FAR EASTERN UNIVERSITY MANAGEMENT ADVISORY SERVICES MIDTERM

EXAMINATION SUMMER 2019

ECONOMICS
1. The law of demand illustrates a(n) ____ relationship between price and ____.
a. direct; quantity demanded
b. inverse; quantity demanded
c. inverse; demand
d. direct; demand
ANS: B PTS: 1

Figure 4-1

2. Refer to Figure 4-1. Using the graph and beginning on D1, a shift to D0 would indicate a(n):
a. increase in demand.
b. decrease in demand.
c. increase in quantity demanded.
d. decrease in quantity demanded.
e. increase in supply.
ANS: B PTS: 1

3. Refer to Figure 4-1. Using the graph and beginning on D1, a shift to D2 would indicate a(n):
a. increase in demand.
b. decrease in demand.
c. increase in quantity demanded.
d. decrease in quantity demanded.
e. increase in supply.
ANS: A PTS: 1

4. If an increase in the price of Product X causes an increase in the demand for Product Y, we can conclude
that:
a. Products X and Y are complements.
b. Products X and Y are substitutes.
c. Products X and Y are normal goods.
d. The price of Product Y will decrease.
e. Products X and Y are inferior goods.
ANS: B PTS: 1
5. Whenever the price of Good A decreases, the demand for Good B increases. Good A and B appear to be:
a. complements.
b. substitutes.
c. inferior goods.
d. normal goods.
e. inverse goods.
ANS: A PTS: 1

Figure 5-6

6. Refer to Figure 5-6. At a market price of P4, which of following conditions exist?
a. Shortage
b. Surplus
c. Equilibrium
d. Any of the above
ANS: B PTS: 1

7. Refer to Figure 5-6. The equilibrium price is:

a. P3
b. P1
c. P4
d. Indeterminate
ANS: A PTS: 1

8. Refer to Figure 5-6. At a market price of P2, which of following conditions exist?
a. Shortage
b. Surplus
c. Equilibrium
d. Either a or b
ANS: A PTS: 1
 9. What type of demand curve is depicted by the graph below?

a. perfectly inelastic
b. perfectly elastic
c. unit elastic
d. relatively inelastic
ANS: A PTS: 1

10. The price of a new toy increases from P5 to P7 and the quantity demanded decreases from 12,000 to
6,000 per month as a result. Based on this information, the price elasticity of demand (in absolute terms)
is estimated to be equal to:
a. 0.5, indicating relatively elastic demand.
b. 0.5, indicating relatively inelastic demand.
c. 2.0, indicating relatively elastic demand.
d. 2.0, indicating relatively inelastic demand.
e. 1.0.
ANS: C PTS: 1

COST BEHAVIOR
Use the following to answer questions 11-14:

Johnson Company has provided the following data for the first five months of the year:

Machine Hours Lubrication Cost

January ..................... 120 P750
February ................... 160 P800
March ....................... 200 P870
April ......................... 150 P790
May .......................... 170 P840

11. Using the high-low method of analysis, the estimated variable lubrication cost per machine hour
is closest to:
A) P1.40
B) P1.25
C) P0.67
D) P1.50
Ans: D

Solution:

Variable cost = Change in cost ÷ Change in activity

 = (P870 – P750) ÷ (200 – 120) = P1.50

12. Using the high-low method of analysis, the estimated monthly fixed component of lubrication
cost is closest to:
A) P570
B) P560
C) P585
D) P565
Ans: A
Solution:

Variable cost = Change in cost ÷ Change in activity

= (P870 − P750) ÷ (200 − 120) = P1.50

Fixed cost element = Total cost − Variable cost element

= P870 − (P1.50 × 200) = P570

13. Using the least-squares regression method of analysis, the estimated variable lubrication cost per
machine hour is closest to:
A) P0.80
B) P1.56
C) P1.40
D) P1.28
Ans: B

The solution using Microsoft Excel functions is:

slope = P1.56 per machine-hour

14. Using the least-squares regression method of analysis, the estimated monthly fixed
component of lubrication cost is closest to:
A) P561
B) P580
C) P525
D) P572
Ans: A

Solution:

The solution using Microsoft Excel functions is:

intercept = P561 per month
Use the following to answer questions 15-17:

An income statement for Crandall's Bookstore for the first quarter of the current year is presented below:

