Certified Public Accountant CPA Questions + Answers Part 14

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QUESTION 302
What is the primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers?
A. ROIisapercentage,whileRIisadollaramount.
B. ROImayleadtorejectingprojectsthatyieldpositivecashflows. C. ROI does not necessarily reflect the company's cost of capital. D. ROI does not reflect all economic gains.

Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. The primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers is that ROI may lead to rejecting projects that yield positive cash flows. Profitable investment center managers might be reluctant to invest in projects that might lower their ROI (especially if their bonuses are based only on their investment center's ROI), even though those projects might generate positive cash flows for the company as a whole.
This characteristic is often known as the "disincentive to invest."
Choice "a" is incorrect. The primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers is that ROI may lead to rejecting projects that yield positive cash flows, not that ROI is a percentage and RI is a dollar amount.
The fact that one is a percentage and one is a dollar amount might make them a little harder to interpret, but this interpretation difficulty would certainly not seem to be the "primary" disadvantage.
Choice "c" is incorrect. The primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers is that ROI may lead to rejecting projects that yield positive cash flows, not that ROI does not necessarily reflect the cost of capital.
Choice "d" is incorrect. The primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers is that ROI may lead to rejecting projects that yield positive cash flows, not that ROI does not reflect all economic gains.
QUESTION 303
The benefits of debt financing over equity financing are likely to be highest in which of the following situations?
A. Highmarginaltaxratesandfewnoninteresttaxbenefits. B. Lowmarginaltaxratesandfewnoninteresttaxbenefits. C. High marginal tax rates and many noninterest tax benefits. D. Low marginal tax rates and many noninterest tax benefits.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
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). Choice "b" is incorrect.

The benefits of debt financing over equity financing are likely to be highest if marginal tax rates are high, not low (because interest on debt is deductible for tax purposes), and if there are few noninterest tax benefits.
Choice "c" is incorrect. 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, not many, noninterest tax benefits.
Choice "d" is incorrect. The benefits of debt financing over equity financing are likely to be highest if marginal tax rates are high, not low (because interest on debt is deductible for tax purposes), and if there are few, not many, noninterest tax benefits.
QUESTION 304
A company has two divisions. Division A has operating income of $500 and total assets of $1,000. Division B has operating income of $400 and total assets of $1,600. The required rate of return for the company is 10%. The company's residual income would be which of the following amounts?
A. $0 B. $260 C. $640 D. $900
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Residual income is the difference between net income and the required return. The required return is net book value (total assets) times the hurdle rate (required rate of return). The calculations are as follows:
Choice "a" is incorrect. Residual income would certainly not be $0 in this question because the operating income is greater than the required return for both Division A and Division B. Choice "b" is incorrect. The $260 is the total required return, not the total residual income. Choice "d" is incorrect. The $900 is the total operating income, not the total residual income.
QUESTION 305
At the beginning of year 1, $10,000 is invested at 8% interest, compounded annually. What amount of interest is earned for year 2?

A. $800.00 B. $806.40 C. $864.00 D. $933.12
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. This question is a compound interest question because the interest is to be determined at the end of the second year. The calculation is as follows and uses different symbols than the SI = PIN formula in the text to show candidates the PRT formula as well (the CPA exam often uses different terminology):
Interest = PRT (for the first year)
Interest = $1,000 x .08 x 1 = $800 and adding the $800 to the beginning principal Interest = PRT (for the second year) Interest = $1,800 x .08 x 1 = $864
It is obvious from the answer that the interest earned in year 2 is interest earned on the original principal ($10,000 x .08 = $800) plus interest on the year 1 interest ($800 x .08 = $64). Choice "a" is incorrect. This answer is interest only on the original principal, and not on the year 1 interest.
Choice "b" is incorrect. This answer has a decimal point error in calculating the year 2 interest on year 1 interest.
Choice "d" is incorrect. This answer is apparently made up. It is sometimes difficult to come up with 3 decent wrong answers, especially with simple questions.
QUESTION 306
The optimal capitalization for an organization usually can be determined by the:
A. Maximumdegreeoffinancialleverage(DFL).
B. Maximumdegreeoftotalleverage(DTL).
C. Lowest total weighted-average cost of capital (WACC).
D. Intersection of the marginal cost of capital and the marginal efficiency of investment.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The optimal capitalization for an organization usually can be determined by the lowest total weighted-average cots of capital (WACC).

