CHAPTER 26

INCREMENTAL ANALYSIS AND CAPITAL BUDGETING

SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY
Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT
True-False Statements
1. 1 K 9. 2 C 17. 2 C 25. 3 K 33. 2 C
2. 1 K 10. 2 C 18. 2 C 26. 3 C 34. 2 K
3. 1 C 11. 2 K 19. 2 C 27. 3 C 35. 2 C
4. 1 K 12. 2 C 20. 2 C 28. 4 C 36. 3 K
5. 1 K 13. 2 C 21. 2 C 29. 4 C 37. 4 K
6. 1 C 14. 2 C 22. 3 C 30. 4 K
7. 2 C 15. 2 C 23. 3 K 31. 1 K
8. 2 C 16. 2 C 24. 3 K 32. 1 K
Multiple Choice Questions
38. 1 K 63. 2 K 88. 2 C 113. 3 AP 138. 4 K
39. 1 K 64. 2 K 89. 2 AN 114. 3 K 139. 4 C
40. 1 K 65. 2 C 90. 2 C 115. 3 K 140. 4 AN
41. 1 K 66. 2 C 91. 2 C 116. 3 K 141. 4 AN
42. 1 K 67. 2 C 92. 2 C 117. 3 C 142. 4 AP
43. 1 C 68. 2 C 93. 2 C 118. 3 K 143. 4 AP
44. 1 K 69. 2 AN 94. 2 C 119. 3 AP 144. 4 AP
45. 1 C 70. 2 AN 95. 2 C 120. 3 K 145. 4 AP
46. 1 C 71. 2 AN 96. 2 C 121. 3 C 146. 4 C
47. 1 K 72. 2 AN 97. 2 AP 122. 3 AP 147. 4 C
st
48. 1 K 73. 2 AN 98. 2 AP 123. 3 C 148. 1 K
49. 1 C 74. 2 AN 99. 2 AN 124. 4 K 149. 2 AN
st
50. 1 C 75. 2 AN 100. 2 AN 125. 3 AP 150. 2 K
51. 1 C 76. 2 AN 101. 2 C 126. 3 AP 151. 2 C
52. 1 C 77. 2 AN 102. 2 AN 127. 4 AP 152. 2 K
53. 2 AN 78. 2 AP 103. 2 C 128. 3 AP 153. 2 C
st
54. 2 AN 79. 2 AN 104. 2 AN 129. 3 AP 154. 2 K
st
55. 2 C 80. 2 AN 105. 3 AP 130. 4 AP 155. 3 K
56. 2 C 81. 2 AN 106. 3 AP 131. 4 AP 156. 3 K
57. 2 C 82. 2 AN 107. 3 AP 132. 4 AP 157. 3 K
st
58. 2 C 83. 2 AP 108. 3 K 133. 4 AP 158. 4 K
59. 2 C 84. 2 AN 109. 3 K 134. 4 AP 159. 4 K
60. 2 C 85. 2 C 110. 3 C 135. 4 AP
61. 2 AP 86. 2 AN 111. 3 AP 136. 4 AP
62. 2 AP 87. 2 AP 112. 3 C 137. 4 AP
Brief Exercises
160. 1 AP 163. 2 AP 166. 2 AP 169. 4 AP
161. 2 AP 164. 2 AN 167. 3 AP 170. 4 AP
162. 2 AP 165. 2 AN 168. 3 AP

st
This question also appears in a self-test at the student companion website.
26 - 2 Test Bank for Accounting Principles, Twelfth Edition

SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY

Exercises
171. 2 AN 177. 2 AP 183. 2 E 189. 3 AP 195. 4 E
172. 2 AN 178. 2 AN 184. 2 AP 190. 3 AP 196. 4 AP
173. 2 E 179. 2 E 185. 2 E 191. 3,4 E
174. 2 E 180. 2 AP 186. 2 AP 192. 3,4 AP
175. 2 AP 181. 2 E 187. 2 E 193. 4 AP
176. 2 E 182. 2 AN 188. 3 AP 194. 4 E
Completion Statements
197. 1 K 200. 2 K 203. 3 K 206. 3 K 209. 4 K
198. 1 K 201. 2 K 204. 3 K 207. 4 K 210. 4 K
199. 2 K 202. 2 K 205. 3 K 208. 4 K
Matching
211. 2 K
Short-Answer Essay
212. 2 K 214. 2 K 216. 3 K
213. 4 K 215. 3 K 217. 2 K

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Item Type Item Type Item Type Item Type Item Type Item Type Item Type
Learning Objective 1
1. TF 5. TF 38. MC 42. MC 46. MC 50. MC 160. BE
2. TF 6. TF 39. MC 43. MC 47. MC 51. MC 197. C
3. TF 31. TF 40. MC 44. MC 48. MC 52. MC 198. C
4. TF 32. TF 41. MC 45. MC 49. MC 148. MC
Learning Objective 2
7. TF 34. TF 67. MC 83. MC 99. MC 165. BE 185. Ex
8. TF 35. TF 68. MC 84. MC 100. MC 166. BE 186. Ex
9. TF 53. MC 69. MC 85. MC 101. MC 171. Ex 187. Ex
10. TF 54. MC 70. MC 86. MC 102. MC 172. Ex 199. C
11. TF 55. MC 71. MC 87. MC 103. MC 173. Ex 200. C
12. TF 56. MC 72. MC 88. MC 104. MC 174. Ex 201. C
13. TF 57. MC 73. MC 89. MC 149. MC 175. Ex 202. C
14. TF 58. MC 74. MC 90. MC 150. MC 176. Ex 211. MA
15. TF 59. MC 75. MC 91. MC 151. MC 177. Ex 212. SA
16. TF 60. MC 76. MC 92. MC 152. MC 178. Ex 214. SA
17. TF 61. MC 77. MC 93. MC 153. MC 179. Ex 217. SA
18. TF 62. MC 78. MC 94. MC 154. MC 180. Ex
19. TF 63. MC 79. MC 95. MC 161. BE 181. Ex
20. TF 64. MC 80. MC 96. MC 162. BE 182. Ex
21. TF 65. MC 81. MC 97. MC 163. BE 183. Ex
33. TF 66. MC 82. MC 98. MC 164. BE 184. Ex

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 3

Learning Objective 3
22. TF 105. MC 112. MC 119. MC 128. MC 188. Ex 205. C
23. TF 106. MC 113. MC 120. MC 129. MC 189. Ex 206. C
24. TF 107. MC 114. MC 121. MC 155. MC 190. Ex 215. SA
25. TF 108. MC 115. MC 122. MC 156. MC 191. Ex 216. SA
26. TF 109. MC 116. MC 123. MC 157. MC 192. Ex
27. TF 110. MC 117. MC 125. MC 167. BE 203. C
36. TF 111. MC 118. MC 126. MC 168. BE 204. C
Learning Objective 4
28. TF 130. MC 136. MC 142. MC 158. MC 193. Ex 209. C
29. TF 131. MC 137. MC 143. MC 159. MC 194. Ex 210. C
30. TF 132. MC 138. MC 144. MC 169. BE 195. Ex 213. SA
37. TF 133. MC 139. MC 145. MC 170. BE 196. Ex
124. MC 134. MC 140. MC 146. MC 191. Ex 207. C
127. MC 135. MC 141. MC 147. MC 192. EX 208. C
Note: TF = True-False BE = Brief Exercise C = Completion
MC = Multiple Choice Ex = Exercise SA = Short-Answer
MA = Matching

CHAPTER LEARNING OBJECTIVES

1. Describe management's decision-making process and incremental analysis.
Management's decision-making process is (a) identify the problem and assign responsibility
(b) determine and evaluate possible courses of action, (c) make the decision, and (d) review
the results of the decision. Incremental analysis identifies financial data that change under
alternative courses of action. These data are relevant to the decision because they will vary
in the future among the possible alternatives.
2. Analyze the relevant costs in various decisions involving incremental analysis. The
relevant information in accepting an order at a special price is the difference between the
variable costs to produce the special order and expected revenues. Any changes in fixed
costs, opportunity costs, or other incremental costs or savings (such as additional shipping)
should be considered. In a make-or-buy decision, the relevant costs are (a) the variable
manufacturing costs that will be saved as well as changes to fixed manufacturing costs, (b)
the purchase price, and (c) opportunity costs.
The decision rule for whether to sell or process materials further is: Process further as long
as the incremental revenue from processing exceeds the incremental processing costs. The
relevant costs to be considered in determining whether equipment should be repaired,
retained, or replaced are the effects on variable costs and the cost of the new equipment.
Also, any disposal value of the existing asset must be considered.
In deciding whether to eliminate an unprofitable segment or product, the relevant costs are
the variable costs that drive the contribution margin, if any, produced by the segment or
product. Opportunity cost and reduction of fixed expenses must also be considered.
3. Contrast annual rate of return and cash payback in capital budgeting. The annual rate
of return is obtained by dividing expected annual net income by the average investment. The
higher the rate of return, the more attractive the investment. The cash payback technique
identifies the time period to recover the cost of the investment. The formula is Cost of capital

For Instructor Use Only

26 - 4 Test Bank for Accounting Principles, Twelfth Edition

expenditure divided by Estimated net annual cash flow equals Cash payback period. The
shorter the payback period, the more attractive the investment.
4. Distinguish between the net present value and internal rate of return methods. Under
the net present value method, compare the present value of future net cash flows with the
capital investment to determine net present value. The NPV decision rule is: Accept the
project if net present value is zero or positive. Reject the investment if net present value is
negative.
Under the internal rate of return method, find the interest yield of the potential investment.
The IRR decision rule is: Accept the project when the internal rate of return is equal to or
greater than the required rate of return. Reject the project when the internal rate of return is
less than the required rate.

TRUE-FALSE STATEMENTS
1. An important step in management's decision-making process is to determine and evaluate
possible courses of action.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Strategic Planning

2. In making decisions, management ordinarily considers both financial and nonfinancial

information.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Strategic Planning

3. In incremental analysis, total variable costs will always change under alternative courses
of action, and total fixed costs will always remain constant.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Quantitative Methods

4. Accountants are mainly involved in developing nonfinancial information for management's

consideration in choosing among alternatives.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Decision Modeling, AICPA PC:
Interaction, IMA: Decision Analysis

5. Decision-making involves choosing among alternative courses of action.

Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

6. Financial data are developed for a course of action under an incremental basis and then it
is compared to data developed under a differential basis before a decision is made.
Ans: F, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

7. A special one-time order should never be accepted if the unit sales price is less than the
unit variable cost.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

8. If a company has excess capacity and present markets will not be affected, it would be
profitable to accept an order at a special unit price even though the price is less than the
unit variable cost to manufacture the item.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 5

9. A company should never accept an order for its product at less than its regular sales price.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

10. A decision whether to continue to make a product or buy it externally, depends on the
external price and the amount of variable and fixed costs that can be eliminated assuming
no alternative uses of resources.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Quantitative Methods

11. An opportunity cost is the potential benefit obtained by using resources in an alternative
course of action.
Ans: T, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics
12. If an incremental make or buy analysis indicates that it is cheaper to buy rather than make
an item, management should always make the decision to choose the lowest cost
alternative.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

13. In a sell or process further decision, management should process further as long as the
incremental revenues from additional processing exceed the incremental variable costs.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

14. It is always better to sell now rather than process further because of the time value of
money.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

15. In a decision concerning replacing old equipment with new equipment, the book value of
the old equipment can be considered a sunk cost.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

16. In a decision to retain or replace old equipment, the salvage value of the old equipment is
relevant in incremental analysis.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

17. It is better not to replace old equipment if it is not fully depreciated.

Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

18. From a quantitative standpoint, a segment should be eliminated if its contribution margin
is less than the fixed costs that can be eliminated.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

19. The elimination of an unprofitable product line may adversely affect the remaining product
lines.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