Sales ................................................................ P800,000

Cost of goods sold .......................................... 560,000
Gross margin................................................... 240,000
Selling and administrative expenses:
Selling.......................................................... P98,000
Administrative ............................................. 98,000 196,000
Net operating income ...................................... P 44,000

On average, a book sells for P50. Variable selling expenses are P5.50 per book, with the remaining selling
expenses being fixed. The variable administrative expenses are 3% of sales, with the remainder being
fixed.
15. The contribution margin for Crandall's Bookstore for the first quarter is:
A) P688,000
B) P128,000
C) P152,000
D) P240,000
Ans: B Solution:

Sales ................................................................ P800,000

Variable expenses:
Cost of goods sold ....................................... P560,000
Administrative (3% × P800,000)................. 24,000
Selling expense (P5.50 × 16,000*).............. 88,000 672,000
Contribution margin........................................ P128,000
* P800,000 ÷ P50 average price per unit = 16,000 units sold

16. The net operating income using the contribution approach for the first quarter is:
A) P240,000
B) P152,000
C) P44,000
D) P128,000
Ans: C
 Solution:

Sales ............................................................................... P800,000

Variable expenses:
Cost of goods sold....................................................... P560,000
Administrative (3% × P800,000) ................................ 24,000
Selling expense (P5.50 × 16,000*) ............................. 88,000 672,000
Contribution margin ....................................................... 128,000
Fixed expenses:
Administrative expense (P98,000 − P24,000) ............ 74,000
Selling expense (P98,000 − P88,000) ......................... 10,000 84,000
Net operating income ..................................................... P 44,000
* P800,000 ÷ P50 average price per unit = 16,000 units sold

17. The cost formula for selling and administrative expenses with “X” equal to the number of books
sold is:
A) Y = P84,000 + P35X
B) Y = P84,000 + P42X
C) Y = P98,000 + P35X
D) Y = P98,000 + P42X

Ans: B
Solution:

Sales ............................................................................ P800,000

Variable expenses:
Cost of goods sold ................................................... P560,000
Administrative (3% × P800,000)............................. 24,000
Selling expense (P5.50 × 16,000*).......................... 88,000 672,000
Contribution margin.................................................... 128,000
Fixed expenses:
Administrative expense (P98,000 − P24,000) ......... 74,000
Selling expense (P98,000 − P88,000) ..................... 10,000 84,000
Net operating income .................................................. P 44,000
* P800,000 ÷ P50 average sales price = 16,000 units sold

Total variable cost per unit = P672,000 ÷ 16,000 units = P42 per unit
Total fixed costs = P10,000 + P74,000 = P84,000

Y = P84,000 + P42X

18. In the standard cost formula Y = a + bX, what does the “Y” represent?
A) total cost
B) total fixed cost
C) total variable cost
D) variable cost per unit
 Ans: A
19. In the standard cost formula Y = a + bX, what does the “a” represent?
A) total cost
B) total fixed cost
C) total variable cost
D) variable cost per unit
Ans: B
21. In the standard cost formula Y = a + bX, what does the “b” represent?
A) total cost
B) total fixed cost
C) total variable cost
D) variable cost per unit
Ans: D
20. In the standard cost formula Y = a + bX, what does the “X” represent?
A) total cost
B) total fixed cost
C) units of activity
D) variable cost per unit
Ans: C
CVP
21. If both the fixed and variable expenses associated with a product decrease, what will be the effect
on the contribution margin ratio and the break-even point, respectively?
Contribution margin ratio Break-even point
A) Decrease Increase
B) Increase Decrease
C) Decrease Decrease
D) Increase Increase
Ans: B
22. Which of the following is true regarding the contribution margin ratio of a single product
company?
A) As fixed expenses decrease, the contribution margin ratio increases.
B) The contribution margin ratio multiplied by the selling price per unit equals the
contribution margin per unit.
 C) The contribution margin ratio will decline as unit sales decline.
D) The contribution margin ratio equals the selling price per unit less the variable expense
ratio.
Ans: B
23. If a company is operating at the break-even point:
A) its contribution margin will be equal to its variable expenses.
B) its margin of safety will be equal to zero.
C) its fixed expenses will be equal to its variable expenses.
D) its selling price will be equal to its variable expense per unit.
Ans: B
24. At the break-even point:
A) sales would be equal to contribution margin.
B) contribution margin would be equal to fixed expenses.
C) contribution margin would be equal to net operating income.
D) sales would be equal to fixed expenses.
Ans: B
25. The break-even point would be increased by:
A) a decrease in total fixed expenses.
B) a decrease in the ratio of variable expenses to sales.
C) an increase in the contribution margin ratio.
D) none of these.
Ans: D
26. The Bronco Birdfeed Company reported the following information:

