a standard direct manufacturing labor cost of four hours at $12.00 per
hour. During June, 1,000 units were produced using 4,100 hours at $12.20 per hour. The unfavorable direct labor
efficiency variance was
a. $1,220
b. $1,200
c. $ 820
d. $ 400
Explanation:
(bb) The solutions approach to compute the direct manufacturing labor efficiency variance is to set up a diagram as
follows:
46
8.
Baby Frames, Inc. evaluates manufacturing overhead in its factory by using variance analysis. The following
information applies to the month of May:
What is the fixed overhead spending variance?
a. $1,000 favorable.
b. $1,000 unfavorable.
c. $2,000 favorable.
d. $2,000 unfavorable.
Explanation:
(dd)
The fixed overhead spending variance is calculated as follows:
9. Which of the following is included in a firm’s financial budget?
a. Budgeted income statement.
b. Capital budget.
c. Production schedule.
d. Cost of goods sold budget.
Explanation:
(bb)
The requirement is to identify the item that is part of a financial budget. Answer (b) is correct. The financial budget
includes the capital budget, cash budget, and the budgeted statement of cash flows. The operating budget includes
the budgeted income statement and supporting budgets. Answers (a), (c), and (d) are incorrect because they are
part of the operating budget.
10. Trumbull Company budgeted sales on account of $120,000 for July, $211,000 for August, and $198,000 for
September.
Collection experience indicates that 60% of the budgeted sales will be collected the month after the sale, 36% the
second month, and 4% will be uncollectible. The cash from accounts receivable that should be budgeted for
September would be
a. $169,800
b. $194,760
c. $197,880
d. $198,600
47
Explanation:
(aa)
The requirement is to calculate the budgeted cash from collection of accounts receivable.
Answer (a) is correct because the amount is equal to July’s collections in September plus August’s collections in
September. This amount is $169,800 (36% × $120,000 + 60% × $211,000).
11.
A company's target gross margin is 40% of the selling price of a product that costs $89 per unit. The
product's selling price should be:
a. $124.60
b. $142.40
c. $148.33
d. $222.50
Explanation
Choice "c" is correct. The selling price is computed at $148.33. The fact pattern provides the basic
relationships and requires that you determine selling price either algebraically or in a tabular form.
Putting the fact pattern in a table, the provide information is used to compute the solution as follows:
The problem provides that the company has a 40% gross margin. By extension, costs are 60% of sales.
If costs are $89, then selling price must be $148.33, as calculated below:
Selling price = Costs ÷ Ratio of costs to sales
Selling price = $89 ÷ 60%
Selling price = $148.33
Choice "a" is incorrect. The proposed solution anticipates that selling price is 40 greater than costs ($89 x1.4).
Choice "b" is incorrect. The proposed solution anticipates that selling price is 60 greater than costs ($89 x1.6),
instead of 60% of costs as computed above.
Choice "d" is incorrect. This proposed solution anticipates that selling price is a function of cost divided by gross
margin percentage.
12.
Wren Co. manufactures and sells two products with selling prices and variable costs as follows:
Wren's total annual fixed costs are $38,400. Wren sells four units of A for every unit of B. If operating
income last year was $28,800, what was the number of units Wren sold?
a. 5,486
b. 6,000
c. 9,600
d. 10,500
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Explanation
Choice "d" is correct. Wren will have sold a total of 10,500 units to achieve a $28,800 operating profit
assuming the fact pattern described above. The question requires the candidate to recall the basic
contribution margin formula and apply some algebra.
The fact pattern describes that the operating income is $28,800 and the fixed costs are $38,400. The
contribution margin is; therefore, the total of the two $67,200.
The basic formula to compute units sold is:
CM per unit x Units = $67,200
The fact pattern indicates that Wren has two products with unique selling and cost patterns.
First, compute the contribution margin:
Second, quantify the selling pattern and the relationship between the products. Wren sells 4 units of
Product A for every unit of Product B, so expressing Product A in terms of Product B:
Product A = 4 x Product B
Third, determine the number of units of Product B that were sold:
$6 contribution margin x (4B) + $8 contribution margin x B = $67,200
24B + 8B = 67,200
32B = 67,200
B = 2,100
Fourth, determine the number of Product A and the total number of products sold:
A = 4 x B (4 x 2,100) or 8,400
Total units = 2,100 + 8,400 or 10,500
Choices "a", "b", and "c" are incorrect, per the computations above.