Capitalization at WACC serves to maximize shareholder's equity.
Choice "a" is incorrect. The degree of financial leverage relates to the risk assumed by a firm using fixed debt service costs to finance operations not comprehensively to capital structure. Choice "b" is incorrect. The degree of total leverage relates the risk assumed by a firm using a combination of both debt services costs to finance operations and fixed costs to operate the business, not comprehensively to capital structure.
Choice "d" is incorrect. The intersection of the marginal cost of capital and the marginal efficiency of investment does not indicate optimal capitalization.
QUESTION 307
Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers the benefits of no fixed charges, no fixed maturity date and an increase in the credit-worthiness of the company. Which of the following would best meet Bander's financing requirements?
A. Bonds.
B. Commonstock. C. Long-term debt. D. Short-term debt.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Common stock is an equity security that conveys ownership. Common stock does not require any payment, it does not mature and, because it increases equity while having no effect on debt, it decreases the debt equity ratio and increases the credit-worthiness of the firm. Choice "a" is incorrect. Bonds are debt instruments that require specific fixed payments, mature at a specific time and increase debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness.
Choice "c" is incorrect. Long-term debt requires specific fixed payments, includes maturity at a specific time and (by definition), increases debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness.
Choice "d" is incorrect. Short-term debt requires specific fixed payments, includes maturity at a specific time and, by definition, increase debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness.
QUESTION 308
Which of the following formulas should be used to calculate the economic rate of return on common stock?
A. (Dividends+changeinprice)dividedbybeginningprice.
B. (Netincome-preferreddividend)dividedbycommonsharesoutstanding. C. Market price per share divided by earnings per share.
D. Dividends per share divided by market price per share.
Correct Answer: A

Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The economic rate of return on common stock measures the dividend income and capital growth in relation to the initial investment, the beginning price of the stock. Choice "b" is incorrect. The proposed solution is earnings per share, a ratio generally computed as the earnings available to common shareholders (net income after payment of preferred shares) divided by the common shares outstanding.
Choice "c" is incorrect. Market price per share divided by earnings per share is the price/earnings or P/E ratio, not the economic rate of return on common stock. Choice "d" is incorrect. The dividends per share divided by the market price per share does not represent the economic rate of return on common stock, the ratio includes change in stock value in the denominator rather than the numerator of the equation.
QUESTION 309
Which of the following factors is inherent in a firm's operations if it utilizes only equity financing?
A. Financialrisk.
B. Businessrisk. C. Interest rate risk. D. Marginal risk.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Business risk represents the risk associated with the unique circumstances of a particular company, as they might affect the shareholder value of that company. If an entity purely uses its own cumulative earnings in capitalizing its operations, it is exposed to the risks of its own unique circumstances. Choice "a" is incorrect. Financial risk, also called default risk, relates to the exposure of lenders to the failure of borrowers to repay principal and interest on debt. An entity using its own cumulative earnings in capitalizing its operations is not exposed to default risk. Choice "c" is incorrect. A business that exclusively uses equity capitalization would not be exposed to the risk that the value of its financial instruments will change as a result of changes in interest rates. Choice "d" is incorrect. Incremental changes in risk would be limited if a firm exclusively used its own equity financing to capitalize its operations.
Financial Statement and Business Implications of Liquid Asset Management
QUESTION 310
Capital investments require balancing risk and return. Managers have a responsibility to ensure that the investments that they make in their own firms increase shareholder value. Managers have met that responsibility if the return on the capital investment:
A. Exceedstherateofreturnassociatedwiththefirm'sbetafactor.

B. Islessthantherateofreturnassociatedwiththefirm'sbetafactor. C. Is greater than the prime rate of return.
D. Is less than the prime rate of return.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. A capital investment whose rate of return exceeds the rate of return associated with the firm's beta factor will increase the value of the firm. Choice "b" is incorrect. A capital investment whose rate of return is less than the rate of return associated with the firm's beta factor will decrease the value of the firm. Choice "c" is incorrect. The return on a capital investment in relation to the prime rate of return will not necessarily indicate if the investment increases or decreases the value of the company without knowing the relative risk of the firm in relation to the market and its relationship to the prime rate. Choice "d" is incorrect. The return on a capital investment in relation to the prime rate of return will not necessarily indicate if the investment increases or decreases the value of the company without knowing the relative risk of the firm in relation to the market and its relationship to the prime rate.
QUESTION 311
The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified a source of funds which is given below:
Pay a factor to buy the company's receivables, which average $125,000 per month and have an average collection period of 30 days. The factor will advance up to 80 percent of the face value of receivables at 10 percent and charge a fee of 2 percent on all receivables purchaseD. The controller estimates that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest are not deductible in advance.
Assume a 360-day year in all of your calculations.
The cost of factoring is:
A. 12.0percent. B. 14.8percent. C. 16.0 percent. D. 20.0 percent.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:

Choice "c" is correct.
QUESTION 312
Spotech Co.'s budgeted sales and budgeted cost of sales for the coming year are $212,000,000 and $132,500,000 respectively. Short-term interest rates are expected to average 5 percent. If Spotech could increase inventory turnover from its current 8 times per year to 10 times per year, its expected cost savings in the current year would be:
A. $165,625 B. $331,250 C. $81,812 D. $250,000
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. $165,625 expected cost savings by increasing inventory turnover from its current 8 times to 10 times per year.