Sales (400 cases) ................................ P100,000

Variable expenses .............................. 60,000
Contribution margin........................... 40,000
Fixed expenses ................................... 35,000
Net operating income ......................... P5,000

How much will the sale of one additional case add to Bronco's net operating income?
A) P250.00
 B) P100.00
C) P150.00
D) P12.50
Ans: B
Current contribution margin ÷ Current sales in cases = Contribution margin per case
P40,000 ÷ 400 = P100 contribution margin per case
If one additional case is sold, net operating income will increase by P100.\
27. The margin of safety in the Flaherty Company is P24,000. If the company's sales are P120,000
and its variable expenses are P80,000, its fixed expenses must be:
A) P8,000
B) P32,000
C) P24,000
D) P16,000
Ans: B
Current sales - Breakeven sales = Margin of safety
Substituting the given information into the above equation, we will have:
P120,000 - Breakeven sales = P24,000
Breakeven sales = P96,000
Sales - Variable expenses = Contribution margin
P120,000 - P80,000 = P40,000
Contribution margin ratio = Contribution margin ÷ Sales
Contribution margin ratio = P 40,000 ÷ P120,000
Contribution margin ratio = 0.33333
Breakeven sales = Fixed costs ÷ Contribution margin ratio
Substituting the given information into the above equation, we will have:
P96,000 = Fixed costs ÷ 0.33333
Fixed costs = P32,000
28. Dodero Company produces a single product which sells for P100 per unit. Fixed expenses total
P12,000 per month, and variable expenses are P60 per unit. The company's sales average 500
units per month. Which of the following statements is correct?
A) The company's break-even point is P12,000 per month.
B) The fixed expenses remain constant at P24 per unit for any activity level within the
relevant range.
C) The company's contribution margin ratio is 40%.
D) Responses A, B, and C are all correct.
Ans: C
Answer A is not correct because:
Sales = Variable expenses + Fixed expenses + Profit
P100Q = P60Q + P12,000 + P0
P40Q = P12,000
Q = P12,000 ÷ P40 per unit = 300 units
300 units × P100 selling price per unit = P30,000 breakeven sales in pesos
Answer B is not correct because fixed costs change as activity level changes
Answer C is correct because:
Contribution margin per unit = Selling price per unit - Variable expenses per unit
= P100 - P60 = P40
Contribution margin ratio = Contribution margin per unit ÷ Selling price per unit
Contribution margin ratio = P40 ÷ P100
Contribution margin ratio = 40%

29. Holt Company's variable expenses are 70% of sales. At a P300,000 sales level, the degree of
operating leverage is 10. If sales increase by P60,000, the degree of operating leverage will be:
A) 12
B) 10
C) 6
D) 4
Ans: D
Solution:

Sales ............................................................... P300,000

Variable expenses (P300,000 × 70%) ............ 210,000
Contribution margin....................................... 90,000
Fixed expenses ............................................... ?
Net operating income ..................................... P ?

Current degree of operating leverage = Current contribution margin ÷ Current net operating
income
 10 = P90,000 ÷ Current net operating income
Current net operating income = P90,000 ÷ 10 = P9,000
Contribution margin = Fixed expenses - Net operating income
P90,000 = Fixed expenses - P9,000
Fixed expenses = P90,000 - P9,000 = P81,000

Sales (P300,000 + P60,000)........................... P360,000

Variable expenses (P360,000 × 70%) ............ 252,000
Contribution margin....................................... 108,000
Fixed expenses ............................................... 81,000
Net operating income ..................................... P 27,000

Degree of operating leverage = Contribution margin ÷ Net operating income

= P108,000/P27,000 = 4.0

30. Gayne Corporation's contribution margin ratio is 12% and its fixed monthly expenses are
P84,000. If the company's sales for a month are P738,000, what is the best estimate of the
company's net operating income? Assume that the fixed monthly expenses do not change.
A) P565,440
B) P654,000
C) P88,560
D) P4,560
Ans: D
Sales ............................................................... P738,000
Variable expenses (P738,000 × 88%) ............ 649,440
Contribution margin (P738,000 × 12%) ........ 88,560
Fixed expenses ............................................... 84,000
Net operating income ..................................... P 4,560