For Instructor Use Only

26 - 6 Test Bank for Accounting Principles, Twelfth Edition

20. The eliminating of an unprofitable product line may actually decrease total company net
income.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

21. In deciding on the future status of an unprofitable segment, management does not usually
consider the effect of elimination on related product lines.
Ans: F, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

22. Capital budgeting decisions usually involve large investments and can have a significant
impact on a company's future profitability.
Ans: T, LO: 3, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Investment Decisions

23. The annual rate of return technique requires dividing a project's annual cash inflows by
the economic life of the project.
Ans: F, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

24. A hurdle rate is the rate of return set by applying ideal standards.
Ans: F, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

25. A major advantage of the annual rate of return technique is that it considers the time value
of money.
Ans: F, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

26. The cash payback capital budgeting technique is a quick way to calculate a project's net
present value.
Ans: F, LO: 3, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

27. The cash payback method is frequently used as a screening tool but it does not take into
consideration the profitability of a project.
Ans: T, LO: 3, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

28. Using the net present value method, a net present value of zero indicates that the project
would be acceptable.
Ans: T, LO: 4, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

29. The net present value method can only be used in capital budgeting if the expected cash
flows from a project are an equal amount each year.
Ans: F, LO: 4, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

30. The interest rate yielded by a project is a rate that will cause the present value of the
proposed capital expenditure to equal the present value of the expected annual cash
inflows.
Ans: T, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Investment Decisions

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 7

31. Accounting contributes to management's decision-making process through internal

reports that review the actual impact of the decision.
Ans: T, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

32. The process used to identify the financial data that change under alternative courses of
action is called allocation of limited resources.
Ans: F, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Decision Analysis

33. If a company is operating at full capacity, the incremental costs of a special order will likely
include fixed manufacturing costs.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Business Economics

34. The basic decision rule in a sell or process further decision is: sell without further
processing as long as the incremental revenue from processing exceeds the incremental
processing costs.
Ans: F, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

35. In deciding on the future status of an unprofitable segment, management should

recognize that net income could decrease by eliminating the unprofitable segment.
Ans: T, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

36. The annual rate of return is computed by dividing expected annual net income by average
investment.
Ans: T, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Decision Analysis

37. The discounted cash flow technique considers estimated total cash inflows from the
investment but not the time value of money.
Ans: F, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Decision Analysis

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
1. T 7. T 13. F 19. T 25. F 31. T 37. F
2. T 8. F 14. F 20. T 26. F 32. F
3. F 9. F 15. T 21. F 27. T 33. T
4. F 10. T 16. T 22. T 28. T 34. F
5. T 11. T 17. F 23. F 29. F 35. T
6. F 12. F 18. T 24. F 30. T 36. T

For Instructor Use Only

26 - 8 Test Bank for Accounting Principles, Twelfth Edition

MULTIPLE CHOICE QUESTIONS

38. A major accounting contribution to the managerial decision-making process in evaluating
possible courses of action is to
a. assign responsibility for the decision.
b. provide relevant revenue and cost data about each course of action.
c. determine the amount of money that should be spent on a project.
d. decide which actions that management should consider.
Ans: B, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Decision Analysis

39. Which of the following stages of the management decision-making process is improperly
sequenced?
a. Evaluate possible courses of action  Make decision.
b. Assign responsibility for the decision  Identify the problem.
c. Identify the problem  Determine possible courses of action.
d. Assign responsibility for decision  Determine possible courses of action.
Ans: B, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

40. Internal reports that review the actual impact of decisions are prepared by
a. department heads.
b. the controller.
c. management accountants.
d. factory workers.
Ans: C, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Reporting, AICPA PC: Problem
Solving, IMA: Performance Measurement

41. Which of the following steps in the management decision-making process does not
generally involve the managerial accountant?
a. Determine possible courses of action
b. Make the appropriate decision based on relevant data
c. Prepare internal reports that review the impact of decisions
d. None of these answer choices are correct.
Ans: B, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Decision Analysis

42. The process of evaluating financial data that change under alternative courses of action is
called
a. double entry analysis.
b. contribution margin analysis.
c. incremental analysis.
d. cost-benefit analysis.
Ans: C, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Risk Analysis, AICPA PC: Problem
Solving, IMA: Decision Analysis

43. Nonfinancial information that management might evaluate in making a decision would not
include
a. employee turnover.
b. contribution margin.
c. the environment.
d. the corporate profile in the community.
Ans: B, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 9

44. Incremental analysis is synonymous with

a. difficult analysis.
b. differential analysis.
c. gross profit analysis.
d. derivative analysis.
Ans: B, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

45. In incremental analysis,

a. only costs are analyzed.
b. only revenues are analyzed.
c. both costs and revenues may be analyzed.
d. both costs and revenues that stay the same between alternate courses of action will
be analyzed.
Ans: C, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

46. Incremental analysis is most useful

a. in developing relevant information for management decisions.
b. in choosing between the net present value method and the internal rate of return
method.
c. in evaluating the master budget.
d. as a replacement technique for variance analysis.
Ans: A, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

47. The source of data to serve as inputs in incremental analysis is generated by

a. market analysts.
b. engineers.
c. accountants.
d. All of these answer choices are correct.
Ans: D, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Information Management

48. Which of the following is not a true statement?

a. Incremental analysis might also be referred to as differential analysis.
b. Incremental analysis is the same as CVP analysis.
c. Incremental analysis is useful in making decisions.
d. Incremental analysis focuses on decisions that involve a choice among alternative
courses of action.
Ans: B, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

49. Incremental analysis would not be appropriate for

a. a make or buy decision.
b. an allocation of limited resource decision.
c. elimination of an unprofitable segment.
d. analysis of manufacturing variances.
Ans: D, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

For Instructor Use Only

26 - 10 Test Bank for Accounting Principles, Twelfth Edition

50. Incremental analysis would be appropriate for

a. acceptance of an order at a special price.
b. a retain or replace equipment decision.
c. a sell or process further decision.
d. all of these answer choices are correct.
Ans: D, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

51. Which of the following is a true statement about cost behaviors in incremental analysis?
1. Fixed costs will not change between alternatives.
2. Fixed costs may change between alternatives.
3. Variable costs will always change between alternatives.
a. only 1
b. only 2
c. only 3
d. both 2 and 3
Ans: B, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

52. A company is considering the following alternatives:

Option 1 Option 2
Revenues $330,000 $330,000
Variable costs 120,000 98,000
Fixed costs 165,000 165,000
Which of the following are relevant in choosing between the alternatives?
a. Variable costs
b. Revenues
c. Fixed costs
d. Variable costs and fixed costs
Ans: A, LO: 1, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

53. It costs Maker Company $22 of variable and $15 of fixed costs to produce one Panini
press which normally sells for $57. A foreign wholesaler offers to purchase 1,000 Panini
presses at $40 each. Maker would incur special shipping costs of $5 per press if the order
were accepted. Maker has sufficient unused capacity to produce the 1,000 Panini
presses. If the special order is accepted, what will be the effect on net income?
a. $13,000 decrease
b. $13,000 increase
c. $22,000 decrease
d. $7,000 increase
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Decision Analysis

Solution: (1,000 × $40) – ($22 × 1,000) – ($5 × 1,000) = $13,000 increase.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 11

54. Preston Company manufactures a product with a unit variable cost of $140 and a unit
sales price of $264. Fixed manufacturing costs were $720,000 when 10,000 units were
produced and sold. The company has a one-time opportunity to sell an additional 3,000
units at $210 each in a foreign market which would not affect its present sales. If the
company has sufficient capacity to produce the additional units, acceptance of the special
order would affect net income as follows:
a. Income would decrease by $162,000.
b. Income would increase by $156,000.
c. Income would increase by $6,000.
d. Income would increase by $210,000.
Ans: D, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Decision Analysis

Solution: ($210 × 3,000) – ($140 × 3,000) = $210,000

55. In incremental analysis,

a. costs are not relevant if they change between alternatives.
b. all costs are relevant if they change between alternatives.
c. only fixed costs are relevant.
d. only variable costs are relevant.
Ans: B, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Decision Analysis

56. If a plant is operating at full capacity and receives a one-time opportunity to accept an
order at a special price below its usual price, then
a. only variable costs are relevant.
b. fixed costs are not relevant.
c. the order will likely be accepted.
d. the order will likely be rejected.
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

57. De Longo Inc. has excess capacity. Under what situations should the company accept a
special order for less than the current selling price?
a. Never
b. When additional fixed costs must be incurred to accommodate the order
c. When the company thinks it can use the cheaper materials without the customer's
knowledge
d. When incremental revenues exceed incremental costs
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

58. If a company must expand capacity to accept a special order, it is likely that there will be
a. an increase in unit variable costs.
b. no increase in fixed costs.
c. an increase in variable and fixed costs per unit.
d. an increase in fixed costs.
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

For Instructor Use Only

26 - 12 Test Bank for Accounting Principles, Twelfth Edition

59. Which of the following is true if a company can accept a special order without affecting its
regular sales and is within plant capacity?
a. Net income will not be affected.
b. Net income will increase if the special sales price per unit exceeds the unit variable
costs.
c. Net income will decrease.
d. Additional fixed costs will probably be incurred.
Ans: B, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

60. If a company anticipates that other sales will be affected by the acceptance of a special
order, then
a. lost sales should be considered in the incremental analysis.
b. lost sales should not be considered in the incremental analysis.
c. the order should not be accepted.
d. the order will only be accepted if the plant is below capacity.
Ans: A, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

61. D’Arien Company incurred the following costs for 70,000 units:
Variable costs $420,000
Fixed costs 392,000

D’Arien has received a special order from an Armenian company for 3,000 units. There is
sufficient capacity to fill the order without jeopardizing regular sales. Filling the order will
require spending an additional $6,600 for shipping.

If D’Arien wants to break even on the order, what should the unit sales price be?
a. $8.20
b. $6.00
c. $11.60
d. $13.80
Ans: A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution: ($420,000 ÷ 70,000)  ($6,600 ÷ 3,000) = $8.20

62. Lagusta Company incurred the following costs for 50,000 units:
Variable costs $180,000
Fixed costs 240,000

Lagusta has received a special order from a foreign company for 5,000 units. There is
sufficient capacity to fill the order without jeopardizing regular sales. Filling the order will
require spending an additional $8,500 for shipping.