QUESTION 313
The amount of inventory that a company would tend to hold in stock would increase as the:
A. Costofcarryinginventorydecreases.
B. Variabilityofsalesdecreases.
C. Cost of running out of stock decreases.
D. Length of time that goods are in transit decreases.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The amount of inventory that a company would tend to hold in stock would increase as the cost of carrying inventory decreases. The amount of inventory that a company would tend to hold in stock would decrease as the:
B. Variability of sales decreases.
C. Cost of running out of stock decreases.
D. Length of time that goods are in transit decreases.
QUESTION 314
Average daily cash outflows are $3 million for Evans Inc. A new cash management system can add two days to the disbursement schedule. Assuming Evans earns 10 percent on excess funds, how much should the firm be willing to pay per year for this cash management system?
A. $3,000,000

B. $1,500,000 C. $600,000 D. $150,000
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. $600,000 allowed for new cash management system.
QUESTION 315
Jackson Distributors sells to retail stores on credit terms of 2/10, net 30. Daily sales average 150 units at a price of $300 each. Assuming that all sales are on credit and 60 percent of customers take the discount and pay on Day 10 while the rest of the customers pay on Day 30, the amount of Jackson's accounts receivable is:
A. $990,000 B. $900,000 C. $810,000 D. $450,000
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. $810,000 accounts receivable.

Choices "a", "b", and "d" are incorrect, per the above calculation.
QUESTION 316
If a retailer's terms of trade are 3/10, net 45 with a particular supplier, what is the cost on an annual basis of not taking the discount? Assume a 360-day year.
A. 37.11percent. B. 36.00percent. C. 24.74 percent. D. 31.81 percent.
Correct Answer: D
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. 31.81% annual cost of not taking the discount. Choices "a", "b", and "c" are incorrect, per the above calculation.
QUESTION 317
If a firm borrows $500,000 at 10 percent and is required to maintain $50,000 as a minimum compensating balance at the bank, what is the effective interest rate on the loan?

A. 11.1percent. B. 9.1percent. C. 12.2 percent. D. 11.0 percent.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. 11.1% effective interest rate on loan.
This question pertains to the computation of the effective rate of interest on a $500,000 note with a 10% stated rate that requires a $50,000 compensating balance. The answer computes the effective rate at 11.1% by taking the ratio of the amount paid $50,000 to the funds available $450,000 ($500,000 - $50,000). Why would the $50,000 in interest payments not also be deducted in arriving at the effective rate?
The simple answer is that the note is not discounted by the interest. It is only subject to the compensating balance.
The borrower receives $500,000 in proceeds but must hold out $50,000 and pay back $550,000, principal + interest, to the lender. At the conclusion of the loan, the compensating balance requirement is removed.
QUESTION 318
A company has daily cash receipts of $150,000. The treasurer of the company has investigated a lockbox service whereby the bank that offers this service will reduce the company's collection time by four days at a monthly fee of $2,500. If money market rates average four percent during the year, the additional annual income (loss) from using the lockbox service would be:
A. $6,000
B. $(6,000) C. $12,000 D. $(12,000)
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation

Explanation/Reference:
Explanation:
Choice "b" is correct. $(6,000). A company's decision to commit to a lockbox plan is an example of marginal analysis. In other words, do the marginal benefits exceed the marginal costs of the plan?
Choices "a", "c", and "d" are incorrect, per the above calculation.
QUESTION 319
Assume that each day a company writes and receives checks totaling $10,000. If it takes five days for the checks to clear and be deducted from the company's account, and only four days for the deposits to clear, what is the float?
A. $10,000 B. $0
C. $(10,000) D. $25,000
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. $10,000. Float is the difference between the balance of checks outstanding, which have not cleared the bank and deposits made but which

have not yet cleared the bank here.
Choices "b", "c", and "d" are incorrect, per the above calculation.
QUESTION 320
The optimal level of inventory would be affected by all of the following, except the:
A. Costperunitofinventory.
B. Currentlevelofinventory.
C. Cost of placing an order for merchandise. D. Lead time to receive merchandise ordered.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. The current level of inventory has no impact on the optimal level of inventory. Choices "a", "c", and "d" are incorrect. The optimal level of inventory is affected by:
1. The inventory usage rate.
2. The cost per unit of inventory - which will have a direct impact on inventory carrying costs.
3. The cost of placing on order impacts order frequency, which affects order size and optimal inventory levels.
QUESTION 321
During 1990, Mason Company's current assets increased by $120, current liabilities decreased by $50, and net working capital:
A. Increasedby$70. B. Decreasedby$170. C. Increasedby$170. D. Decreasedby$70.

Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Net working capital is the difference between current assets and current liabilities. Because current assets went up $120 and current liabilities down by $50, the net effect is an increase in net working capital of $170.
Therefore, working capital has increased $170,000.
Choices "a", "b", and "d" are incorrect, per the above calculation.
QUESTION 322
As a company becomes more conservative with respect to working capital policy, it would tend to have a (n):
A. Increaseintheratioofcurrentliabilitiestononcurrentliabilities. B. Decreaseintheoperatingcycle.
C. Decrease in the quick ratio.
D. Increase in the ratio of current assets to noncurrent assets.
Correct Answer: D
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
RULE: Working capital policy is deemed to be more conservative as an increasing portion of an organization's long-term assets, permanent current assets, and temporary current assets are funded by long-term financing.
Choice "d" is correct. An increase in the ratio of current assets to non-current assets would be indicative of an increasingly conservative working capital policy. With no other information, an increase in current assets would indicate that a growing percentage of current assets are financed by non current liabilities and that,

nominally, the absolute amount of working capital and the current ratio is improving.
Choice "a" is incorrect. An increase in the ratio of current liabilities to noncurrent liabilities would indicate that an increasing portion of our assets are funded by current liabilities, a more aggressive approach to working capital management.
Choice "b" is incorrect. A decrease in the operating cycle implies that the time to convert inventory into sales (receivables) and receivables into cash has decreased. Assuming no change in liabilities or sales, a decreased operating cycle infers declining current asset balances, greater funding of assets by current liabilities and a more aggressive rather than conservative working capital policy. Choice "c" is incorrect. A decrease in the quick ratio would indicate that either temporary current assets are decreasing (and are therefore increasingly funded by current liabilities, indicating a more aggressive working capital policy) or that current liabilities are increasing, signaling a decrease in the amount of noncurrent liabilities used to fund temporary current assets, a sign of an increasingly aggressive working capital policy.
QUESTION 323
In inventory management, the safety stock will tend to increase if the:
A. Carryingcostincreases.
B. Costofrunningoutofstockdecreases. C. Variability of lead-time increases.
D. Fixed order cost decreases.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. If lead times became more variable, the amount of safety stock needed to reduce the risk of stock outs will increase.
Choice "a" is incorrect. A high carrying cost would decrease safety stock. Choice "b" is incorrect. A lower stockout cost would decrease safety stock. Choice "d" is incorrect. If order costs decrease, then inventory will be ordered more frequently and less safety stock will be needed.
QUESTION 324
Quantree Company is quoted credit terms of 3/15, net 60 (using a 360-day year). The effective cost of not taking this discount and paying on day 60 is (rounded to nearest hundredth):
A. 24.74percent. B. 24.00percent. C. 18.56 percent. D. 18.00 percent.

Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The formula for computing the cost of credit discounts is:
Choices "b", "c", and "d" are incorrect, per the above calculation.
QUESTION 325
Which of the following inventory management approaches orders at the point where carrying costs equate nearest to restocking costs in order to minimize total inventory cost?
A. Economicorderquantity.
B. Just-in-time.
C. Materials requirements planning. D. ABC.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The economic order quantity (EOQ) method of inventory control anticipates orders at the point where carrying costs are nearest to restocking

costs. The objective of EOQ is to minimize total inventory costs. The formula for EOQ is:
Choice "b" is incorrect. Just in time (JIT) inventory models were developed to reduce the lag time between inventory arrival and inventory use.
Choice "c" is incorrect. Materials requirements planning (MRP) is a method of determining inventory requirements when a given number of units is needed. The method is used to create precise schedules of which items will be needed and what times they will be needed. Choice "d" is incorrect. ABC is an acronym for Activity Based Costing, a method of cost assignment that identifies value added activities and related cost drivers. It is not an inventory management approach.
QUESTION 326
Which of the following ratios is appropriate for the evaluation of accounts receivable?
A. Dayssalesoutstanding. B. Returnontotalassets. C. Collection to debt ratio. D. Current ratio.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Among the ratios listed, the ratio that is appropriate for the evaluation of accounts receivable is the number of days sales are outstanding. Sales are related to accounts receivable, so the more days the sales are outstanding, the longer the receivables are outstanding. Choice "b" is incorrect. Return on total assets is not appropriate for the evaluation of accounts receivable.
It is appropriate for the evaluation of return and of total assets, but not for the evaluation of account receivable specifically.
Choice "c" is incorrect. The collection to debt ratio has nothing to do with the evaluation of accounts receivable.
Choice "d" is incorrect. The current ratio is appropriate for the evaluation of liquidity (one of the ways to evaluate liquidity) but has nothing to do with the evaluation