13.
The regression analysis results for ABC Co. is shown as y = 90x + 45. The standard error (Sb) is 30 and
coefficient of determination (r2) is 0.81. The budget calls for production of 100 units. What is ABC's estimate of total
costs?
a. $3,090
b. $4,590
c. $9,030
d. $9,045
Explanation
Choice "d" is correct. The total cost formula is the formula for a line where total cost, the dependent variable (y) is
equal to volume times the independent variable, variable costs (x) plus a constant (fixed costs).
The formula for ABC Company is:
y = 90x + 45
The problem tells us that we plan to produce 100 units so total costs, y, is computed as follows:
Y = (90 x 100) + 45
Y = 9,045
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The coefficient of determination measures the proportion of the total variation in "y" or total cost that is
explained by the total variation in the independent variable, x, or variable costs. The coefficient of
determination measures the reliability of the formula, but is not used for determining the value of "y".
The standard error (also standard error of the mean) is a measurement used in conjunction with standard
deviation computations and is not relevant to this projection.
Choices "a", "b", and "c" are incorrect, per the above.
50
Corporate Governance
1.
Which of the following statements best states the purpose of cumulative voting?
a. To assure the continuance of incumbent directors.
b. To allow minority shareholders to gain representation on the board of directors.
c. To allow for the election of one-third of the board of directors each year.
d. To assure that a majority of shares voted elects the entire board of directors.
Explanation
Choice "b" is correct. In cumulative voting, each share is entitled to one vote for each director position that is being
filled and the shareholders may cast the votes in any way, including casting all for a single candidate. This helps
minority shareholders gain representation on the board.
Choices "a", "c", and "d" are incorrect. Cumulative voting does not insure the continuance of incumbent directors. It
does not permit the election of 1/3 of the board each year. It does not assure that the majority of the votes cast
elect the entire board. If a 1/3 minority of shares cast all votes for a single candidate of their choice and the 2/3
majority of shares split their votes among the remaining candidates, the minority would be assured of electing their
candidate.
2.
The principle that protects corporate directors from personal liability for acts performed in good faith on behalf of
the corporation is known as:
a. The clean hands doctrine.
b. The full disclosure rule.
c. The responsible person doctrine.
d. The business judgment rule.
Explanation
Choice "d" is correct. If a director acts in good faith and in a manner the director believes is in the best interest of the
corporation, and the director exercises the care that a reasonably prudent person would exercise in a similar
position, the director is protected against liability for decisions the director makes that turn out poorly for the
corporation. This is commonly known as the business judgment rule.
Choice "a" is incorrect. The clean hands doctrine (better known as the unclean hands doctrine) is a defense in actions
brought in cases seeking equitable relief. If a person seeking equitable relief has acted improperly in the transaction
before the court, he is said to have unclean hands and the court will not grant equitable relief. The doctrine has
nothing to do with releasing directors from liability for acting in good faith and is outside the scope of the CPA Exam
topics.
Choices "b" and "c" are incorrect. There are no such rules. Full disclosure may be required in certain situations under
corporate law, but such disclosure requirement is not the described doctrine.
3.
Hughes and Brody start a business as a closely-held corporation. Hughes owns 51 of the 100 shares of stock issued by
the firm and Brody owns 49. One year later, the corporation decides to sell another 200 shares. Which of the
following types of rights would give Hughes and Brody a preference over other purchasers to buy shares to maintain
control of the firm?
a. Shareholder derivative rights.
b. Pre-emptive rights.
c. Cumulative voting rights.
d. Inspection rights.
51
Explanation
Choice "b" is correct. The right to purchase new issuances of additional stock in order to maintain current
proportional ownership is known as a pre-emptive right.