If Lagusta wants to earn $9,000 on the order, what should the unit price be?
a. $3.60
b. $11.90
c. $7.10
d. $5.30
Ans: C, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution: ($9,000 ÷ 5,000)  ($8,500 ÷ 5,000)  ($180,000 ÷ 50,000) = 7.10

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 13

63. Which decision will involve no incremental revenues?

a. Make or buy decision
b. Drop a product line
c. Accept a special order
d. Additional processing decision
Ans: A, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

64. An opportunity cost

a. should be initially recorded as an asset.
b. is the cost of a new product proposal.
c. is the potential benefit that may be obtained by following an alternative course of action.
d. is classified as manufacturing overhead.
Ans: C, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

65. Opportunity cost must be considered in decisions involving

a. budgeting.
b. financial accounting.
c. CVP analysis.
d. resources that have alternative uses.
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

66. The opportunity cost of an alternate course of action that is relevant to a make-or-buy
decision is
a. subtracted from the "Make" costs.
b. added to the "Make" costs.
c. added to the "Buy" costs.
d. None of these answer choices are correct.
Ans: B, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

67. Opportunity cost is usually

a. a standard cost.
b. a potential benefit.
c. a sunk cost.
d. included as part of cost of goods sold.
Ans: B, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

68. Each of the following is a disadvantage of buying rather than making a component of a
company's product except that
a. quality control specifications may not be met.
b. the outside supplier could increase prices significantly in the future.
c. profitable product lines may be dropped.
d. the supplier may not deliver on time.
Ans: C, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

For Instructor Use Only

26 - 14 Test Bank for Accounting Principles, Twelfth Edition

69. Nelson Manufacturing Company can make 100 units of a necessary component part with
the following costs:
Direct Materials $120,000
Direct Labor 25,000
Variable Overhead 45,000
Fixed Overhead 70,000

If Nelson Manufacturing Company purchases the component externally, $30,000 of the

fixed costs can be avoided. At what external price for the 100 units is the company
indifferent between making or buying?
a. $190,000
b. $200,000
c. $210,000
d. $220,000
Ans: D, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($120,000  $25,000  $45,000  $30,000)  $220,000

70. Nelson Manufacturing Company can make 100 units of a necessary component part with
the following costs:
Direct Materials $120,000
Direct Labor 25,000
Variable Overhead 45,000
Fixed Overhead 20,000
If Nelson Manufacturing Company can purchase the component externally for $190,000
and only $5,000 of the fixed costs can be avoided, what is the correct make-or-buy
decision?
a. Make and save $5,000
b. Buy and save $5,000
c. Make and save $15,000
d. Buy and save $15,000
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($190,000  $5,000)  ($120,000  $25,000  $45,000)  $5,000

71. Greenwond Inc. can make 1,000 units of a necessary component with the following costs:
Direct Materials $72,000
Direct Labor 18,000
Variable Overhead 9,000
Fixed Overhead ?
The company can purchase the 1,000 units externally for $117,000. The avoidable fixed
costs are $6,000 if the units are purchased externally. An analysis shows that at this
external price, the company is indifferent between making or buying the part. What are the
fixed overhead costs of making the component?
a. $24,000
b. $18,000
c. $12,000
d. Cannot be determined.
Ans: A, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($117,000  $6,000)  ($72,000  $18,000  $9,000)  $24,000

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 15

72. Red Company produces 1,000 units of a necessary component with the following costs:
Direct Materials $34,000
Direct Labor 15,000
Variable Overhead 8,000
Fixed Overhead 10,000
Red's Company could avoid $6,000 in fixed overhead costs if it acquires the components
externally. If cost minimization is the major consideration and the company would prefer to
buy the components, what is the maximum external price that Red Company would
accept to acquire the 1,000 units externally?
a. $57,000
b. $61,000
c. $59,000
d. $63,000
Ans: D, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($34,000  $15,000  $8,000  $6,000)  $63,000

73. Red Company produces 1,000 units of a necessary component with the following costs:
Direct Materials $34,000
Direct Labor 15,000
Variable Overhead 8,000
Fixed Overhead 10,000

None of Red fixed overhead costs can be reduced, but another product could be made
that would increase profit contribution by $12,000 if the components were acquired
externally. If cost minimization is the major consideration and the company would prefer to
buy the components, what is the maximum external price that Red Company would be
willing to accept to acquire the 1,000 units externally?
a. $55,000
b. $46,000
c. $79,000
d. $69,000
Ans: D, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($34,000  $15,000  $8,000  $12,000)  $69,000

74. Sutton Inc. can produce 100 units of a component part with the following costs:
Direct Materials $130,000
Direct Labor 103,000
Variable Overhead 82,000
Fixed Overhead 62,000

If Sutton Inc. can purchase the units externally for $300,000, by what amount will its total
costs change?
a. An decrease of 67,000
b. An increase of $15,000
c. An increase of $135,000
d. A decrease of $47,000
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $300,000  $130,000  $103,000  $82,000  $15,000

For Instructor Use Only

26 - 16 Test Bank for Accounting Principles, Twelfth Edition

75. Sutton Inc. can produce 100 units of a component part with the following costs:
Direct Materials $130,000
Direct Labor 103,000
Variable Overhead 82,000
Fixed Overhead 62,000

If Sutton Inc. can purchase the component part externally for $345,000 and only $28,000
of the fixed costs can be avoided, what is the correct make-or-buy decision?
a. Make and save $99,000
b. Buy and save $4,000
c. Make and save $2,000
d. Buy and save $32,000
Ans: C, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($345,000  $28,000)  $317,000; $130,000  $103,000  $82,000  $315,000; $317,000  $315,000  $2,000

76. Flamingo Music produces 60,000 CDs on which to record music. The CDs have the
following costs:
Direct Materials $11,000
Direct Labor 15,000
Variable Overhead 3,000
Fixed Overhead 7,000
Flamingo could avoid $6,000 in fixed overhead costs if it acquires the CDs externally. If
cost minimization is the major consideration and the company would prefer to buy the
60,000 units externally, what is the maximum external price that Flamingo would expect to
pay for the units?
a. $30,000
b. $29,000
c. $35,000
d. $36,000
Ans: C, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $11,000  $15,000  $3,000  $6,000  $35,000

77. Flamingo Music produces 60,000 CDs on which to record music. The CDs have the
following costs:
Direct Materials $11,000
Direct Labor 15,000
Variable Overhead 3,000
Fixed Overhead 7,000
None of Flamingo’s fixed overhead costs can be reduced, but another product could be
made that would increase profit contribution by $4,000 if the CDs were acquired
externally. If cost minimization is the major consideration and the company would prefer to
buy the CDs, what is the maximum external price that Flamingo would be willing to accept
to acquire the 60,000 units externally?
a. $36,000
b. $32,000
c. $33,000
d. $40,000
Ans: C, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($11,000  $15,000  $3,000)  $4,000 = $33,000

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 17

78. Lean Foods produces a variety of snack products, including fried pork rinds. The cost of
one batch of pork rinds is below:
Direct materials $12.00
Direct labor 10.00
Variable overhead 7.00
Fixed overhead 9.00
An outside supplier has offered to produce the pork rinds for $25 per batch. How much will
Lean save if it accepts the offer?
a. $3.00 per batch
b. $4.00 per batch
c. $18.00 per batch
d. $13.00 per batch
Ans: B, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $25  ($12  $10  $7.00)  ($4)

79. Karpentry Company is unsure of whether to sell its product assembled or unassembled.
The unit cost of the unassembled product is $30 and Karpentry would sell it for $66. The
cost to assemble the product is estimated at $21 per unit and the company believes the
market would support a price of $85 on the assembled unit. What decision should
Karpentry make?
a. Sell before assembly, the company will be better off by $1 per unit.
b. Sell before assembly, the company will be better off by $2 per unit.
c. Process further, the company will be better off by $29 per unit.
d. Process further, the company will be better off by $14 per unit.
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($66  $30)  $36 versus ($85  ($30  $21))  $34; $36  $34  $2; sell before assembly

80. Wayne Company spent $13,000 to produce Product 612, which can be sold as is for
$15,000, or processed further incurring additional costs of $11,500 and then be sold for
$17,000. Which amounts are relevant to the decision about Product 612?
a. $13,000, $15,000, and $17,000
b. $13,000, $11,500, and $17,000
c. $15,000, $11,500, and $17,000
d. $13,000, $15,000, $11,500 and $17,000
Ans: C, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

81. Renee Company has old inventory on hand that cost $12,000. Its scrap value is $16,000.
The inventory could be sold for $40,000 if manufactured further at an additional cost of
$12,000. What should Renee do?
a. Sell the inventory for $16,000 scrap value
b. Dispose of the inventory to avoid any further decline in value
c. Hold the inventory at its $12,000 cost
d. Manufacture further and sell it for $40,000
Ans: D, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $40,000  $12,000  $28,000; $28,000  $16,000

For Instructor Use Only

26 - 18 Test Bank for Accounting Principles, Twelfth Edition

82. Suite Sixteen Makeup produces facial moisturizer. Each bottle of moisturizer costs $10 to
produce and can be sold for $13. The bottles can be sold as is, or processed further into
sunscreen at a cost of $14 each. Suite Sixteen Makeup could sell the bottles of sunscreen
for $22 each.
a. Moisturizer must be processed further because its profit is $8 each.
b. Moisturizer must not be processed further because costs increase more than revenue.
c. Moisturizer must not be processed further because it decreases profit by $2 each.
d. Moisturizer must be processed further because it increases profit by $3 each.
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $22  $13  $9; $9  $14

83. Carelli Company has old inventory on hand that cost $36,000. Its scrap value is $48,000.
The inventory could be sold for $120,000 if manufactured further at an additional cost of
$38,000. What should Carelli do?
a. Sell the inventory for $48,000 scrap value
b. Dispose of the inventory to avoid any further decline in value
c. Hold the inventory at its $36,000 cost
d. Manufacture further and sell it for $120,000.
Ans: D, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $120,000  $38,000  $82,000; $82,000  $48,000

84. JK Company has a process that results in 15,000 pounds of Product A that can be sold for
$8 per pound. An alternative would be to process Product A further at a cost of $100,000
and then sell it for $14 per pound. Should management sell Product A now or should
Product A be processed further and then sold? What is the effect of the action?
a. Process further, the company will be better off by $10,000.
b. Sell now, the company will be better off by $10,000.
c. Process further, the company will be better off by $90,000.
d. Sell now, the company will be better off by $100,000.
Ans: B, LO: 2, Bloom: AN, Difficulty: Hard, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($14  $8)  15,000)  $100,000  ($10,000)

85. The decision rule on whether to sell or process further

a. varies from situation to situation.
b. is process further as long as total revenue exceeds present revenues.
c. is process further if incremental revenue from such processing exceeds incremental
fixed costs.
d. is process further if incremental revenue from such processing exceeds the
incremental processing costs.
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Cost Management

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 19

86. Calico Company is starting business and is unsure of whether to sell its product
assembled or unassembled. The unit cost of the unassembled product is $90 and Calico
Company would sell it for $180. The cost to assemble the product is estimated at $36 per
unit and Calico Company believes the market would support a price of $232 on the
assembled unit. What is the correct decision using the sell or process further decision
rule?
a. Sell before assembly, the company will be better off by $36 per unit.
b. Sell before assembly, the company will be better off by $52 per unit.
c. Process further, the company will be better off by $52 per unit.
d. Process further, the company will be better off by $16 per unit.
Ans: D, LO: 2, Bloom: AN, Difficulty: Hard, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($232  $36  $90)  ($180  $90)  $16

87. Ellen Company manufactures kitchen utensils. Bolla Company has approached Ellen with
a proposal to sell the company spatulas at a price of $100,000 for 100,000 units. Elllen is
currently making the spatulas in its own factory. The following costs are associated with
this part of the process when 100,000 spatulas are produced:
Direct material $ 41,000
Direct labor 19,000
Manufacturing overhead 50,000
Total $110,000
The manufacturing overhead consists of $36,000 of costs that will be eliminated if the
components are no longer produced by Ellen. From Ellen's point of view, how much is the
incremental cost or savings if the spatulas are bought instead of made?
a. $10,000 incremental savings
b. $4,000 incremental cost
c. $4,000 incremental savings
d. $10,000 incremental cost
Ans: B, LO: 2, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($100,000  $36,000)  ($41,000  $19,000)  $4,000 incremental cost

88. The focus of a sell or process further decision is

a. incremental revenue.
b. incremental cost.
c. both incremental revenue and incremental cost.
d. neither incremental revenue nor incremental cost.
Ans: C, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

For Instructor Use Only

26 - 20 Test Bank for Accounting Principles, Twelfth Edition

89. TAD Company gathered the following data about the three products that it produces:
Present Estimated Additional Estimated Sales
Product Sales Value Processing Costs if Processed Further
Alpha $12,000 $8,000 $21,000
Beta 14,000 6,000 18,000
Delta 11,000 3,000 16,000
Which of the products should not be processed further?
a. Product Alpha
b. Product Beta
c. Product Delta
d. Products Alpha and Delta
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($18,000  $6,000)  $12,000; $12,000  $14,000

90. A company decided to replace an old machine with a new machine. Which of the following
is considered a relevant cost?
a. The book value of the old equipment
b. Depreciation expense on the old equipment
c. The loss on the disposal of the old equipment
d. The current disposal price of the old equipment
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

91. Which of the following is not relevant information in a decision whether old equipment
presently being used should be replaced by new equipment?
a. The cash price of the new equipment
b. The salvage value of the old equipment
c. The book value of the old equipment
d. The cost savings if the new equipment is purchased
Ans: C, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

92. Book value of old equipment is considered to be a

a. relevant cost.
b. semi-relevant cost.
c. sunk cost.
d. cost that can be changed by a present or future decision.
Ans: C, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

93. A company is deciding on whether to replace some old equipment with new equipment.
Which of the following is not a relevant cost for incremental analysis?
a. Annual operating cost of the new equipment
b. Annual operating cost of the old equipment
c. Net cost of the new equipment
d. Accumulated depreciation on the old equipment
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 21

94. A company is considering replacing old equipment with new equipment. Which of the
following is a relevant cost for incremental analysis?
a. Annual depreciation charge on the old equipment
b. Book value of the old equipment
c. Estimated annual depreciation of the new equipment
d. Cost of the new equipment
Ans: D, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

95. In a retain or replace equipment decision, trade-in allowance available on old equipment
a. increases the cost of the new equipment.
b. is relevant because it will not be realized if the old equipment is retained.
c. is not relevant to the decision.
d. reduces the cost of the old equipment.
Ans: B, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Strategic/Critical Thinking, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

96. Spencer Company is contemplating the replacement of an old machine with a new one.
The following information has been gathered:
Old Machine New Machine
Price $390,000 $530,000
Accumulated Depreciation 170,000 -0-
Remaining useful life 6 years -0-
Useful life -0- 10 years
Annual operating costs $167,000 $151,500

If the old machine is replaced, it can be sold for $120,000.