of accounts receivable, other than that accounts receivable is in the numerator of the current ratio.
QUESTION 327
Which of the following is not a typical characteristic of a just-in-time (JIT) production environment?
A. Lotsizesequaltoone.
B. Insignificantsetuptimesandcosts. C. Push-through system.
D. Balanced and level workloads.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Just-in-time has the goal to minimize the level of inventory carried. Typical characteristics include lot sizes equal to one, insignificant set-up times and costs, and balanced and level workloads. In a just-in-time environment, the flow of goods is controlled by a "pull" approach, where an item is produced only when it is needed down the line, and not a "push-through" system. Choices "a", "b", and "d" are incorrect based on the above Explanation:.
QUESTION 328
Bell Co. changed from a traditional manufacturing philosophy to a just-in-time philosophy. What are the expected effects of this change on Bell's inventory turnover and inventory as a percentage of total assets reported on Bell's balance sheet?
A. Option A B. OptionB C. Option C D. Option D
Correct Answer: C

Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. In a just-in-time system, products are produced just-in-time to be sold. Therefore, JIT systems maintain a much smaller level of inventory when compared to traditional systems. Inventory turnover (cost of goods sold divided by average inventory) increases with a switch to JIT, and inventory as a percentage of total assets decreases. Choices "a", "b", and "d" are incorrect based on the above Explanation:.
QUESTION 329
The benefits of a just-in-time system for raw materials usually include:
A. Eliminationofnonvalueaddingoperations.
B. Increaseinthenumberofsuppliers,therebyensuringcompetitivebidding.
C. Maximization of the standard delivery quantity, thereby lessening the paperwork for each delivery. D. Decrease in the number of deliveries required to maintain production.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. The just-in-time system focuses on expediting the production process by having materials available as needed without having to store them prior to usage. Thus, the nonvalue adding operation of storing materials is eliminated.
Choice "b" is incorrect. A just-in-time system is designed to facilitate the flow of materials whether the materials come from one or more suppliers. Competitive bidding is not a major benefit of the just-in- time system.
Choice "c" is incorrect. Maximizing the delivery quantity of materials may increase the need to store the materials prior to using them. The just-in-time system focuses on minimizing storage time and storage costs. Lessening paperwork is not a focus of the just-in-time system. Choice "d" is incorrect. With a just-in-time system, deliveries are made as materials are needed. A decrease in deliveries may increase the delivery quantity, thus increasing the need to store the materials prior to using them. The just-in-time system focuses on minimizing storage time and storage costs.
QUESTION 330
Amicable Wireless, Inc. offers credit terms of 2/10, net 30 for its customers. Sixty percent of Amicable's customers take the 2% discount and pay on day 10. The remainder of Amicable's customers pay on day 30. How many days' sales are in Amicable's accounts receivable?
A. 6 B. 12

C. 18 D. 20
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Days' sales in accounts receivable is normally calculated as Days' sales = Ending accounts receivable / Average daily sales. However, that formula will not work in this case because the necessary information is not provided. However, enough information about payments is provided so that the total days' sales can be determined on a weighted average basis. In this question, nobody pays before the 10th day and 60% of the customers pay on the 10th day, so there are 10 x .60, or 6 day's sales there. The other 40% of the customers pay on the 30th day so there are 30 x .40, or 12 day's sales there. The total is 18 days sales.
Choice "a" is incorrect. This answer is apparently calculated from just the 60% of the customers who pay on the 10th day. The others have to be included also. Choice "b" is incorrect. This answer is apparently calculated from just the 40% of the customers who pay on the 30th day. The others have to be included also. Choice "d" is incorrect. This answer is apparently calculated by as the difference between the 30th day and the 10th day. The answer does not take into account how many customers pay when.
QUESTION 331
Why would a firm generally choose to finance temporary assets with short-term debt?
A. Matchingthematuritiesofassetsandliabilitiesreducesrisk.
B. Short-terminterestrateshavetraditionallybeenmorestablethanlong-terminterestrates.
C. A firm that borrows heavily long term is more apt to be unable to repay the debt than a firm that borrows heavily short term. D. Financing requirements remain constant.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Matching the maturities of current assets with liabilities as they come due is designed to ensure liquidity and reduce risk of cash shortages. Temporary assets (such as inventories, generally, and seasonal inventories, specifically) might be financed with short term debt such that the earnings from the sales of those temporary assets could be used to liquidate the related obligations as they come due and ensure that cash is available to meet cash flow requirements. Choice "b" is incorrect. Interest rate risks would likely motivate a firm to use longer term financing than short-term financing.
Choice "c" is incorrect. Matching cash inflows with cash outflows are more influential in determining a firm's ability to repay debt rather than the length of the

obligation. Choice "d" is incorrect. Long-term rather than short-term debt promotes consistent finance charges. The requirements for financing itself are driven by business practice, not by the maturity of financial instruments used.
QUESTION 332
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. Pledgingtheaccountsreceivabletoafinancecompany.
B. Changingcustomertermsto1/10,net30.
C. Entering into a factoring agreement with a finance company. D. Changing customer terms to 3/20, net 30.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
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.
QUESTION 333
Which of the following effects would a lockbox most likely provide for receivables management?
A. Minimizedcollectionfloat.
B. Maximizedcollectionfloat.
C. Minimized disbursement float. D. Maximized disbursement float.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation

Explanation/Reference:
Explanation:
Choice "a" is correct. A lockbox system expedites cash inflows (minimizes collection float) by having a bank receive payments from a company's customers directly, via mailboxes to which the bank has access. Payments that arrive in these mailboxes are deposited into the company's account immediately. Choice "b" is incorrect. Lockboxes minimize rather than maximize collection float. Choices "c" and "d" are incorrect. Lockbox systems relate to collection rather than disbursement float.
Supplemental Questions
QUESTION 334
Managers are often engaged in decision-making. There are numerous logical steps to reach a decision. The step least likely to used by a manager for decision- making would be:

A. Obtaininginformation.
B. Establishmentofastrategicvision.
C. Selecting alternatives.
D. Identifying alternative courses of action.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Establishing a strategic vision is not normally included as part of the logical steps to reach a decision. Although decision-making techniques are incorporated as part of establishing a strategic vision and consideration of strategic issues is important, the process of deriving the vision is not considered part of the decision-making process.
Choice "a" is incorrect. Obtaining information as a basis for selecting between alternatives is generally viewed as a critical part of decision-making.
Choice "c" is incorrect. Selecting alternatives is a specific decision-making action that is generally included as one of the steps identified in decision-making. Choice "d" is incorrect. Identifying alternative courses of action from which to choose is a decisionmaking process that is generally included as one of the steps identified in

decision-making.
QUESTION 335
Management accountants are frequently asked to analyze various decision situations including the following.
A. Thecostofaspecialdevicethatisnecessaryifaspecialorderisaccepted.
II. The cost proposed annually for the plant service for the grounds at corporate headquarters.
III. Joint production costs incurred, to be considered in a sell-at-split versus a process-further decision. IV. The costs associated with alternative uses of plant space, to be considered in a make/buy decision.
B. Thecostofobsoleteinventoryacquiredseveralyearsago,tobeconsideredinakeep-versusdisposaldecision. The costs described in situations I and IV above are:
C. Prime costs.
D. Sunk costs.
E. Discretionarycosts.
F. Relevantcosts.
Correct Answer: D
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. Relevant costs.
Both I and IV are costs that are relevant to a decision. Choice "a" is incorrect. Prime costs include direct material and direct labor. Choice "b" is incorrect. Sunk costs are costs previously incurred and not relevant to decision-making. Choice "c" is incorrect. Discretionary costs are discretionary. In I, the special device is necessary.
QUESTION 336
Management accountants are frequently asked to analyze various decision situations including the following.
A. Thecostofaspecialdevicethatisnecessaryifaspecialorderisaccepted.
II. The cost proposed annually for the plant service for the grounds at corporate headquarters.
III. Joint production costs incurred, to be considered in a sell-at-split versus a process-further decision. IV. The costs associated with alternative uses of plant space, to be considered in a make/buy decision.
B. Thecostofobsoleteinventoryacquiredseveralyearsago,tobeconsideredinakeep-versusdisposaldecision. The cost described in situation II above is a:
C. Prime cost. D. Sunk cost.

E. Discretionarycost. F. Relevantcost.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Discretionary cost. The proposed cost for plant service for the grounds at corporate headquarters is an example of an avoidable cost that is discretionary. Choice "a" is incorrect. Prime costs are direct materials and direct labor. Choice "b" is incorrect. Sunk costs are costs previously incurred and not relevant. Choice "d" is incorrect. Relevant costs are expected future costs that vary with the action taken.
QUESTION 337
Companies that adopt just-in-time purchasing systems often experience:
A. Areductioninthenumberofsuppliers.
B. Fewerdeliveriesfromsuppliers.
C. A greater need for inspection of goods as the goods arrive.
D. Less need for linkage with a vendor's computerized order entry system.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. Just-in-time purchasing systems usually results in a reduction in the number of suppliers. Because a company that adopts J-I-T is very dependent on supplier performance, usually fewer suppliers are used and a very close working relationship is developed. Choice "b" is incorrect. Just-in-time requires more deliveries from suppliers. Choice "c" is incorrect. Usually there is more reliance on quality control by the supplier. Finding defective goods as they arrive is too late; a stock-out could cause production to shut down. Choice "d" is incorrect. There is much more need for linkage with the vendor's order entry system with JI- T because the company is dependent on timely deliveries from the vendor.
QUESTION 338
In a decision analysis situation, which one of the following costs is generally not relevant to the decision?
A. Incrementalcost. B. Avoidablecost.