Choice "a" is incorrect. A shareholder's derivative right is the right of a shareholder to enforce a legal obligation—for
example, by filing a lawsuit—owed to the corporation by a third party when the corporation does not seek to
vindicate its own rights. Choice "c" is incorrect. Cumulative voting rights refers to the right of a shareholder to cast
votes in the election of directors equal to the product of the number of shares the shareholder owns times the
number of directors being elected (e.g., if a shareholder owns 100 shares and three directors are being elected, the
shareholder may cast 300 votes). Cumulative voting is often used to help assure representation of minority
shareholders. Choice "d" is incorrect. A shareholder's inspection rights refer to the right of a shareholder to inspect
and copy certain shareholder records (e.g., minutes of shareholder meetings, list of shareholders, etc.).
4.
Which of the following is a key difference in controls when changing from a manual system to a computer system?
a. Internal control principles change.
b. Internal control objectives differ.
c. Control objectives are more difficult to achieve.
d. Methodologies for implementing controls change.
Explanation
Choice "d" is correct. When changing from a manual system to a computer system, the controls almost always are
different. That does not mean that they are better or are worse, but they certainly are different.
Choice "a" is incorrect. When changing from a manual system to a computer system, internal control "principles" do
not change. The principles remain the same; it is the implementation of the principles that is different.
Choice "b" is incorrect. When changing from a manual system to a computer system, internal control "objectives" do
not change. The objectives remain the same.
Choice "c" is incorrect. When changing from a manual system to a computer system, control objectives are not
necessarily more difficult to achieve. Some will be more difficult, and some will be easier. But, almost always, the
specific controls will be different.
5.
According to COSO, which of the following is the most effective method to transmit a message of ethical behavior
throughout an organization?
a. Demonstrating appropriate behavior by example.
b. Strengthening internal audit's ability to deter and report improper behavior.
c. Removing pressures to meet unrealistic targets, particularly for short-term results.
d. Specifying the competence levels for every job in an organization and translating those levels to requisite
knowledge and skills.
Explanation
Choice "a" is correct. According to the COSO, demonstrating appropriate behavior by example is the most effective
method to transmit a message of ethical behavior throughout an organization. The commitment to ethical behavior
begins with the tone at the top, and is best established by management's demonstrated commitment to ethical behavior.
52
Choice "b" is incorrect. Although detection of unethical behavior with improved internal audit resources is important,
it is not as effective in transmitting a message of ethical behavior as leadership by example.
Choice "c" is incorrect. Realistic goals are an important component of a corporate culture that encourages ethical
behavior; unrealistic goals may provide reasons for unethical behavior. But, according to COSO, they are no
substitute for a strong commitment by management and an ethical tone at the top.
Choice "d" is incorrect. A competent work force supports ethical behavior and provides an environment where ethical
behavior will thrive. However, a demonstrated commitment to ethical behavior by management is the most effective
method for transmitting a message of ethical behavior throughout the organization.
6.
Within the COSO Internal Control—Integrated Framework, which of the following components is designed to ensure
that internal controls continue to operate effectively?
a. Control environment.
b. Risk assessment.
c. Information and communication.
d. Monitoring.
Explanation
Choice "d" is correct. The monitoring component or function of the internal control framework is designed to ensure
that internal controls continue to operate effectively. Monitoring of internal control effectiveness is done to provide
an assessment of the performance of the system of internal control over time. Monitoring is designed to ensure that
internal controls operate effectively.
Choice "a" is incorrect. The control environment is sometimes referred to as the "tone at the top." The control
environment is the framework upon which all other principles are built. It is not as specifically designed to ensure
that internal controls continue to operate effectively as is monitoring.
Choice "b" is incorrect. The risk assessment component of the COSO framework includes principles associated with
management's consideration of the risk of material misstatement, not the assurance that internal controls continue
to operate effectively.
Choice "c" is incorrect. The information and communication components of the COSO framework consider those
systems that identify, capture, process, and distribute information supporting the accomplishment of financial
reporting objectives, not the assurance that internal controls operate effectively.
7.
According to COSO, an effective approach to monitoring internal control involves each of the following steps, except:
a. Establishing a foundation for monitoring.
b. Increasing the reliability of financial reporting and compliance with applicable laws and regulations.
c. Designing and executing monitoring procedures that are prioritized based on risks to achieve organizational
objectives.
d. Assessing and reporting the results, including following up on corrective action where necessary.