Which of the following amounts is a sunk cost?

a. $167,000
b. $151,500
c. $220,000
d. $170,000
Ans: C, LO: 2, Bloom: C, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($390,000  $170,000)  $220,000

97. Salem Co. is contemplating the replacement of an old machine with a new one. The
following information has been gathered:
Old Machine New Machine
Price $390,000 $530,000
Accumulated Depreciation 170,000 -0-
Remaining useful life 6 years -0-
Useful life -0- 10 years
Annual operating costs $167,000 $151,500

If the old machine is replaced, it can be sold for $120,000.

For Instructor Use Only

26 - 22 Test Bank for Accounting Principles, Twelfth Edition

MC. 97 (Cont.)
Which of the following amounts is relevant to the replacement decision?
a. $170,000
b. $390,000
c. $151,500
d. $0
Ans: C, LO: 2, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

98. Oscar Co. is contemplating the replacement of an old machine with a new one. The
following information has been gathered:
Old Machine New Machine
Cost $250,000 $500,000
Accumulated Depreciation 75,000 -0-
Remaining useful life 10 years -0-
Useful life -0- 10 years
Annual operating costs $200,000 $150,500

If the old machine is replaced, it can be sold for $20,000.

The net advantage (disadvantage) of replacing the old machine is

a. $15,000
b. $20,000
c. $(5,000)
d. $(50,000)
Ans: A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($200,000  $150,500)  10)  $500,000  $20,000  $15,000

99. Sardine Kitchen Company produces three sizes of crock pots: small, medium, and large. A
condensed segmented income statement for a recent period follows:
Large Medium Small Total
Sales $200,000 $200,000 $105,000 $505,000
Variable expenses 125,000 110,000 65,000 300,000
Contribution margin 75,000 90,000 40,000 205,000
Fixed expenses 55,000 55,000 47,000 157,000
Net income (loss) $ 20,000 $ 35,000 $(7,000) $ 48,000

Assume none of the fixed expenses for the small size crock pot are avoidable. What will
be total net income if the line is dropped?
a. $47,000
b. $13,000
c. $8,000
d. $55,000
Ans: C, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $20,000  $35,000  $47,000  $8,000

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 23

100. Sardine Kitchen Company produces three versions of crock pots: small, medium, and
large. A condensed segmented income statement for a recent period follows:
Large Medium Small Total
Sales $200,000 $200,000 $105,000 $505,000
Variable expenses 125,000 110,000 65,000 300,000
Contribution margin 75,000 90,000 40,000 205,000
Fixed expenses 55,000 55,000 47,000 157,000
Net income (loss) $ 20,000 $ 35,000 $(7,000) $ 48,000

Assume all of the fixed expenses for the small size crock pot are avoidable. What will be
total net income if the line is dropped?
a. $55,000
b. $47,000
c. $95,000
d. $10,000
Ans: A, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $20,000  $35,000  $55,000

101. What will most likely occur if a company eliminates an unprofitable segment when a
portion of fixed costs are unavoidable?
a. All expenses of the eliminated segment will be eliminated.
b. Net income will decrease.
c. Net income will increase.
d. The company's variable costs will increase.
Ans: B, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Cost Management

102. Bordeaux Company has three product lines, one of which reflects the following results:
Sales $215,000
Variable expenses 125,000
Contribution margin 90,000
Fixed expenses 150,000
Net loss $ (60,000)
If this product line is eliminated, 50% of the fixed expenses can be eliminated and the
other 50% will be allocated to other product lines. If management decides to eliminate this
product line, the company's net income will
a. increase by $60,000.
b. decrease by $90,000.
c. decrease by $15,000.
d. increase by $15,000.
Ans: C, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: ($150,000  .50)  $60,000  $15,000 decrease

For Instructor Use Only

26 - 24 Test Bank for Accounting Principles, Twelfth Edition

103. A company is considering eliminating a product line. The fixed costs currently allocated to
the product line will be allocated to other product lines upon discontinuance. If the product
line is discontinued,
a. total net income will increase by the amount of the product line's fixed costs.
b. total net income will decrease by the amount of the product line's fixed costs.
c. the contribution margin of the product line will indicate the net income increase or
decrease.
d. the company's total fixed costs will decrease.
Ans: C, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Cost Management

104. A segment has the following data:

Sales $350,000
Variable expenses 150,000
Fixed expenses 285,000
What will be the incremental effect on net income if this segment is eliminated, assuming
the fixed expenses will be allocated to profitable segments?
a. $200,000 increase
b. $200,000 decrease
c. $275,000 decrease
d. Cannot be determined from the data provided.
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: $350,000  $150,000  $285,000  $285,000  $200,000 decrease

105. A company is considering purchasing factory equipment that costs $320,000 and is
estimated to have no salvage value at the end of its 8-year useful life. If the equipment is
purchased, annual revenues are expected to be $90,000 and annual operating expenses
exclusive of depreciation expense are expected to be $40,000. The straight-line method of
depreciation would be used.
If the equipment is purchased, the annual rate of return expected on this equipment is
a. 31.3%.
b. 6.25%.
c. 3.125%.
d. 15.6%.
Ans: B, LO: 3, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution: [($90,000  $40,000)  ($320,000 ÷ 8)] / ($320,000 ÷ 2) = 6.25%

106. A company is considering purchasing factory equipment that costs $320,000 and is
estimated to have no salvage value at the end of its 8-year useful life. If the equipment is
purchased, annual revenues are expected to be $90,000 and annual operating expenses
exclusive of depreciation expense are expected to be $40,000. The straight-line method of
depreciation would be used.
The cash payback period on the equipment is
a. 3.6 years.
b. 8.0 years.
c. 3.2 years.
d. 6.4 years.
Ans: D, LO: 3, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $320,000 ÷ ($90,000  $40,000) = 6.4

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 25

107. Lawson Co. is considering purchasing a new machine which will cost $350,000, but which
will decrease costs each year by $100,000. The useful life of the machine is 10 years. The
machine would be depreciated straight-line with no residual value over its useful life at the
rate of $35,000/year. The cash payback period is
a. 7.0 years.
b. 3.5 years.
c. 3.2 years.
d. 10.0 years.
Ans: B, LO: 3, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $350,000 ÷ $100,000 = 3.5 years

108. The following are all quantitative capital budgeting techniques except
a. annual rate of return technique.
b. cost-volume-profit technique.
c. discounted cash flow technique.
d. cash payback technique.
Ans: B, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Budget Preparation

109. A company's cost of capital refers to the

a. rate management expects to pay on all borrowed and equity funds.
b. total cost of a capital project.
c. cost of printing and registering common stock shares.
d. rate of return earned on total assets.
Ans: A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Cost Management

110. How is annual cash inflow determined?

a. Depreciation is subtracted from net income because it is an expense.
b. Depreciation is added back to net income because it is not an outflow of cash.
c. Depreciation is subtracted from net income because it is an outflow of cash.
d. Depreciation is added back to net income because it is an inflow of cash.
Ans: B, LO: 3, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Cost Management

111. If an asset cost $270,000 and is expected to have a $60,000 salvage value at the end of
its twelve-year life, and generates annual net cash inflows of $40,000 each year, the cash
payback period is
a. 2.7 years.
b. 8.25 years.
c. 6.75 years.
d. 5.25 years.
Ans: C, LO: 3, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $270,000 ÷ $40,000 = 6.75 years

112. If the payback period for a project is greater than its economic life, the
a. project will always be profitable.
b. entire initial investment will never be recovered.
c. project would only be acceptable if the company's cost of capital was low.
d. project's return will always exceed the company's cost of capital.
Ans: B, LO: 3, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

For Instructor Use Only

26 - 26 Test Bank for Accounting Principles, Twelfth Edition

113. A company is considering purchasing factory equipment which costs $480,000 and is
estimated to have no salvage value at the end of its 8-year useful life. If the equipment is
purchased, annual revenues are expected to be $225,000 and annual operating expenses
exclusive of depreciation expense are expected to be $95,000. The straight-line method of
depreciation would be used. If the equipment is purchased, the annual rate of return
expected on this project is
a. 54.2%.
b. 14.6%.
c. 29.2%.
d. 27.1%.
Ans: C, LO: 3, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: ($225,000  $95,000  ($480,000 / 8) ÷ ($480,000 ÷ 2) = 29.2%

114. Capital budgeting is the process

a. used in sell or process further decisions.
b. of determining how much capital stock to issue.
c. of making capital expenditure decisions.
d. of eliminating unprofitable product lines.
Ans: C, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Budget Preparation

115. Which of the following is not a common method of capital budgeting?

a. Gross profit method
b. Payback method
c. Discounted cash flow method
d. Annual rate of return method
Ans: A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Budget Preparation

116. The rate that management expects to pay on borrowed or equity funds is known as
a. the hurdle rate.
b. the cost of capital.
c. the cutoff rate.
d. all of these answer choices are correct.
Ans: B, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

117. The higher the rate of return for a given risk, the
a. more attractive the investment.
b. less attractive the investment.
c. higher the cost of capital.
d. higher the hurdle rate.
Ans: A, LO: 3, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

118. The annual rate of return method is based on

a. accounting data.
b. time value of money data.
c. market values.
d. replacement values.
Ans: A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 27

119. A company projects an increase in net income of $180,000 each year for the next five
years if it invests $900,000 in new equipment. The equipment has a five-year life and an
estimated salvage value of $300,000. What is the annual rate of return on this
investment?
a. 30%
b. 20%
c. 40%
d. 60%
Ans: A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $180,000 ÷ ($900,000  $300,000) ÷ 2 = 30%

120. When using the payback method, payback is expressed in terms of

a. a percent.
b. dollars.
c. time.
d. a discount factor.
Ans: C, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

121. The payback method is criticized on the grounds that it

a. ignores obsolescence factors.
b. ignores the cost of an investment.
c. is complicated to use.
d. ignores the time value of money.
Ans: D, LO: 3, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

122. Crea Company is considering buying a machine for $54,000 with an estimated life of ten
years and no salvage value. The straight-line method of depreciation will be used. The
machine is expected to generate cash inflow of $6,000 each year. The cash payback on
this investment is
a. 15 years.
b. 10 years.
c. 9 years.
d. 4.5 years.
Ans: C, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $54,000 ÷ 6,000 = 9 years