VARIABLE FULL COSTING

31. Fleet Corporation produces a single product. The company manufactured 700 units last year. The
ending inventory consisted of 100 units. There was no beginning inventory. Variable
manufacturing costs were P6.00 per unit and fixed manufacturing costs were P2.00 per unit. What
would be the change in the peso amount of ending inventory if variable costing was used instead
of absorption costing?
A) P800 decrease
B) P200 decrease
C) P0
D) P200 increase
Ans: B
Solution:
 Change in inventory × Fixed manufacturing costs per unit
= 100 × P2 = P200 decrease
Use the following to answer questions 32-35:
Jarbo Company, which has only one product, has provided the following data concerning its most recent
month of operations:

Selling price .................................................... P129

Units in beginning inventory .......................... 500

Units produced ................................................ 3,600
Units sold ........................................................ 3,800
Units in ending inventory ............................... 300

Variable costs per unit:

Direct materials ........................................... P13
Direct labor .................................................. P59
Variable manufacturing overhead ............... P4
Variable selling and administrative ............. P8

Fixed costs:
Fixed manufacturing overhead .................... P97,200
Fixed selling and administrative.................. P64,600

The company produces the same number of units every month, although the sales in units vary from
month to month. The company's variable costs per unit and total fixed costs have been constant from
month to month.

32. What is the unit product cost for the month under variable costing?
A) P76
B) P103
C) P84
D) P111
Ans: A
Solution:

Unit product cost = Direct materials + Direct labor + Variable manufacturing overhead = P13 +
P59 + P4 = P76
33. What is the unit product cost for the month under absorption costing?
A) P84
B) P76
C) P103
D) P111
Ans: C
Unit fixed manufacturing overhead = P97,200 ÷ 3,600 = P27
Unit product cost = Direct materials + Direct labor + Variable manufacturing overhead + Fixed
manufacturing overhead = P13 + P59 + P4 + P27 = P103

34. What is the net operating income for the month under variable costing?
A) P3,800
B) P24,400
C) P9,200
D) P8,100
Ans: C
Solution:

Sales revenue (P129 × 3,800) ....................................... P490,200

Variable costs:
Variable cost of goods sold (P76 × 3,800) ................ P288,800

Variable selling and administrative (P8 × 3,800)...... 30,400 319,200

Contribution margin ..................................................... 171,000
Fixed costs:
Fixed manufacturing overhead.................................. P 97,200
Fixed selling and administrative ............................... 64,600 161,800
Net operating income ................................................... P 9,200
35. What is the net operating income for the month under absorption costing?
A) P8,100
B) P9,200
C) P3,800
D) P24,400
Ans: C
Solution:

Sales revenue (P129 × 3,800) ....................................... P490,200

Cost of goods sold (P103 × 3,800) ............................... 391,400
Gross margin................................................................. 98,800
Selling and administrative expenses costs:
Variable selling and administrative (P8 × 3,800) ...... P30,400
Fixed selling and administrative................................ 64,600 95,000
Net operating income .................................................... P 3,800

36. When sales are constant, but the production level fluctuates, net operating income determined by
the variable costing method will:
A) fluctuate in direct proportion to changes in production.
B) remain constant.
C) fluctuate inversely with changes in production.
D) be greater than net operating income under absorption costing.
Ans: B
37. Under the variable costing method, which of the following is always expensed in its entirety in
the period in which it is incurred?
A) fixed manufacturing overhead cost
B) fixed selling and administrative expense
C) variable selling and administrative expense
D) all of the above
Ans: D
38. Net operating income under variable and absorption costing will generally:
A) always be equal.
B) never be equal.
C) be equal only when production and sales are equal.
 D) be equal only when production exceeds sales.
Ans: C
39. When production exceeds sales, net operating income reported under variable costing generally
will be:
A) greater than net operating income reported under absorption costing.
B) less than net operating income reported under absorption costing
C) equal to net operating income reported under absorption costing.
D) higher or lower because no generalization can be made.
Ans: B
40. Net operating income under absorption costing may differ from net operating income determined
under variable costing. How is this difference calculated?
A) change in the quantity of units in inventory times the fixed manufacturing overhead rate
per unit.
B) number of units produced during the period times the fixed manufacturing overhead rate
per unit.
C) change in the quantity of units in inventory times the variable manufacturing cost per unit.
D) number of units produced during the period times the variable manufacturing cost per unit.
Ans: A
RELEVANT COSTING
41. Which of the following best describes an opportunity cost:
A) it is a relevant cost in decision making, but is not part of the traditional accounting records.
B) it is not a relevant cost in decision making, but is part of the traditional accounting records.
C) it is a relevant cost in decision making, and is part of the traditional accounting records.
D) it is not a relevant cost in decision making, and is not part of the traditional accounting
records.
Ans: A