Explanation
Choice "b" is correct. Increasing the reliability of financial reporting and compliance with applicable laws and
regulations is an approach to promoting a management philosophy and style that is congruent with effective
financial reporting and control, not monitoring. Monitoring internal control may involve establishing a foundation for
monitoring, prioritization of monitoring procedures based on risk to achieve organizational objectives, and assessing
reporting results and following up as appropriate with corrective actions.
53
Choice "a" is incorrect. Embracing the attributes of the monitoring principle including establishing a foundation for
monitoring is an effective approach to monitoring.
Choice "c" is incorrect. Designing procedures that are prioritized based on risks to achieving organization objectives is
an effective approach to monitoring. Management might consider, for example, developing a list of control
weaknesses that would seriously, rather than immaterially, threaten the reliability of financial reporting to establish
standards for immediate reporting.
Choice "d" is incorrect. Assessing and reporting results, including following up on corrective actions, is an effective
approach to monitoring. Management might consider, for example, establishing procedures that require reporting all
deficiencies to a responsible manager.
8.
According to COSO, which of the following is a compliance objective?
a. To maintain adequate staffing to keep overtime expense within budget.
b. To maintain a safe level of carbon dioxide emissions during production.
c. To maintain material price variances within published guidelines.
d. To maintain accounting principles that conform to GAAP.
Explanation
Choice "b" is correct. Maintaining safe (mandated by regulation) carbon dioxide emissions during production is a
compliance objective. Compliance objectives include adherence to the laws, rules, and regulations associated with
operations, including environmental regulations and other laws.
Choice "a" is incorrect. Maintaining adequate staffing to keep overtime expense within budget is likely an operations
rather than compliance objective.
Choice "c" is incorrect. Maintaining material price variances within published guidelines is likely an operations
objective.
Choice "d" is incorrect. Maintaining accounting principles that conform to GAAP is likely a reporting objective.
9.
A member of the board of directors of Central Communications Co. is offered a license by a third party to operate a
cellular phone system. The director does not present this offer to the board of directors for approval but informally
mentions it to a fellow board member, who does not think it will be a problem. The director buys the license. Which
of the following statements is correct regarding the director’s actions?
a. The director breached a duty of care by failing to use prudent business judgment.
b. The director breached the duty of due diligence.
c. The director breached a duty of loyalty by usurping a corporate opportunity.
d. The director acted properly in purchasing the license.
Explanation
The requirement is to evaluate the action of the board member. Answer (c) is correct because the director breached
a duty of loyalty by usurping a corporate opportunity. Answers (a), (b), and (d) are incorrect because the director
breached a duty of loyalty by usurping a corporate opportunity.
54
10.
Company management completes event identification and analyzes the risks. The company wishes to assess its risk
after management’s response to the risk. According to COSO, which of the following types of risk does this situation
represent?
a. Inherent risk.
b. Residual risk.
c. Event risk.
d. Detection risk.
Explanation
(b)
The requirement is to identify the type of risk that is described. Answer (b) is correct because the risk after
management’s response is the residual risk. Answer (a) is incorrect because it is the risk before management takes
any action. Answer (c) is incorrect because it is the risk of loss from a particular event. Answer (d) is incorrect
because it is not a risk related to enterprise risk management
11.
Explanation
Choice 3 is correct.
Section 407 of the Sarbanes-Oxley Act requires that at least one member of the audit committee be a financial expert.
Choice”2“is incorrect. The Sarbanes-Oxley Act requires that at least one member of the audit committee be a financial
expert, not a majority.
12.
Which of the following is true regarding a financial expert serving on the audit committee of an issuer that is
complying with the Sarbanes-Oxley Act of 2002?
1. An audit committee member qualifying as a financial expert must have adequate technical training and
Experience as an auditor
2. An audit committee member must have been a member of the board of directors for five years before serving
as a financial expert.
3. The audit committee member may qualify for recognition as a financial expert using most any combination of
education and experience auditing or preparing financial reports.
4. Disclosure of the financial expert is made at the election of the audit committee.
55
Explanation
Choice 3 is correct.
13.
Explanation
Choice 1 is correct.
Organizational structure is a principle of the environment component of the International Control—Integrated
Framework and is not a principle of risk assessment.
Choice 3 is incorrect.Specifying organizational objectives that allow for identification and assessment of the
56
Performance Measures and Management Techniques
1.