123. Rumsy Company is considering buying equipment for $240,000 with a useful life of five
years and an estimated salvage value of $10,000. If annual expected income is $21,000,
the denominator in computing the annual rate of return is
a. $250,000.
b. $120,000.
c. $240,000.
d. $125,000.
Ans: D, LO: 3, Bloom: C, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: ($240,000  $10,000) ÷ 2 = $125,000

For Instructor Use Only

26 - 28 Test Bank for Accounting Principles, Twelfth Edition

124. A capital budgeting technique which takes into consideration the time value of money is
the
a. annual rate of return approach.
b. return on stockholders' equity approach.
c. payback approach.
d. net present value method.
Ans: D, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

125. Bish Company had an investment which cost $270,000 and had a salvage value at the
end of its useful life of zero. If Bish's expected annual net income is $16,200, the annual
rate of return is:
a. 6%.
b. 8.3%.
c. 16.7%.
d. 12%.
Ans: D, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $16,200 ÷ (270,000 ÷ 2) = 12%

126. Flores Company has identified that the cost of new manufacturing equipment will be
$60,000, but with the use of the new equipment, net income will increase by $5,000 a
year. If depreciation expense is $5,000 a year, the cash payback period is:
a. 16.7 years.
b. 11.4 years.
c. 12 years.
d. 6 years.
Ans: D, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $60,000 ÷ ($5,000  $5,000) = 6 years

127. R&R Company purchased some equipment 3 years ago. The company's required rate of
return is 12%, and the net present value of the project was $(550). Annual cost savings
were: $5,000 for year 1; $4,000 for year 2; and $3,000 for year 3. The amount of the initial
investment was
Present Value PV of an Annuity
Year of 1 at 12% of 1 at 12%
1 .893 .893
2 .797 1.690
3 .712 2.402
a. $9,239.
b. $10,014.
c. $9,789.
d. $10,339.
Ans: D, LO: 4, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: $550  [($5,000  .893)  ($4,000  .797)  ($3,000  .712)] = $10339

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 29

128. JP Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Echo Project Charlie
Initial investment $400,000 $600,000
Annual net income 20,000 42,000
Net annual cash inflow 100,000 142,000
Estimated useful life 5 years 6 years
Salvage value 0 0
The company requires an 11% rate of return on all new investments.
Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111

The cash payback period for Project Echo is

a. 20 years.
b. 10 years.
c. 5 years.
d. 4 years.
Ans: D, LO: 3, Bloom: AP, Difficulty: Hard, Min: 7, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: $400,000 ÷ 100,000 = 4 years

129. JP Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Echo Project Charlie
Initial investment $400,000 $600,000
Annual net income 20,000 42,000
Net annual cash inflow 100,000 142,000
Estimated useful life 5 years 6 years
Salvage value 0 0
The company requires an 11% rate of return on all new investments.
Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111

The annual rate of return for Project Echo is

a. 5%.
b. 10%.
c. 25%.
d. 50%.
Ans: B, LO: 3, Bloom: AP, Difficulty: Hard, Min: 7, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: $20,000 ÷ ($400,000 / 2) = 10%

For Instructor Use Only

26 - 30 Test Bank for Accounting Principles, Twelfth Edition

130. JP Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Echo Project Charlie
Initial investment $400,000 $600,000
Annual net income 20,000 42,000
Net annual cash inflow 100,000 142,000
Estimated useful life 5 years 6 years
Salvage value 0 0

The company requires a 11% rate of return on all new investments.

Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111
The net present value for Project Charlie is
a. $600,802.
b. $802.
c. $100,000.
d. $178,900.
Ans: B, LO: 4, Bloom: AP, Difficulty: Hard, Min: 7, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: ($142,000  4.231)  $600,000 = $802

131. JP Company is considering two capital investment proposals. Estimates regarding each
project are provided below:
Project Echo Project Charlie
Initial investment $400,000 $600,000
Annual net income 20,000 42,000
Net annual cash inflow 100,000 142,000
Estimated useful life 5 years 6 years
Salvage value 0 0

The company requires a 11% rate of return on all new investments.

Present Value of an Annuity of 1
Periods 9% 10% 11% 12%
5 3.890 3.791 3.696 3.605
6 4.486 4.355 4.231 4.111
The internal rate of return for Project Charlie is approximately
a. 10%.
b. 11%.
c. 12%.
d. 9%.
Ans: B, LO: 4, Bloom: AP, Difficulty: Hard, Min: 7, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: ($142,000  4.231)  $600,000 = $802; closest to zero; 11%

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 31

132. Use the following table,

Present Value of an Annuity of 1
Period 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487

A company has a minimum required rate of return of 10% and is considering investing in a
project that requires an investment of $99,000 and is expected to generate cash inflows of
$42,000 at the end of each year for three years. The present value of future cash inflows
for this project is
a. $99,000.
b. $104,454.
c. $114,898.
d. $5,454.
Ans: B, LO: 4, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: ($42,000  2.487) = $104,454

133. Use the following table,

Present Value of an Annuity of 1
Period 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 8% and is considering investing in a
project that costs $175,000 and is expected to generate cash inflows of $70,000 at the
end of each year for three years. The net present value of this project is
a. $5,390.
b. $35,000.
c. $2,170.
d. $180,390.
Ans: A, LO: 4, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: ($70,000  2.577)  $175,000 = 5,390

134. Use the following table,

Present Value of an Annuity of 1
Period 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 8% and is considering investing in a
project that costs $68,337 and is expected to generate cash inflows of $27,000 each year
for three years. The approximate internal rate of return on this project is
a. 8%.
b. 9%.
c. 10%.
d. less than the required 8%.
Ans: B, LO: 4, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: $68,337  ($27,000  2.531) = 0; thus IRR is 9%

For Instructor Use Only

26 - 32 Test Bank for Accounting Principles, Twelfth Edition

135. Cha Li Lao Company wants to purchase equipment with a 3-year useful life, which is
expected to produce cash inflows of $15,000 each year for two years, and $9,000 in year
3. Woods has a 14% cost of capital, and uses the following factors. What is the present
value of these future cash flows?
Present Value of 1
Period 14%
1 .88
2 .77
3 .67
a. $26,130
b. $30,780
c. $30,870
d. $34,750
Ans: B, LO: 4, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: ($15,000  .88)  ($15,000  .77)  ($9,000  .67) = 30,780

136. Mezzita Inc. is considering purchasing equipment costing $12,000 with a 6-year useful
life. The equipment will provide cost savings of $3,100 and will be depreciated straight-line
over its useful life with no salvage value. Mezzita requires a 10% rate of return.
Present Value of an Annuity of 1
Period 8% 9% 10% 11% 12% 15%
6 4.623 4.486 4.355 4.231 4.111 3.784

What is the approximate net present value of this investment?

a. $13,116
b. $1,501
c. $2,116
d. $13,501
Ans: B, LO: 4, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: ($3,100  4.355)  $12,000 = $1,501

137. October Inc. is considering purchasing equipment costing $46,300 with a 6-year useful
life. The equipment will provide cost savings of $10,950 and will be depreciated straight-
line over its useful life with no salvage value. October Inc. requires a 10% rate of return.
Present Value of an Annuity of 1
Period 8% 9% 10% 11% 12% 15%
6 4.623 4.486 4.355 4.231 4.111 3.784

What is the approximate internal rate of return for this investment?

a. 9%
b. 10%
c. 11%
d. 12%
Ans: C, LO: 4, Bloom: AP, Difficulty: Hard, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution: $46,300  $10,950 = 4.228; IRR = 11%

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 33

138. Which one of the following is correct?

a. Cash flows are used to calculate the internal rate of return.
b. Accrual income is used to calculate the payback period.
c. Cash flows are used to calculate the annual rate of return.
d. Accrual income is used to calculate the net present value.
Ans: A, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

139. If a company's required minimum rate of return is 9%, and in using the net present value
method, a project's net present value is zero, this indicates that the
a. project's rate of return exceeds 9%.
b. project's rate of return is less than the minimum rate required.
c. project earns a rate of return of 9%.
d. project earns a rate of return of 0%.
Ans: C, LO: 4, Bloom: C, Difficulty: Medium, Min: 2, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

140. Using the net present value method, the total present value of cash inflows for Project A is
$30,000 and the total present value of cash inflows of Project B is $35,000. If Project A
and Project B both require an initial investment of $30,000 and have the same economic
life, the project that should be accepted is
a. Project A.
b. Project B.
c. neither; they are both the same.
d. not capable of being calculated.
Ans: B, LO: 4, Bloom: AN, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

141. Valerta Company used the net present value method and determined that project 34 had
a zero net present value. What does this tell management about the project?
a. The return from this project is equal to the cost of capital.
b. The project guarantees company profitability.
c. The project's cash inflows will equal its cash outflows.
d. The project earns the company's desired minimum rate of return.
Ans: D, LO: 4, Bloom: AN, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

142. In using the internal rate of return method, the internal rate of return factor was 5.0 and
the equal annual cash inflows were $40,000. The initial investment in the project must
have been
a. $40,000.
b. $8,000.
c. $200,000.
d. an amount which cannot be determined.
Ans: C, LO: 4, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $40,000  5 = $200,000

For Instructor Use Only

26 - 34 Test Bank for Accounting Principles, Twelfth Edition

143. Use the following table,

Present value of an Annuity of 1
Period 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 9%. It is considering investing in a
project which costs $420,000 and is expected to generate cash inflows of $168,000 at the
end of each year for three years. The net present value of this project is
a. $425,208.
b. $252,000.
c. $5,208.
d. $42,516.
Ans: C, LO: 4, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: ($168,000  2.531)  $420,000 = $5,208

144. Use the following table,

Present value of an Annuity of 1
Period 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487
A company has a minimum required rate of return of 8%. It is considering investing in a
project that costs $231,930 and is expected to generate cash inflows of $90,000 each
year for three years. The approximate internal rate of return on this project is
a. 8%.
b. 9%.
c. 10%.
d. The IRR on this project cannot be approximated.
Ans: A, LO: 4, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: $231,930  $90,000 = 2.577; IRR = 8%

145. Use the following table,

Present value of an Annuity of 1
Period 8% 9% 10%
1 .926 .917 .909
2 1.783 1.759 1.736
3 2.577 2.531 2.487

A company has a minimum required rate of return of 9%. It is considering investing in a

project that requires an investment of $210,000 and is expected to generate cash inflows
of $90,000 at the end of each year for three years. The present value of future cash
inflows for this project is
a. $210,000.
b. $223,830.
c. $227,790.
d. $17,790.
Ans: C, LO: 4, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: ($90,000  2.531) = $227,790

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 35

146. The conceptually superior approach to capital budgeting is

a. a discounted cash flow method.
b. the payback method.
c. the annual rate of return method.
d. none of these answer choices are correct.
Ans: A, LO: 4, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

147. The appropriate table to use when an investment promises to return unequal cash flows is the
a. future value of 1 table.
b. future value of annuity table.
c. present value of 1 table.
d. present value of annuity table.
Ans: C, LO: 4, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

148. Accounting's contribution to the decision-making process occurs in all of the following
steps except to
a. identify the problem and assign responsibility.
b. determine possible courses of action.
c. review results of the decision.
d. make a decision.
Ans: A, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

149. It costs Galiente Company $46 per unit ($27 variable and $19 fixed) to produce its
product, which normally sells for $58 per unit. A Brazilian wholesaler offers to purchase
5,000 units at $36 each. Galiente would incur special shipping costs of $5 per unit if the
order were accepted. Galiente has sufficient unused capacity to produce the 5,000 units.
If the special order is accepted, what will be the effect on net income?
a. $50,000 decrease
b. $20,000 increase
c. $15,000 increase
d. $35,000 increase
Ans: B, LO: 2, Bloom: AN, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution: ($36  $27  $5) = $4  5,000 = $20,000

150. In a make-or-buy decision, opportunity costs are

a. added to the make total cost.
b. deducted from the make total cost.
c. added to the buy total cost.
d. ignored.
Ans: A, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