\ 42. Gandy Company has 5,000 obsolete desk lamps that are carried in inventory at a manufacturing
cost of P50,000. If the lamps are reworked for P20,000, they could be sold for P35,000.
Alternatively, the lamps could be sold for P8,000 for scrap. In a decision model analyzing these
alternatives, the sunk cost would be:
A) P8,000
B) P15,000
C) P20,000
 D) P50,000
Ans: D
43. Hodge Inc. has some material that originally cost P74,600. The material has a scrap value of
P57,400 as is, but if reworked at a cost of P1,500, it could be sold for P54,400. What would be
the incremental effect on the company's overall profit of reworking and selling the material rather
than selling it as is as scrap?
A) -P79,100
B) -P21,700
C) -P4,500
D) P52,900
Ans: C
Incremental revenue from reworking (P54,400 − P1,500) ........ P52,900
Less incremental revenue from selling as scrap ........................ 57,400
Net loss from reworking ............................................................ (P 4,500)

44. Motor Company manufactures 10,000 units of Part M-l each year for use in its production. The
following total costs were reported last year:

Direct materials ............................................... P 20,000

Direct labor ...................................................... 55,000
Variable manufacturing overhead ................... 45,000
Fixed manufacturing overhead ........................ 70,000
Total manufacturing cost ................................. P190,000

Valve Company has offered to sell Motor 10,000 units of Part M-l for P18 per unit. If Motor
accepts the offer, some of the facilities presently used to manufacture Part M-l could be rented to
a third party at an annual rental of P15,000. Additionally, P4 per unit of the fixed overhead
applied to Part M-l would be totally eliminated. Should Motor Company accept Valve Company's
offer, and why?
A) No, because it would be P5,000 cheaper to make the part.
B) Yes, because it would be P10,000 cheaper to buy the part.
C) No, because it would be P15,000 cheaper to make the part.
D) Yes, because it would be P25,000 cheaper to buy the part.
Ans: A
Relevant cost of manufacturing:
Direct materials ............................................................ P 20,000
 Direct labor ................................................................... 55,000
Variable manufacturing overhead ................................ 45,000
Fixed manufacturing overhead (P4 × 10,000) .............. 40,000
Relevant manufacturing cost ........................................ P160,000

Net advantage (disadvantage):

Relevant manufacturing cost savings ................. P160,000
Annual rental of manufacturing facilities given
up if manufacture Part M-1 ............................ 15,000
Cost of purchasing the part (P18 × 10,000)........ ( 180,000)
Net disadvantage of purchasing part M-1 .......... (P 5,000)

45. Rice Corporation currently operates two divisions which had operating results last year as
follows:

West Troy
Division Division
Sales ................................................................ P600,000 P300,000
Variable costs .................................................. 310,000 200,000
Contribution margin ........................................ 290,000 100,000
Traceable fixed costs ....................................... 110,000 70,000
Allocated common corporate costs ................. 90,000 45,000
Net operating income (loss) ............................ P 90,000 (P 15,000)

Since the Troy Division also sustained an operating loss in the prior year, Rice's president is
considering the elimination of this division. Troy Division's traceable fixed costs could be
avoided if the division were eliminated. The total common corporate costs would be unaffected
by the decision. If the Troy Division had been eliminated at the beginning of last year, Rice
Corporation's operating income for last year would have been:
A) P15,000 higher
B) P30,000 lower
C) P45,000 lower
D) P60,000 higher
Ans: B
Solution:

Troy Division:
Contribution margin .................................................................. P100,000
Less: traceable fixed costs ......................................................... 70,000
Segment margin of Troy Division ............................................. P 30,000
 Rice Corporation’s operating income would have been P30,000 less without the segment margin
contributed by the Troy Division.