C. Historical cost. D. Opportunitycost.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. Historical cost is generally not relevant in a decision analysis situation. All of the following costs are relevant in a decision analysis situation:
A. Incremental cost B. Avoidable cost D. Opportunity cost
QUESTION 339
The relevance of a particular cost to a decision is determined by:
A. Riskinessofthedecision.
B. Numberofdecisionvariables. C. Potential effect on the decision. D. Accuracyofthecost.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The relevance of a particular cost to a decision is determined by potential effect on the decision. Relevant costs are expected future costs that vary with the action taken. All other costs are assumed to be constant and thus have no effect on the decision. The relevance of a particular cost to a decision is not determined by:
A. Riskiness of the decision.
B. Number of decision variables. D. Accuracy of the cost.
QUESTION 340

Capital budgeting decisions include all but which of the following?
A. Selectingamonglong-terminvestmentalternatives.
B. Financingshort-termworkingcapitalneeds.
C. Making investments that produce returns over a long period of time. D. Financing large expenditures.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. Capital budgeting decisions do not include the financing of short-term working capital needs, which are more operational in nature. Choices "a", "c", and "d" are incorrect, as these are all types of capital budgeting decisions.
QUESTION 341
An example of an indirect cash flow effect would be:
A. Cashcommittedatinceptionoftheproject.
B. Increasedpayrollexpensesduetotheproject.
C. A depreciation tax shield.
D. An increase in expected future operating cash flows.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. A depreciation tax shield is one of the most common indirect cash flow effects. Choices "a", "b", and "d" are incorrect, as these are all directly related to the capital investment and have an immediate effect on the amount of cash available to the company. Thus, they are all direct cash flow effects.
QUESTION 342
The annual tax depreciation expense on an asset reduces income taxes by an amount equal to: A. Thefirm'saveragetaxratetimesthedepreciationamount.

B. Oneminusthefirm'saveragetaxratetimesthedepreciationamount. C. The firm's marginal tax rate times the depreciation amount.
D. One minus the firm's marginal tax rate times the depreciation amount.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The annual tax depreciation expense reduces income taxes by an amount equal to the firm's marginal tax rate (the tax on the next dollar of income) times the depreciation amount.
Choices "a", "b", and "d" are incorrect, per above.
QUESTION 343
When employing the MACRS method of depreciation in a capital budgeting decision, the use of MACRS as compared to the straight-line method of depreciation will result in:
A. Equaltotaldepreciationforbothmethods.
B. MACRSproducinglesstotaldepreciationthanstraightline.
C. Equal total tax payments, after discounting for the time value of money. D. MACRS producing more total depreciation than straight line.
Correct Answer: A
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "a" is correct. MACRS and straight line depreciation will be equal in total (only the timing differs).
Choices "b" and "d" are incorrect, per above.
Choice "c" is incorrect. The timing of the depreciation tax shields will differ. The discounting will result in different present values based on the differing timing.
QUESTION 344
Kore Industries is analyzing a capital investment proposal for new equipment to produce a product over the next eight years. The analyst is attempting to determine the appropriate "end-of-life" cash flows for the analysis. At the end of eight years, the equipment must be removed from the plant and will have a net book value of zero, a tax basis of $75,000, a cost to remove of $40,000, and scrap salvage value of $10,000. Kore's effective tax rate is 40 percent. What is the appropriate "end- of-life" cash flow related to these items that should be used in the analysis?

A. $27,000 B. $12,000 C. $(18,000) D. $(30,000)
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. $12,000 "end-of-life" cash flow.
The $75,000 loss on disposal is a non-cash reduction in taxable income that will reduce taxes paid by $30,000 (75,000 × 40%).
The cost to remove the equipment is a cash expense that will reduce taxable income by $40,000 and reduce taxes paid by $16,000 (40,000 × 40%), resulting in a net cash expense of $24,000 ($40,000 minus $16,000, or $40,000 × 60%).
The $10,000 salvage value will increase after-tax cash flow by $6,000 (10,000 × 60%).
Choices "a", "c", and "d" are incorrect, per the above calculation.
QUESTION 345
Which one of the following is most relevant to a manufacturing equipment replacement decision?

