Willis, Inc. has a desired rate of return of 15% and is considering the acquisition of a new machine which costs $400,000 and has a useful life of 5 years. Willis projects that earnings and cash flow will increase as follows:The net present value of Willis' investment is
Answer(s): C
The NPV is calculated by discounting the after-tax cash flows by the desired rate of return. The cash flows of this company constitute an annuity of $100,000 per year plus additional flows of $60,000 in Year 1 and $40,000 in Year 2. Thus, the present value of these flows is $418,600 [($100,000 x 3.36 PV of an annuity of $1 for 5 periods at 15%) + ($60,000 x .87 PV of $1 for 1 period at 15%) + ($40,000 x .76 PV of $1 for 2 periods at 15%)]. The NPV is therefore $18,600 ($418,600 --$400,000).
Cost-volume-profit (CVP) analysis is a key factor in many decisions, including choice of product lines, pricing of products, marketing strategy, and use of productive facilities. A calculation used in a CVP analysis is the breakeven point. Once the breakeven point has been reached, operating income will increase by the
Answer(s): B
At the breakeven point, total revenue equals the fixed cost plus the variable cost. Beyond the BEP, each unit sale will increase operating income by the unit contribution margin (unit sales price--unit variable cost) because fixed cost will already have been recovered.
If inventories are expected to change, the type of costing that provides the best information for breakeven analysis is
A variable (direct) costing system is best for providing the information needed for CVP analysis because both techniques separate the fixed costs from variable costs. CVP analysis calculates a variable cost per unit and deducts it from unit sales price to determine the unit contribution margin. The total contribution margin from a given level of unit sales measures the extent of recovery of fixed costs and the profit earned. Direct costing is likewise oriented toward determination of the contribution margin because it treats fixed manufacturing overhead as a period, not a product, cost. Thus, it facilitates CVP analysis by isolating variable manufacturing costs.
One of the major assumptions limiting the reliability of breakeven analysis is that
The inherent simplifying assumptions used in CVP analysis are the following: Costs and revenues are predictable and are linear over the relevant range; variable costs change proportionally with activity level; changes in inventory are insignificant in amount fixed costs remain constant over the relevant range of volume; prices remain fixed; production equals sales; there is a relevant range in which the various relationships are true for a given time span; all costs are either fixed or variable; productive efficiency is constant; costs vary only with changes in sales volume; and there is a constant mix of products (or only one product).
In working on a CVP analysis1 the accountant is unsure of the exact results and/or assumptions under which to operate. What can the accountant do to help management in this CVP decision?
The assumptions under which CVP analysis operates primarily hinge on certainty. Once [uncertainty enters the situation, the results are not so clear. Thus, the accountant should make an appropriate effort to ascertain the probabilities of various outcomes. The accountant can then work with management to help make the appropriate decision.
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