46. Holden Company produces three products, with costs and selling prices as follows:

Product A Product B Product C

Selling price per unit .................... P30 100% P20 100% P15 100%
Variable costs per unit ................. 18 60% 15 75% 6 40%
Contribution margin per unit ....... P12 40% P5 25% P9 60%

A particular machine is a bottleneck. On that machine, 3 machine hours are required to produce
each unit of Product A, 1 hour is required to produce each unit of Product B, and 2 hours are
required to produce each unit of Product C. In which order should it produce its products?
A) C, A, B
B) A, C, B
C) B, C, A
D) The order of production doesn't matter.
Ans: C

Product A Product B Product C

Contribution margin per unit..................... P12 P5 P9
Machine-hours per unit ............................. 3 1 2
Contribution margin per hour ................... P4.00 P5.00 P4.50

Rank in terms of profitability .................... 3 1 2

47. The constraint at Rauchwerger Corporation is time on a particular machine. The company makes
three products that use this machine. Data concerning those products appear below:

WX KD FS
Selling price per unit .......................... P192.00 P542.66 P222.84
Variable cost per unit ......................... P158.72 P420.54 P167.76
Minutes on the constraint ................... 3.20 8.60 3.60

Assume that sufficient time is available on the constrained machine to satisfy demand for all but
the least profitable product. Up to how much should the company be willing to pay to acquire
more of the constrained resource?
A) P33.28 per unit
B) P10.40 per minute
 C) P122.12 per unit
D) P15.30 per minute
Ans: B
Solution:

WX KD FS
Selling price per unit ................................. P192.00 P542.66 P222.84
Variable cost per unit ................................ 158.72 420.54 167.76
Contribution margin per unit ..................... P33.28 P122.12 P55.08
Machine minutes per unit .......................... 3.20 8.60 3.60
Contribution margin per minute ................ P10.40 P14.20 P15.30

Rank in terms of profitability .................... 3 2 1

The company should be willing to pay up to the contribution margin per minute for the least
profitable job, which is P10.40.

48. The Freed Company produces three products, X, Y, Z, from a single raw material input. Product
Y can be sold at the splitoff point for total revenues of P50,000, or it can be processed further at a
total cost of P16,000 and then sold for P68,000. Product Y:
A) should be sold at the split-off point, rather than processed further.
B) would increase the company's overall net operating income by P18,000 if processed further
and then sold.
C) would increase the company's overall net operating income by P68,000 if processed further
and then sold.
D) would increase the company's overall net operating income by P2,000 if processed further
and then sold.
Ans: D
Product Y
Sales value after further processing ................ P68,000
Costs of further processing ............................. 16,000
Benefit of further processing........................... 52,000
Less: Sales value at split-off point .................. 50,000
Net advantage.................................................. P 2,000

49. Faustina Chemical Company manufactures three chemicals (TX14, NJ35, and KS63) from a joint
process. The three chemicals are in industrial grade form at the split-off point. They can either be
sold at that point or processed further into premium grade. Costs related to each batch of this
chemical process is as follows:
 TX14 NJ35 KS63
Sales value at split-off point ............................ P16,000 P12,000 P5,000
Allocated joint costs ........................................ P6,000 P6,000 P6,000
Sales value after further processing ................. P20,000 P18,000 P9,000
Cost of further processing ................................ P5,000 P3,000 P2,000

For which product(s) above would it be more profitable for Faustina to sell at the split-off point
rather than process further?
A) TX14 only
B) KS63 only
C) TX14 and KS63 only
D) NJ35 and KS63 only
Ans: A
TX14 NJ35 KS63
Sales value after further processing .......... P20,000 P18,000 P9,000
Sales value at split-off ............................... 16,000 12,000 5,000
Incremental revenue .................................. 4,000 6,000 4,000
Further processing costs ............................ 5,000 3,000 2,000
Incremental income (loss) ......................... (P1,000) P 3,000 P2,000

Product TX14 should be sold at the split-off point without any further processing. Products NJ35
and KS63 should be sold after further processing beyond the split-off point.

50. Khiem, Inc. manufactures baseball gloves that normally sell for P55 each. Khiem currently has
400 defective gloves in inventory that have P35 of materials, labor, and overhead assigned to
each glove. The defective gloves can either be completely repaired at a cost of P25 per glove or
sold as is at a reduced price of P18 per glove. Khiem would be better off by:
A) P2,000 to sell the gloves at the reduced price.
B) P2,800 to sell the gloves at the reduced price.
C) P4,800 to repair the gloves and sell them at the normal price.
D) P5,200 to sell the gloves at the reduced price.
Ans: C
Sales value after repairing (P55 × 400) ........................ P22,000
Sales value at split-off (P18 × 400) .............................. 7,200
Incremental revenue ..................................................... 14,800
Repair costs (P25 × 400) .............................................. 10,000
Incremental income from further processing ............... P 4,800

