Chapter 2 TCDN 2

A company with high operating leverage typically means:

• A large portion of the company’s costs are variable costs.

• Variable costs increase significantly with sales.

• A large portion of the company’s costs are fixed costs.

• The company is less profitable as sales increase.

According to the sources, the Accounting Rate of Return (ARR) refers to a project's average income expected to be generated by:

• The initial investment in the project.

• The average investment in the project.

• The total cash flows over the project's life

• The net present value of the project

For independent projects, the Payback Rule suggests that projects should be accepted if their payback period is

• Longer than the predetermined length of time

• Equal to the initial investment

• Shorter than the predetermined length of time

• Exactly 3 years

One significant disadvantage of the Payback Rule is that it

• Considers the time value of money

• Provides an insight into risk

• Ignores cash flows beyond the cut-off date

• Is easy to understand and calculate

In accounting/economics, the breakeven point refers to the point at which:

• Total revenues exceed total operating costs

• Total operating costs equal to total revenues.

• A company achieves its maximum profit.

• Fixed costs are covered by sales revenue.

For independent projects, what is the decision rule using the Profitability Index (PI)?

• Projects with PI < 1 should be selected

• Projects with PI > 0 should be selected

• Projects with PI > 1 should be selected

• Projects with the highest PI should be selected

A company with high operating leverage implies that a large portion of its total costs are:

• Variable costs

• Fixed costs

• Opportunity costs

• Sunk costs

The Degree of Operating Leverage (DOL) is calculated using the formula:

• % Change in Sales / % Change in Operating Income

• Total Fixed Costs / Total Variable Costs

• % Change in Operating Income / % Change in Sales

• (Sales - Variable Costs) / Fixed Costs

Business risk is primarily defined as the uncertainty of

• Net Present Value (NPV)

• Earnings before Interest and Taxes (EBIT)

• Market share growth

• The discount rate

A disadvantage of the Internal Rate of Return (IRR) method is that it

• Considers the time value of money

• Is easy to interpret

• May ignore the size of the project

• Uses incremental cash flows