151. Which of the following would generally not affect a make-or-buy decision?
a. Selling expenses
b. Direct labor
c. Variable manufacturing costs
d. Opportunity cost
Ans: A, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

For Instructor Use Only

26 - 36 Test Bank for Accounting Principles, Twelfth Edition

152. A cost that cannot be changed by any present or future decision is a(n)
a. incremental cost.
b opportunity cost.
c. sunk cost.
d. variable cost.
Ans: C, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

153. If an unprofitable segment is eliminated

a. it is impossible for net income to decrease.
b. fixed expenses allocated to the eliminated segment will be eliminated.
c. variable expenses of the eliminated segment will be eliminated.
d. it is impossible for net income to increase.
Ans: C, LO: 2, Bloom: C, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

154. All of the following are relevant in deciding whether to eliminate an unprofitable segment
except the segment's
a. sales.
b. variable expenses.
c. contribution margin.
d. fixed expenses.
Ans: D, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

155. The rate of return that management expects to pay on all borrowed and equity funds is the
a. cost of capital.
b. cutoff rate.
c. hurdle rate.
d. minimum rate.
Ans: A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

156. The cash payback formula is

a. Cost of capital investment  Net income.
b. Cost of capital investment  Annual cash inflow.
c. Average investment  Net income.
d. Average investment  Annual cash inflow.
Ans: B, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

157. To determine annual cash inflow, depreciation is

a. subtracted from net income because it is an expense.
b. subtracted from net income because it is an outflow of cash.
c. added back to net income because it is an inflow of cash.
d. added back to net income because it is not an outflow of cash.
Ans: D, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

158. Net present value is the difference between the

a. future cash inflows and the capital investment.
b. future cash inflows and the present value of the capital investment.
c. present value of future cash inflows and the capital investment.
d. present value of future net income and the capital investment.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 37
Ans: C, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

For Instructor Use Only

26 - 38 Test Bank for Accounting Principles, Twelfth Edition

159. A negative net present value means that the

a. project's rate of return exceeds the required rate of return.
b. project's rate of return is less than the required rate of return.
c. project's rate of return equals the required rate of return.
d. project is acceptable.
Ans: B, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Answers to Multiple Choice Questions

Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans.
38. b 56. d 74. b 92. c 110. b 128. d 146. a
39. b 57. d 75. c 93. d 111. c 129. b 147. c
40. c 58. d 76. c 94. d 112. b 130. b 148. a
41. b 59. b 77. c 95. b 113. c 131. b 149. b
42. c 60. a 78. b 96. c 114. c 132. b 150. a
43. b 61. a 79. b 97. c 115. a 133. a 151. a
44. b 62. c 80. c 98. a 116. b 134. b 152. c
45. c 63. a 81. d 99. c 117. a 135. b 153. c
46. a 64. c 82. b 100. a 118. a 136. b 154. d
47. d 65. d 83. d 101. b 119. a 137. c 155. a
48. b 66. b 84. b 102. c 120. c 138. a 156. b
49. d 67. b 85. d 103. c 121. d 139. c 157. d
50. d 68. c 86. d 104. b 122. c 140. b 158. c
51. b 69. d 87. b 105. b 123. d 141. d 159. b
52. a 70. b 88. c 106. d 124. d 142. c
53. b 71. a 89. b 107. b 125. d 143. c
54. d 72. d 90. d 108. b 126. d 144. a
55. b 73. d 91. c 109. a 127. d 145. c

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 39

BRIEF EXERCISES
BE 160
Bayonette Inc. is considering Plan 1 which is estimated to have sales of $60,000 and costs of
$22,500. The company currently has sales of $57,000 and costs of $21,500.

Instructions
Compare plans using incremental analysis.
Ans: N/A, LO: 1, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 160 (3 min.)

Incremental revenue ($60,000 – $57,000) $3,000
Incremental costs ($22,500 – $21,500) (1,000)
Incremental increase in profit if Plan 1 is selected $2,000

BE 161
Brigg Enterprises produces miniature parasols. Each parasol consists of $1.20 of variable costs
and $.90 of fixed costs and sells for $4.50. A French wholesaler offers to buy 8,000 units at $1.40
each, of which Brigg has the capacity to produce. Brigg will incur extra shipping costs of $.12 per
parasol.

Instructions
Determine the incremental income or loss that Brigg Enterprises would realize by accepting the
special order.
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 161 (5 min.)

Incremental revenue (8,000 × $1.40) $11,200
Incremental variable costs ($1.20 × 8,000) (9,600)
Incremental shipping costs ($.12 × 8,000) (960)
Incremental profit if special order accepted $ 640

BE 162
R&R Inc. produces several models of clocks. An outside supplier has offered to produce the
commercial clocks for R&R for $270 each. R&R needs 1,500 clocks annually. R&R has provided
the following unit costs for its commercial clocks:
Direct materials $100
Direct labor 110
Variable overhead 30
Fixed overhead (70% avoidable) 150

Instructions
Prepare an incremental analysis which shows the effect of the make-or-buy decision.
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

For Instructor Use Only

26 - 40 Test Bank for Accounting Principles, Twelfth Edition

Solution 162 (5 min.)

Incremental Analysis Incremental Effect
Cost to buy (1,500 × $270) $(405,000)
Cost savings:
Savings of DM $100 × 1,500 = $150,000
Savings of DL $110 × 1,500 = 165,000
Savings of VOH $30 × 1,500 = 45,000
Savings of FOH 70% × $150 × 1,500 = 157,500
Total cost savings + 517,500
Incremental net cost to make $ 112,500

BE 163
Raymond Corporation currently manufactures 3,000 units of component XYZ annually for its main
product. The costs per unit are as follows:
Direct materials $ 4.00
Direct labor 7.00
Variable overhead 3.20
Fixed overhead 7.00
Total $21.20

Dorie Company has contacted Raymond with an offer to sell it 3,000 components of XYZ for
$17.40 each. Sixty percent of the fixed overhead per unit is unavoidable.

Instructions
Prepare an incremental analysis for the make-or-buy decision.
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 5, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 163 (5 min.)

Incremental cost to buy $(52,200)
Incremental savings on direct materials + 12,000
Incremental savings on direct labor + 21,000
Incremental savings on variable MOH + 9,600
Incremental savings on fixed MOH + 8,400 (7  3,000  .40)
Incremental net cost to buy $(1,200)

BE 164
Abel Quail Farm, Inc. produces a crop of heritage quail at a total cost of $66,000. The production
generates 16,000 quail which can be sold for $4 each to restaurants, or the quail can be
processed in house and then sold for $9 each. It costs $55,000 more to process the quail .

Instructions
If Abel Quail Farm processes the quail, determine how much incremental profit or loss it would
report. What should Abel Quail Farm do?
Ans: N/A, LO: 2, Bloom: AN, Difficulty: Medium, Min: 4, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 41

Solution 164 (4 min.)

Incremental revenues: ($9 – $4) × 16,000 = $80,000
Incremental costs: given as $55,000
Incremental profits: $80,000 – $55,000 = $25,000 profit
Abel Quail Farm should process the quail.

BE 165
Western Company has a machine that affixes labels to bottles. The machine has a book value of
$60,000 and a remaining useful life of 3 years and no salvage value. A new, more efficient
machine is available at a cost of $210,000 that will have a 5-year useful life with no salvage
value. The new machine will lower annual variable production costs from $490,000 to $390,000.

Instructions
Prepare an analysis showing whether the old machine should be retained or replaced.
Ans: N/A, LO: 2, Bloom: AN, Difficulty: Medium, Min: 4, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 165 (4 min.)

Retain Equipment Replace Equipment Net Income Change
Variable manufacturing costs $1,470,000*** $1,170,000** $300,000*
New machine cost (210,000)
Net savings over 3 years $ 90,000

*For 3 years of remaining life

**390,000  3 = 1,170,000
***490,000 x 3 – 1,470,000 and 390,000 x 3 = 1,170,000

BE 166
Northern States Dairy Inc. has 4 product lines: sour cream, ice cream, yogurt, and butter. The
allocated fixed costs are based on units sold and are unavoidable. Demand of individual products
is not affected by changes in other product lines. 40% of the fixed costs are direct, and the other
60% are allocated. Results of June follow:
Sour Cream Ice Cream Yogurt Butter Total
Units sold 2,000 500 400 200 3,100
Revenue $10,000 $20,000 $10,000 $20,000 $60,000
Variable departmental costs 6,000 13,000 4,200 4,800 28,000
Fixed costs 6,000 2,000 3,000 7,000 18,000
Net income (loss) $ (2,000) $ 5,000 $ 2,800 $ 8,200 $14,000

Instructions
Prepare an incremental analysis of the effect of dropping the sour cream product line.
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 4, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 166 (4 min.)

Incremental revenue $(10,000)
Incremental variable cost savings + 6,000
Incremental fixed cost savings ($6,000 x .40) + 2,400
Incremental decrease in profits if dropped $ (1,600)

For Instructor Use Only

26 - 42 Test Bank for Accounting Principles, Twelfth Edition

BE 167
United Co. is considering investing in new equipment that will cost $1,400,000 with a 10-year
useful life. The new equipment is expected to produce annual net income of $60,000 over its
useful life. Depreciation expense, using the straight-line rate, is $140,000 per year.

Instructions
Compute the cash payback period.
Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 167 (3 min.)

$1,400,000 ÷ ($60,000 + $140,000) = 7 years

BE 168
Crapty Company is considering investing in a new facility to extract and produce salt. The facility
will increase revenues by $240,000, but will also increase annual expenses by $180,000. The
facility will cost $980,000 to build, but will have a $20,000 salvage value at the end of its 20-year
useful life.

Instructions
Calculate the annual rate of return on this facility.
Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 4, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 168 (4 min.)

The annual rate of return is calculated by dividing expected annual income by the average
investment. The company’s expected annual income is:
$240,000 – $180,000 = $60,000

Its average investment is:

$980,000 + $20,000
————————— = $500,000
2

Therefore, its annual rate of return is:

$60,000 ÷ $500,000 = 12%

BE 169
Vineyard Company is proposing to spend $138,000 to purchase a machine that will provide
annual cash flows of $25,000. The appropriate present value factor for 10 periods is 5.65.

Instructions
Compute the proposed investment’s net present value, and indicate whether the investment
should be made by Vineyard Company.
Ans: N/A, LO: 4, Bloom: AP, Difficulty: Medium, Min: 4, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 43

Solution 169 (4 min.)

Present Value
Cash inflows—$25,000 × 5.65 $141,250
Cash outflow—investment $138,000 × 1.00 (138,000)
Net present value $ 3,250

The investment should be made because the net present value is positive.

BE 170
An investment costing $90,000 is being contemplated by Mergenthaler Inc. The investment will
have a life of 8 years with no salvage value and will produce annual cash flows of $16,870.

Instructions
Compute the approximate internal rate of return for this investment. (Table G-2 is needed)
Ans: N/A, LO: 4, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 170 (3 min.)

When net annual cash inflows are expected to be equal, the internal rate of return can be
approximated by dividing the capital investment by the net annual cash inflows to determine the
discount factor, and then locating this discount factor on the present value of an annuity table.

$90,000 ÷ $16,870 = 5.33

By tracing across on the 8-year row, we see that the discount factor for 10% is 5.33493. Thus, the
internal rate of return on this project is approximately 10%.

For Instructor Use Only

26 - 44 Test Bank for Accounting Principles, Twelfth Edition

EXERCISES
Ex. 171
FromZetherz Company produced and sold 50,000 units of product and is operating at 80% of
plant capacity. Unit information about its product is as follows:
Sales Price $68
Variable manufacturing cost $42
Fixed manufacturing cost ($600,000 ÷ 50,000) 12 54
Profit per unit $14
The company received a proposal from a Danish company to buy 10,000 units of FromZetherz
Company's product for $49 per unit. This is a one-time only order and acceptance of this proposal
will not affect the company's regular sales. The president of FromZetherz Company is reluctant to
accept the proposal because he is concerned that the company will lose money on the special
order.