CAPITAL BUDGETING
51. Suture Corporation's discount rate is 12%. If Suture has a 5-year investment project that has a
 project profitability index of one, this means that:
A) the net present value of the project is equal to zero.
B) the internal rate of return of the project is equal to the discount rate.
C) the payback period of the project is equal to the project's useful life.
D) both A and B above are true.
Ans: D

52. Amster Corporation has not yet decided on the required rate of return to use in its capital
budgeting. This lack of information will prevent Amster from calculating a project's:

Payback Net Present Value Internal Rate of Return

A) No No No
B) Yes Yes Yes
C) No Yes Yes
D) No Yes No

Ans: D
53. If income taxes are ignored, how is depreciation used in the following capital budgeting
techniques?

Internal Rate of Return Net Present Value

A) Excluded Excluded
B) Excluded Included
C) Included Excluded
D) Included Included

Ans: A
54. If the net present value of a project is zero based on a discount rate of 16%, then the internal rate
of return is:
A) equal to 16%.
B) less than 16%.
C) greater than 16%.
D) cannot be determined from this data.
Ans: A
55. Three potential investment projects (A, B, and C) at Nit Corporation all require the same initial
 investment, have the same useful life (3 years), and have no expected salvage value. Expected net
cash inflows from these three projects each year is as follows:
A B C
Year 1 .......... P1,000 P2,000 P3,000
Year 2 .......... P2,000 P2,000 P2,000
Year 3 .......... P3,000 P2,000 P1,000

What can be determined from the information provided above?

A) the net present value of project C will be the highest.
B) the internal rate of return of projects A and C cannot be computed.
C) the net present value and the internal rate of return will be the same for all three projects.
D) both A and B above.
Ans: A
56. (Ignore income taxes in this problem.) Given the following data:

Cost of equipment .................. P55,750

Annual cash inflows .............. P10,000
Internal rate of return ............. 16%

The life of the equipment must be:

A) it is impossible to determine from the data given
B) 15 years
C) 12.5 years
D) 5.75 years
Ans: B Solution:
The internal rate of return factor is 5.575, or P55,750 ÷ P10,000. In the table for the Present
Value of an Annuity of P1 in Arrears, the factor of 5.575 can be found in the 16% column in the
15th row; 15 then represents the life of the equipment.
57. (Ignore income taxes in this problem.) Heap Company is considering an investment in a project
that will have a two year life. The project will provide a 10% internal rate of return, and is
expected to have a P40,000 cash inflow the first year and a P50,000 cash inflow in the second
year. What investment is required in the project?
A) P74,340
B) P77,660
C) P81,810
 D) P90,000
Ans: B
Solution:

Year(s) Amount 10% Factor PV

Cash inflow−1st year ............. 1 40,000 0.909 P36,360
Cash inflow−2nd year ............ 2 50,000 0.826 41,300
Net present value................... P77,660

For the net present value of this project to be zero, the initial investment should be equal to the
present value of the cash inflows, or P77,660.

58. (Ignore income taxes in this problem.) Congener Beverage Corporation is considering an
investment in a capital budgeting project that has an internal rate of return of 20%. The only cash
outflow for this project is the initial investment. The project is estimated to have an 8 year life
and no salvage value. Cash inflows from this project are expected to be P100,000 per year in each
of the 8 years. Congener's discount rate is 16%. What is the net present value of this project?
A) P5,215
B) P15,464
C) P50,700
D) P55,831
Ans: C
Solution:
Internal rate of return factor = Initial investment ÷ Annual inflows
Look up the factor in the table Present Value of an Annuity of P1 in Arrears for 8 periods, 20%
column; the factor is 3.837. Substituting into the above equation, 3.837 = Initial investment ÷
P100,000
Initial investment = P383,700.

Year(s) Amount 16% Factor PV

Initial investment .................. Now (P383,700) 1.000 (P383,700)
Annual net cash receipts ....... 1-8 P100,000 4.344 434,400
Net present value................... P 50,700

59. (Ignore income taxes in this problem.) The Able Company is considering buying a new donut
maker. This machine will replace an old donut maker that still has a useful life of 2 years. The
new machine will cost P2,500 a year to operate, as opposed to the old machine, which costs
P2,700 per year to operate. Also, because of increased capacity, an additional 10,000 donuts a
 year can be produced. The company makes a contribution margin of P0.02 per donut. The old
machine can be sold for P5,000 and the new machine costs P25,000. The incremental annual net
cash inflows provided by the new machine would be:
A) P200
B) P400
C) P5,200
D) P5,400
Ans: B
Solution:

Operating cost savings per year (P2,700 − P2,500) ................................. P200

Additional contribution margin provided by the new donut maker
(P0.02 × 10,000)................................................................................... 200
Incremental annual net cash inflows provided by new machine .............. P400

60. (Ignore income taxes in this problem.) Given the following data:

Initial investment ................... P80,000

Annual cash inflow ................ ?
Salvage value ......................... P0
Net present value ................... P13,600
Life of the project .................. 6 years
Discount rate .......................... 16%

Based on the data given above, the annual cash inflow from the project after the initial investment
is closest to:
A) P50,116
B) P21,710
C) P25,400
D) P38,376
Ans: C
Solution:

First, set up table:

Year(s) Amount 16% Factor PV
Initial investment .................. Now P80,000 1.000 (P80,000)
 Annual cash inflows .............. 1-6 ? 3.685 ?
Net present value................... P13,600

Second, solve for the present value of the annual cash inflow:
PV of annual cash inflow = P13,600 − (-P80,000) = P93,600
Finally, solve for the annual cash inflow:
Annual cash inflow × 3.685 = P93,600
Annual cash inflow = P25,400

COST OF CAPITAL
61. _________ is the risk to the firm of being unable to cover operating costs.
(a) Total risk
(b) Business risk
(c) Financial risk
(d) Diversifiable risk
Answer: B

62. _________ is the risk to the firm of being unable to cover financial obligations.
(a) Total risk
(b) Business risk
(c) Financial risk
(d) Diversifiable risk
Answer: C
63. Firms underprice new issues of common stock for the following reason(s).
(a) When the market is in equilibrium, additional demand for shares can be achieved only at a
lower price.
(b) When additional shares are issued, each share’s percent of ownership in the firm is diluted,
thereby justifying a lower share value.
(c) Many investors view the issuance of additional shares as a signal that management is using
common stock equity financing because it believes that the shares are currently overpriced.
(d) All of the above.
Answer: D

64. Generally, the order of cost, from the least expensive to the most expensive, for long-term capital of
a corporation is
(a) new common stock, retained earnings, preferred stock, long-term debt.
(b) common stock, preferred stock, long-term debt, short-term debt.
(c) preferred stock, retained earnings, common stock, new common stock.
(d) long-term debt, preferred stock, retained earnings, new common stock.
Answer: D

65. Debt is generally the least expensive source of capital. This is primarily due to
(a) fixed interest payments.
(b) its position in the priority of claims on assets and earnings in the event of liquidation.
(c) the tax deductibility of interest payments.
(d) the secured nature of a debt obligation.
Answer: C

66. The approximate after-tax cost of debt for a 20-year, 7 percent, P1,000 par value bond selling at
P960 (assume a marginal tax rate of 40 percent) is
(a) 4.41 percent.
(b) 5.15 percent.
(c) 7 percent.
(d) 7.35 percent.
Answer: A
67. A firm has determined it can issue preferred stock at P115 per share par value. The stock will pay a
P12 annual dividend. The cost of issuing and selling the stock is P3 per share. The cost of the
preferred stock is
(a) 6.4 percent.
(b) 10.4 percent.
(c) 10.7 percent.
(d) 12 percent.
Answer: C

68. A firm has a beta of 1.2. The market return equals 14 percent and the risk-free rate of return equals
6 percent. The estimated cost of common stock equity is
(a) 6 percent.
(b) 7.2 percent.
(c) 14 percent.
(d) 15.6 percent.
Answer: D

69. A firm has common stock with a market price of P25 per share and an expected dividend of P2 per
share at the end of the coming year. The growth rate in dividends has been 5 percent. The cost of
the firm’s common stock equity is
(a) 5 percent.
(b) 8 percent.
(c) 10 percent.
(d) 13 percent.
Answer: D

70. A firm has determined its cost of each source of capital and optimal capital structure, which is
composed of the following sources and target market value proportions:

Target Market After-Tax

Source of Capital Proportions Cost
Long-term debt 45% 5%
Preferred stock 10 14
Common stock equity 45 22

If the firm were to shift toward a more leveraged capital structure (i.e., a greater percentage of debt
in the capital structure), the weighted average cost of capital would
(a) increase.
(b) remain unchanged.
(c) decrease.
(d) not be able to be determined.
Answer: C