A company has two divisions. Division A has operating income of $500 and net assets of $1,000.
Division B has operating income of $400 and net assets of $1,600. The required rate of return for the
company is 10%. Division B's residual income would be which of the following amounts?
a. $40
b. $240
c. $400
d. $640
Explanation
Choice "b" is correct. The formula for residual income is as follows:
Choice "a" is incorrect. The solution incorrectly computes the residual income for Division B based upon
Division B's revenue and the hurdle associated with both Division A and Division B.
Choice "c" is incorrect. The solution incorrectly proposes the residual income for Division A.
Choice "d" is incorrect. The solution incorrectly proposes the residual income for both divisions.
2.
The management of a company would do which of the following to compare and contrast its financial
information to published information reflecting optimal amounts?
a. Budget.
b. Forecast.
c. Benchmark.
d. Utilize best practices.
Explanation
Choice "c" is correct. Benchmarking would be used by a company in comparing its financial data to
published information to determine if optimal. Benchmarking is the process often used to identify
standards that define or quantify critical success factors.
Choice "a" is incorrect. Budgets are internal comparisons, not external.
Choice "b" is incorrect. Forecasts are internal comparisons, not external.
Choice "d" is incorrect. Use of best practices represents the implementation of procedures or
modifications to operations, not the comparison of data to externally-published benchmarks.
3.
Which of the following terms represents the residual income that remains after the cost of all capital,
including equity capital, has been deducted?
a. Free cash flow.
b. Market value-added.
c. Economic value-added.
57
d. Net operating capital.
Explanation
Choice "c" is correct. Economic value-added is a residual income technique used for capital budgeting
and performance evaluation. It represents the residual (excess) income of project earnings in excess of
the cost of capital (including cost of equity) associated with invested capital.
Choice "a" is incorrect. Free cash flow is defined as operating cash flows net of dividends paid to
preferred shareholders and capital expenditures—it is not a residual income technique.
Choice "b" is incorrect. Market value added is defined as the difference between the market value of
company's stock and the adjusted book value of the equity and debt invested in the company—it is not a
residual income technique.
Choice "d" is incorrect. Net operating capital is a term generally synonymous with working capital—it is
not a residual income technique.
4.
Which of the following performance measures is nonfinancial?
a. Percentage of defective products.
b. Return on investment.
c. Gross profit margin.
d. Economic value-added.
Explanation
Choice "a" is correct. Computation and reporting of a percentage of defective products is a nonfinancial measure.
Typically financial measures deal with costs, revenues, or financial reports. Nonfinancial measures generally focus on
operational statistics (such as defective products) rather than items measured in dollars.
Choice "b" is incorrect. Return on investment is based on financial statement amounts and represents a financial
measure, not a nonfinancial measure.
Choice "c" is incorrect. Gross profit margin is based on financial statement amounts and represents a financial
measure, not a nonfinancial measure.
Choice "d" is incorrect. Economic value added is based on financial statement amounts and represents a financial
measure, not a nonfinancial measure.
5.
Which of the following techniques effectively measures improvements in product quality as a result of internal
failure costs?
a. Inspection of in-process goods.
b. Recording the number of products returned over time.
c. Tracking the number of products reworked.
d. Tracking warranty expenses over time.
Explanation
Choice "c" is correct. Measures of internal failure costs, a subset of nonconformance costs, include tracking the
number of products reworked. Rework of products assumes errors are caught and corrected before delivery.
Reduction of rework is an indication of improved efficiency and product quality.
Choice "a" is incorrect. Inspection of in-process goods is an appraisal cost, not an internal failure cost. It is a subset of
conformance costs.
Choice "b" is incorrect. Product returns create nonconformance costs, but these are external failure costs, not
58
internal failure costs.
Choice "d" is incorrect. Although warranty expense is a nonconformance cost, it is an external failure cost, not an
internal failure cost.
6.
Managers of the Doggie Food Co. want to add a bonus component to their compensation plan. They are trying to
decide between return on investment (ROI) and residual income (RI) as the performance measure they will use. If
Doggie adopts the RI performance measure, the relevant required rate of return would be 18%. One segment of Doggie
is the Good Treats division, where the manager has invested in new equipment. The operating results from this
equipment are as follows:
Assuming that there are nono income taxes, what would be the ROI and RI for this equipment that has an average value
of $100,000?