Instructions
Prepare a schedule reflecting an incremental analysis of this proposal and indicate the effect the
acceptance of this order might have on the company's income.
Ans: N/A, LO: 2, Bloom: AN, Difficulty: Hard, Min: 9, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 171 (9–13 min.)

FROMZETHERZ COMPANY
Incremental Analysis
Proposal to sell 10,000 units at $49

Net Income
Reject Order Accept Order Increase (Decrease)
Revenues (10,000 × $49) $ -0- $490,000 $490,000
Costs (10,000 × $42) -0- (420,000) (420,000)
Net Income $ -0- $ 70,000 $ 70,000

FromZetherz Company would increase its income by $70,000 in accepting the special order.

Ex. 172
Good Cabin Company manufactures cappuccino makers. For the first ten months of 2016, the
company reported the following operating results while operating at 80% of plant capacity:

Sales (500,000 units) $90,000,000

Cost of goods sold 54,000,000
Gross profit 36,000,000
Operating expenses 24,000,000
Net income $12,000,000

An analysis of costs and expenses reveals that variable cost of goods sold is $85 per unit and
variable operating expenses are $35 per unit.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 45

Ex. 172 (Cont.)

In November, Good Cabin Company receives a special order for 30,000 machines at $135 each
from a major coffee shop franchise. Acceptance of the order would result in $10,000 of shipping
costs but no increase in fixed expenses.

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Good Cabin Company accept the special order? Justify your answer.
Ans: N/A, LO: 2, Bloom: AN, Difficulty: Medium, Min: 12, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 172 (12–17 min.)

(a) Net Income
Reject Order Accept Order Increase (Decrease)
Revenues $ -0- $4,050,000 $4,050,000
Cost of Goods Sold -0- 2,550,000* (2,550,000)
Operating Expense -0- 1,060,000** (1,060,000)
Net Income $ -0- $ 440,000 $ 440,000

*Variable cost of goods sold = 30,000 × $85 = $2,550,000.

**Variable operating expenses = 30,000 × $35 = $1,050,000 + $10,000 = $1,060,000.

(b) The incremental analysis shows Good Cabin Company should accept the special order
because incremental revenues exceed incremental costs. This recommendation assumes
that acceptance of the special order will not affect relations with existing customers.

Ex. 173
Jim-Mate Company supplies schools with floor mattresses to use in physical education classes.
Jim-Mate has received a special order from a large school district to buy 700 mats at $55 each.
Acceptance of the special order will not affect fixed costs but will result in $1,500 of shipping
costs.

For the first 7 months of 2016, the company reported the following operating results while
operating at 75% capacity:
Sales (100,000 units) $9,000,000
Cost of goods sold 5,300,000
Gross profit 3,700,000
Operating expenses 2,500,000
Net income $ 1,200,000
Cost of goods sold was 70% variable and 30% fixed; operating expenses were 75% variable and
25% fixed.

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Jim-Mate Company accept the special order? Justify your answer.
Ans: N/A, LO: 2, Bloom: E, Difficulty: Medium, Min: 13, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

For Instructor Use Only

26 - 46 Test Bank for Accounting Principles, Twelfth Edition

Solution 173 (13–18 min.)

(a) Net Income
Reject Order Accept Order Increase (Decrease)
Revenues $ -0- $38,500 $38,500
Cost of Goods Sold -0- 25,970 (25,970)
Operating Expense -0- 14,625 (14,625)
Net Income $ -0- $ (2,095) $ (2,095)

Variable cost of goods sold = $5,300,000 × 70% = $3,710,000.

Variable cost of goods sold per unit = $3,710,000 ÷ 100,000 = $37.10.
Variable cost of goods sold for the special order = 700 × $37.10 = $25,970.
Variable operating expenses = $2,500,000 × 75% = $1,875,000
Variable operating expenses per unit = $1,875,000 ÷ 100,000 = $18.75
Variable operating expenses for the special order = 700 × $18.75 = $13,125 + $1,500
= $14,625

(b) The incremental analysis shows Jim-Mate Company should not accept the special order
because incremental costs exceed incremental revenues.

Ex. 174
Springfield Company produces golf discs which it normally sells to retailers for $6 each. The cost
of manufacturing 25,000 golf discs is:

Materials $ 10,000
Labor 30,000
Variable overhead 20,000
Fixed overhead 40,000
Total $100,000

Springfield also incurs 5% sales commission ($0.30) on each disc sold.

Lundy Corporation offers Springfield $5.25 per disc for 5,000 discs. Lundy would sell the discs
under its own brand name in foreign markets not yet served by Springfield. If Springfield accepts
the offer, its fixed overhead will increase from $40,000 to $45,000 due to the purchase of a new
imprinting machine. No sales commission will result from the special order.

Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Springfield accept the special order? Why or why not?
Ans: N/A, LO: 2, Bloom: E, Difficulty: Hard, Min: 12, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 174 (12 min.)

(a) Reject Accept
Order Order Net Income Effect
Revenues $ -0- $26,250 $26,250
Materials ($0.40) -0- (2,000) (2,000)
Labor ($1.20) -0- (6,000) (6,000)
Variable overhead ($0.80) -0- (4,000) (4,000)
Fixed overhead -0- (5,000) (5,000)
Sales commissions -0- -0- -0-
Net income $ -0- $ 9,250 $ 9,250
For Instructor Use Only
 Incremental Analysis and Capital Budgeting 26 - 47

Solution 174 (Cont.)

(b) As shown in the incremental analysis, Springfield should accept the special order because
incremental revenue exceeds incremental expenses by $9,250.

Ex. 175
Lean Inc. budgeted to produce 10,000 widgets during 2016. Lean has capacity to produce 12,000
units. Fixed factory overhead is allocated to production. The following estimated costs were
provided:
Direct material ($7/unit) $ 70,000
Direct labor ($15/hr. × 2 hrs./unit) 300,000
Variable manufacturing overhead ($3/unit) 30,000
Fixed factory overhead costs ($5/unit) 50,000
Total $450,000
Cost per unit = $45

Instructions
Answer each of the following independent questions:
1. Lean received an order for 1,000 units from a new customer in a country in which Lean has
never done business. This customer has offered $44 per widget. Should Lean accept the
order?

2. Lean received an offer from another company to manufacture the same quality widgets for
$39. Should Lean let someone else manufacture all 10,000 widgets and focus only on
distribution?
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 10, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 175 (10–12 min.)

1. Yes, Lean can make an extra $4,000.
Incremental revenue per widget $44
Incremental cost per widget: $7 + ($15 × 2) + $3 = 40
Incremental profit per unit $ 4
Total incremental profit = $4 × 1,000 = $4,000

2. Yes, Lean will save $10,000 if it buys instead of makes.

Cost to buy per widget $39
Cost to make per widget: $7 + ($15 × 2) + $3 = 40
Incremental savings per widget if purchased $ 1
Total incremental savings if purchased = $1 × 10,000 = $10,000

For Instructor Use Only

26 - 48 Test Bank for Accounting Principles, Twelfth Edition

Ex. 176
Winston Company manufactured 5,000 units of a component part that is used in its product and
incurred the following costs:

Direct materials $35,000

Direct labor 25,000
Variable manufacturing overhead 20,000
Fixed manufacturing overhead 18,000
$98,000

Another company has offered to sell the same component part to the company for $17.50 per
unit. The fixed manufacturing overhead consists mainly of depreciation on the equipment used to
manufacture the part and would not be reduced if the component part was purchased from the
outside firm. If the component part is purchased from the outside firm, Winston Company has the
opportunity to use the factory equipment to produce another product which is estimated to have a
contribution margin of $19,000.

Instructions
Prepare an incremental analysis report for Winston Company which can serve as informational
input into this make or buy decision.
Ans: N/A, LO: 2, Bloom: E, Difficulty: Medium, Min: 13, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 176 (13–18 min.)

Make Buy Increase (Decrease)
Direct materials $35,000 $ -0- $ 35,000
Direct labor 25,000 -0- 25,000
Variable manufacturing overhead 20,000 -0- 20,000
Fixed manufacturing overhead 18,000 18,000 -0-
Purchase price (5,000 × $17.50) -0- 87,500 (87,500)
Total annual cost 98,000 105.500 (7,500)
Opportunity cost 19,000 -0- 19,000
Total cost $117,000 $105,500 $11,500

Income is expected to increase by $11,500 if the component part is purchased from the outside
firm and the new product is manufactured.

Ex. 177
Grouperman Corporation currently manufactures a subassembly for its main product. The costs
per unit are as follows:

Direct materials $10

Direct labor 10
Variable overhead 7
Fixed overhead 9
Total $36

Fez Company has contacted Grouperman with an offer to sell it 7,000 of the subassemblies for
$30 each. If Fez makes the subassemblies, $4 of the fixed overhead per unit will be allocated to
other products.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 49

Ex. 177 (Cont.)

Instructions
Should Grouperman make or buy the subassemblies? Explain your answer.
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 6, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution 178 (6 min.)

Cost to make - cost to buy = incremental cost
($36 – $4) – $30 = $2
Incremental cost to make = $2 × 7,000 units = $14,000

Grouperman should buy to save $2 per unit.

Ex. 178
Downtown Unicycle Company has been manufacturing its own seats for its unicycles. The
company is currently operating at 100% capacity, and variable manufacturing overhead is
charged to production at the rate of 70% of direct labor cost. The direct materials and direct labor
cost per unit to make the bicycle seats are $8.00 and $9.00, respectively. Normal production is
50,000 unicycles per year.

A supplier offers to make the unicycle seats at a price of $20 each. If the unicycle company
accepts this offer, all variable manufacturing costs will be eliminated, but the $30,000 of fixed
manufacturing overhead currently being charged to the unicycle seats will have to be absorbed
by other products.

Instructions
(a) Prepare the incremental analysis for the decision to make or buy the bicycle seats.
(b) Should Downtown Unicycle Company buy the seats from the outside supplier? Justify your
answer.
Ans: N/A, LO: 2, Bloom: AN, Difficulty: Medium, Min: 15, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Cost Management

Solution 178 (15–20 min.)

(a) Net Income
Make Buy Increase (Decrease)
Direct Materials (50,000 × $8) $ 400,000 $ -0- $ 400,000
Direct Labor (50,000 × $9) 450,000 -0- 450,000
Variable Manufacturing Costs
($450,000 × 70%) 315,000 -0- 315,000
Fixed Manufacturing Costs 30,000 30,000 -0-
Purchase Price (50,000 × $20) -0- 1,000,000 (1,000,000)
Total annual cost $1,195,000 $1,030,000 $ 165,000

(b) The seats should be purchased from the outside supplier. As indicated, the company's net
income would increase $165,000 by purchasing the seats.

For Instructor Use Only

26 - 50 Test Bank for Accounting Principles, Twelfth Edition

Ex. 179
Bay States Chemical Corporation produces an oil-based chemical product which it sells to paint
manufacturers. In 2016, the company incurred $344,000 of costs to produce 40,000 gallons of the
chemical. The selling price of the chemical is $11.00 per gallon. The costs per unit to
manufacture a gallon of the chemical are presented below:
Direct materials $6.00
Direct labor 1.20
Variable manufacturing overhead .80
Fixed manufacturing overhead .60
Total manufacturing costs $8.60

The company is considering manufacturing the paint itself. If the company processes the
chemical further and manufactures the paint itself, the following additional costs per gallon will be
incurred: Direct materials $1.80, Direct labor $.60, Variable manufacturing overhead $.50. No
increase in fixed manufacturing overhead is expected. The company can sell the paint at $15.00
per gallon.