A. Originalcostoftheoldequipment.
B. Disposalpriceoftheoldequipment.
C. Gain or loss on the disposal of the old equipment.
D. A lump-sum write-off amount from the disposal of the old equipment.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Rule: Relevant costs are only those costs that will differ among many alternatives.
Choice "b" is correct. The disposal price of the old equipment is most relevant because it is an expected future inflow that will differ among alternatives. If this old equipment is replaced, there will be a cash inflow from the sale of the old equipment. If the old equipment is kept, there will be no cash inflow from the sale of the old equipment.
Choice "a" is incorrect. The original cost of the old equipment is a sunk cost and, therefore, not relevant.
Choice "c" is incorrect. The gain or loss on the disposal of the old equipment is not relevant. The gain or loss is an accounting computation that combines the book value, which is always not relevant, and the disposal value, which is relevant. The result is meaningless to future decisions and, therefore, is not relevant.
Choice "d" is incorrect. The book value is not relevant to future decisions because the undepreciated sunk cost of an asset will only reduce net income in the future as either depreciation expense or as a loss on disposal.
QUESTION 346
Lawson Inc. is expanding its manufacturing plant, which requires an investment of $4 million in new equipment and plant modifications. Lawson's sales are expected to increase by $3 million per year as a result of the expansion. Cash investment in current assets averages 30 percent of sales; accounts payable and other current liabilities are 10 percent of sales. What is the estimated total investment for this expansion?
A. $3.4million. B. $4.3million. C. $4.6 million. D. $4.9 million.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:

Rule: The expansion of working capital (WC = CA-CL) is treated as an increase in investment. Choice "c" is correct. $4.6 million estimated total investment for this expansion.
Choices "a", "b", and "d" are incorrect, per the above calculation.
QUESTION 347
All of the following items are included in discounted cash flow analysis, except:
A. Futureoperatingcashsavings.
B. Thecurrentassetdisposalprice.
C. The future asset depreciation expense.
D. The tax effects of future asset depreciation.
Correct Answer: C
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "c" is correct. The future asset depreciation expense is not included in discounted cash flow analysis. Choices "a", "b", and "d" are incorrect. All of these are included in discounted cash flow analysis:
· Future operating cash savings
· Current asset disposal price
· Tax effects of future asset depreciation · Future asset disposal price
QUESTION 348
The method that recognizes the time value of money by discounting the after-tax cash flows over the life of a project, using the company's minimum desired rate of return is the:
A. Accountingrateofreturnmethod.

B. Netpresentvaluemethod.
C. Internal rate of return method. D. Payback method.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct. The net present value method recognizes the time value of money and discounts cash flows over the life of a project, using the minimum desired (hurdle) rate. Choice "a" is incorrect. The accounting rate of return is the accrual accounting increase compared to the initial investment.
Choice "c" is incorrect. IRR is similar to NPV, but does not assume a desired rate of return. The rate is calculated that produces a NPV of zero.
Choice "d" is incorrect. Payback method does not recognize the time value of money.
QUESTION 349
In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1, 1997. The following information is being considered by Gunning Industries.
· The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000.
· The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs are comprised of $30 per unit in variable costs and total fixed costs of $40,000 per year.
· The investment in the new machine will require an immediate increase in working capital of $35,000. · Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of five years and zero salvage value. · Gunning is subject to a 40 percent corporate income tax rate. Gunning uses the net present value method to analyze investments and will employ the following factors and rates.
Gunning Industries' net cash outflow in a capital budgeting decision would be: A. $190,000

B. $195,000 C. $204,525 D. $225,000
Correct Answer: D
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "d" is correct. $225,000 net cash outflow.
Choices "a", "b", and "c" are incorrect, per the above calculation. Note: This question is the first from a series of questions on a prior exam. The last in the series is presented for you in the regular homework questions (not the supplemental questions) for this chapter.
QUESTION 350
A company has unlimited capital funds to invest. The decision rule for the company to follow in order to maximize shareholders' wealth is to invest in all projects having a (n):
A. Presentvaluegreaterthanzero.
B. Netpresentvaluegreaterthanzero.
C. Internal rate of return greater than zero.
D. Accounting rate of return greater than the hurdle rate used in capital budgeting analyses.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:

Choice "b" is correct.
Rule: If the net present value is positive (greater than zero), a project should be accepted, unless there is a better project. If, however, a company has unlimited funds, all projects with a net present value greater than zero should be accepted in order to maximize shareholder wealth. Choice "a" is incorrect. Considering only present value greater than zero accounts for future net cash inflows, but it ignores cash outflows from the initial capital investment. Choice "c" is incorrect. Considering only internal rate of return greater than zero may result in the acceptance of a project with an internal rate of return less than the company's minimum desired rate of return.
Choice "d" is incorrect. Considering only accounting rate of return greater than hurdle rate ignores the time value of money.
QUESTION 351
When determining net present value in an inflationary environment, adjustments should be made to:
A. Increasethediscountrate,only.
B. Increasetheestimatedcashinflowsandincreasethediscountrate. C. Increase the estimated cash inflows but not the discount rate.
D. Decrease the estimated cash inflows and increase the discount rate.
Correct Answer: B
Section: Business Environment and Concepts (Volume C) Explanation
Explanation/Reference:
Explanation:
Choice "b" is correct.
Rule: In an inflationary environment, future cash flows (except for cash flows generated from the tax effect of depreciation) should be increased to the extent of predicted inflation. For internal consistency, an inflationary factor should also be added to the discount rate. Choices "a", "c", and "d" are incorrect, per the above Explanation:.