Explanation
Choice "d" is correct. Return on investment and residual income measures are computed as follows:
Return on Investment (ROI)
ROI = Income / Investment
ROI = (Revenues – Cost of goods sold – General & administrative expense) / Investment
ROI = ($80,000 – $45,000 – $15,000) / $100,000
ROI = $20,000 / $100,000 20%20%
Residual Income (RI)
RI = Income – (Investment x Hurdle rate)
RI = ($80,000 – $45,000 – $15,000) – ($100,000 x 18%)
RI = $20,000 – $18,000 $2,000
Choices "a", "b", and "c" are incorrect based on the computation above.
59
7.
As part of a benchmarking process, a company's costs of quality for the current month have been identified as follows:
What amount is the company's prevention cost for the current month?
a. $39,500
b. $57,000
c. $165,000
d. $175,500
Explanation
Choices "b" is correct. The company's prevention costs total $57,000, as computed below:
Choices "a", "c", and "d" are incorrect based on the above analysis.
8.
Which of the following performance measures may lead a manager of an investment center to forgo investments
that could benefit the company as a whole?
a. Return on investment.
b. Residual income.
c. Profitability index.
d. Economic value added.
Explanation
Choice "a" is correct. Return on investment (ROI) measures may discourage mangers from avoiding investments that
could benefit the company as a whole. Use of the ROI exclusively as a measure of performance can inadvertently
focus managers purely on maximizing short-term returns. Profitable units are reluctant to invest in additional
60
productive resources because their short-term result will be to reduce ROI.
Choice "b" is incorrect. Residual income methods (including economic value added) focus on target return and
amount and encourage managers to invest in projects that exceed the hurdle rate. As a result, divisions with high
rates of return do not fear dilution of their rates and are not discouraged from making investments that demonstrate
strong residual income performance.
Choice "c" is incorrect. The profitability index is a method for ranking previously screened investments and rationing
available capital. It would not discourage a manager from making an investment.
Choice "d" is incorrect. Residual income methods (including economic value added) focus on target return and amount
and encourage managers to invest in projects that exceed the hurdle rate. As a result, divisions with high rates of return
do not fear dilution of their rates and are not discouraged from making investments that demonstrate strong residual
income performance.
9.
A company has income after tax of $5.4 million, interest expense of $1 million for the year, depreciation expense of
$1 million, and a 40% tax rate. What is the company's times-interest-earned ratio?
a. 5.4
b. 6.4
c. 7.4
d. 10.0
Explanation
Choice "d" is correct. The times interest earned ratio is 10.0, based the following formula:
Explanation
Choice "a" is incorrect. After-tax income, unadjusted for interest, was incorrectly used in the numerator for the
proposed solution. The numerator of the times interest earned ratio should be EBIT.
Choice "b" is incorrect. After-tax income, adjusted for interest, was incorrectly used in the numerator for the
proposed solution. The numerator of the times interest earned ratio should be EBIT.
Choice "c" is incorrect. After-tax income, adjusted for interest and depreciation, was incorrectly used in the numerator
for the proposed solution. The numerator of the times interest earned ratio should be EBIT.
61
10.
Which of the following involves comparing measures of actual progress of a project to planned progress?
a. Project planning.
b. Project scheduling.
c. Project control.
d. Project closure.
Explanation
Choice“c” is correct.
The requirement is to identify the stage that involves comparing measures of actual progress to planned progress.
Answer (c) is correct because this describes an aspect of project control. Answers (a), (b), and (d) are incorrect because
they represent other stages of the project management lifecycle.
11.
Explanation
Choice“4” is correct.
Drivers would most likely comprehend non-financial measures that represent controllable features of their job.In
12.
Lifetime Insurance Agency sells a full line of personal as well as property and casualty lines. The Company pays
commissions to its sales force based upon a combination of premium and customer satisfaction matrices.
Commission rates are 20% in the first year and 10% for renewals. Lifetime’s marketing practice would best be
described as:
1. Network.
2. Transactional.
3. Relationship.
. Database.
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Explanation
Choice“3” is correct.
13.
4.A cooperative program based on company-wide performance.
Explanation
Choice“1” is correct.
63