Instructions
Determine the incremental per gallon increase in net income and the total increase in net income
if the company manufactures the paint.
Ans: N/A, LO: 2, Bloom: E, Difficulty: Medium, Min: 15, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 179 (15–20 min.)

Net Income
Sell Chemical Process Further Increase (Decrease)
Sales price per unit $11.00 $15.00 $4.00
Cost per unit:
Direct materials (A) 6.00 7.80 (1.80)
Direct labor (B) 1.20 1.80 (.60)
Variable manufacturing overhead (C) .80 1.30 (.50)
Fixed manufacturing overhead .60 .60 —
Total 8.60 11.50 (2.90)
Net income per unit $ 2.40 $ 3.50 $1.10

(A) $6.00 + $1.80

(B) $1.20 + $.60
(C) $.80 + $.50

Assuming the company sells all 40,000 gallons that it produces, the incremental net income
would be $44,000 (40,000 gallons × $1.10).

Ex. 180
Chipper Cow Dairy Inc. produces milk at a total cost of $75,000. The production generates
55,000 gallons of organic milk which can be sold for $2 per gallon to a pasteurization company, or
the milk can be processed further into ice cream and then sold for $4.50 per gallon. It costs
$92,000 more to turn the annual milk supply into ice cream.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 51

Ex. 180 (Cont.)

Instructions
If Chipper Cow processes the milk into ice cream, how much is the incremental profit or loss?
Should Chipper Cow process the milk into ice cream or sell it as is?
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 6, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 180 (6 min.)

Incremental revenues: ($4.50 – $2.00) × 55,000 gallons = $137,500
Incremental costs: given as $92,000
Incremental profits: $137,500 – $92,000 = $45,500 profit

Chipper Cow should process into ice cream.

Ex. 181
Stop Light Bikes could sell its bicycles to retailers either assembled or unassembled. The cost of
an unassembled bike is as follows.
Direct materials $150
Direct labor 70
Variable overhead (70% of direct labor) 49
Fixed overhead (30% of direct labor) 21
Manufacturing cost per unit $290

The unassembled bikes are sold to retailers at $400 each.

Stop Light currently has unused productive capacity that is expected to continue indefinitely;
management has concluded that some of this capacity can be used to assemble the bikes and
sell them at $440 each. Assembling the bikes will increase direct materials by $5 per bike, and
direct labor by $5 per bike. Additional variable overhead will be incurred at the normal rates, but
there will be no additional fixed overhead as a result of assembling the bikes.

Instructions
(a) Prepare an incremental analysis for the sell-or-process-further decision.
(b) Should Stop Light sell or process further? Why or why not?
Ans: N/A, LO: 2, Bloom: E, Difficulty: Medium, Min: 12, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 181 (12 min.)

(a) Net Income
Process Increase
Sell Further (Decrease)
Sales per unit $400 $440 $ 40
Costs per unit
Materials 150 155 (5)
Labor 70 75 (5)
Variable overhead (70%) 49 52.50 (3.50)
Fixed overhead 21 21 -0-
Total $290 303.50 (13.50)
Net income per unit $110 $136.50 $ 26.50

For Instructor Use Only

26 - 52 Test Bank for Accounting Principles, Twelfth Edition

Solution 181 (Cont.)

(b) As shown in the incremental analysis, Stop Light Bikes should process further (rather than
sell unassembled) because incremental revenue exceeds incremental expenses by $26.50
per unit.

Ex. 182
Mountain Lumber Corporation uses a machine that removes the bark from cut timber. The
machine is unreliable, resulting in significant downtime and wasted labor costs. Management is
considering replacing the machine with a more efficient one which will minimize downtime and
excessive labor costs. Data are presented below for the two machines:
Old Machine New Machine
Original purchase cost $325,000 $405,000
Accumulated depreciation 230,000 —
Estimated life 4 years 4 years
It is estimated that the new machine will produce annual cost savings of $107,000. The old
machine can be sold to a scrap dealer for $12,000. Both machines will have a salvage value of
zero if operated for the remainder of their useful lives.

Instructions
Determine whether the company should purchase the new machine.
Ans: N/A, LO: 2, Bloom: AN, Difficulty: Medium, Min: 11, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 182 (11–16 min.)

Retain Replace Net Income
Equipment Equipment Increase/(Decrease)
Cost savings $ -0- $428,000 (A) $428,000
New machine cost -0- (405,000) (405,000)
Proceeds from sale of old machine $ -0- 12,000 12,000
Net incremental net income $ -0- $ 35,000 $ 35,000
(A) $107,000 × 4 = $428,000.
The company should purchase the new machine because there will be an increase in net income
of $35,000.

Ex. 183
Moon City Enterprises relies heavily on a copier machine to process its paperwork. Recently the
copy clerk has not been able to process all the necessary copies within the regular work week.
Management is considering updating the copier machine with a faster model.
Current Copier New Model
Original purchase cost $15,000 $21,000
Accumulated depreciation 12,000 —
Estimated operating costs (annual) 9,000 3,700
Useful life 4 years 4 years
If sold now, the current copier would have a salvage value of $1,000. If operated for the
remainder of its useful life, the current machine would have zero salvage value. The new machine
is expected to have zero salvage value after five years.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 53

Ex. 183 (Cont.)

Instructions
Prepare an analysis to show whether the company should retain or replace the machine.
Ans: N/A, LO: 2, Bloom: E, Difficulty: Medium, Min: 12, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 183 (12–16 min.)

Net Income
Retain Machine Replace Machine Increase (Decrease)
Operating costs $36,000 $14,800 $21,200
New machine cost -0- 21,000 (21,000)
Salvage value -0- (1,000) 1,000
Totals $36,000 $34,800 $ 1,200
The current copier should be replaced. The incremental analysis shows that net income for the
five-year period will be $1,200 higher by replacing the current copier.

Ex. 184
Multi-Cities Inc. has three divisions: Buck, Leonard, and Hickory. The results of August, 2016 are
presented below.
Buck Leonard Hickory Total
Units sold 3,000 5,000 2,000 10,000
Revenue $70,000 $50,000 $40,000 $160,000
Less variable costs 32,000 26,000 16,000 74,000
Less direct fixed costs 14,000 19,000 12,000 45,000
Less allocated fixed costs 6,000 10,000 4,000 20,000
Net income $18,000 $ (5,000) $ 8,000 $ 21,000

All of the allocated costs will continue even if a division is discontinued. Multi-Cities allocates
indirect fixed costs based on the number of units to be sold. Since the Leonard division has a net
loss, Multi-Cities feels that it should be discontinued. Multi-Cities feels if the division is closed,
that sales at the Buck division will increase by 10%, and that sales at the Hickory division will stay
the same.

Instructions
(a) Prepare an analysis showing the effect of discontinuing the Leonard division.
(b) Should Multi-Cities close the Leonard division? Briefly indicate why or why not.
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 10, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 184 (10–12 min.)

(a) Buck Hickory Total
Revenue $77,000 $40,000 $117,000
Less variable costs 35,200 16,000 51,200
Less direct fixed costs 14,000 12,000 26,000
Less allocated fixed costs 12,453 7,547 20,000
Net income $15,347 $ 4,453 $ 19,800

For Instructor Use Only

26 - 54 Test Bank for Accounting Principles, Twelfth Edition

Solution 184 (Cont.)

Calculations:
Revenue = $70,000 × 110% = $77,000
Variable costs = $32,000 × 110% = $35,200
Allocation of total allocated fixed costs of $20,000:
To Boone: [3,300 ÷ (3,300 + 2,000)] × $20,000 = $12,453
To Hickory: [2,000 ÷ (3,300 + 2,000)] × $20,000 = $7,547

(b) No. The profit decreases by $1,200 ($21,000 – $19,800) when the division is eliminated. The
increase in sales by 10% of the Buck division was not enough to offset the loss of the
Leonard division.

Ex. 185
Mississippi Forest Corporation operates two divisions, the Commercial Division and the
Consumer Division. The Commercial Division manufactures and sells logs to paper
manufacturers. The Consumer Division operates retail lumber mills which sell a variety of
products in the do-it-yourself homeowner market. The company is considering disposing of the
Consumer Division since it has been consistently unprofitable for a number of years. The income
statements for the two divisions for the year ended December 31, 2014 are presented below:

Commercial Consumer Total

Sales revenue $1,500,000 $500,000 $2,000,000
Cost of goods sold 900,000 350,000 1,250,000
Gross profit 600,000 150,000 750,000
Selling & administrative expenses 250,000 180,000 430,000
Net income $ 350,000 $ (30,000) $ 320,000

In the Consumer Division, 70% of cost of goods sold are variable costs and 35% of selling and
administrative expenses are variable costs. The management of the company feels it can save
$45,000 of fixed cost of goods sold and $42,000 of fixed selling expenses if it discontinues
operation of the Consumer Division.

Instructions
(a) Determine whether the company should discontinue operating the Consumer Division.
(b) If the company had discontinued the division for 2014, determine what net income would
have been.
Ans: N/A, LO: 2, Bloom: E, Difficulty: Medium, Min: 20, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 55

Solution 185 (20–25 min.)

(a) CONSUMER DIVISION
Net Income
Continue Eliminate Increase (Decrease)
Sales revenue $500,000 $ -0- $(500,000)
Variable expenses:
Cost of goods sold 245,000 (A) -0- 245,000
Selling and admin. exp. 63,000 (B) -0- 63,000
Contribution margin 192,000 -0- (192,000)
Fixed expenses:
Cost of goods sold 105,000 (C) 60,000 45,000
Selling and admin. exp. 117,000 (D) 75,000 42,000
Net income $ (30,000) $(135,000) $(105,000)

(A) $350,000 × 70% = $245,000 (C) $350,000 – $245,000 = $105,000

(B) $180,000 × 35% = $63,000 (D) $180,000 – $63,000 = $117,000

The company should continue the Consumer Division because contribution margin, $192,000, is
greater than the avoidable fixed costs, $105,000.

(b) Net income for the total company would have been $215,000:
Commercial Division + Decrease in Net Income
$320,000 + $(105,000) = $215,000

Ex. 186
Brown Bear Merchandising Inc. has three product lines in its retail stores: books, videos, and
music. Results of the fourth quarter are presented below:
Books Music Videos Total
Revenue $25,000 $40,000 $28,000 $93,000
Variable departmental costs 17,000 21,000 12,000 50,000
Direct fixed costs 4,000 6,000 3,000 13,000
Allocated fixed costs 5,000 5,000 5,000 15,000
Net income (loss) $ (1,000) $ 8,000 $ 8,000 $ 15,000

The allocated fixed costs are unavoidable. Demand for individual products is not affected by
changes in other product lines.

Instructions
What will happen to profits if Brown Bear discontinues the Books product line?
Ans: N/A, LO: 2, Bloom: AP, Difficulty: Medium, Min: 6, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 186 (6 min.)

Incremental revenue $(25,000)
Incremental costs:
Variable costs savings + 17,000
Direct fixed costs savings + 4,000
Decrease in profits if discontinued $ (4,000)

For Instructor Use Only

26 - 56 Test Bank for Accounting Principles, Twelfth Edition

Ex. 187
A recent accounting graduate from East Southwest State University evaluated the operating
performance of Patel Company's four divisions. The following presentation was made to Patel 's
Board of Directors. During the presentation, the accountant made the recommendation to
eliminate the Northern Division stating that total net income would increase by $60,000. (See
analysis below.)
Other Three Divisions Northern Division Total
Sales revenue $2,000,000 $480,000 $2,480,000
Cost of Goods Sold 950,000 400,000 1,350,000
Gross Profit 1,050,000 80,000 1,130,000
Operating Expenses 800,000 140,000 940,000
Net Income $ 250,000 $ (60,000) $ 190,000

For the other divisions, cost of goods sold is 80% variable and operating expenses are 70%
variable. The cost of goods sold for the Northern Division is 35% fixed, and its operating
expenses are 75% fixed. If the division is eliminated, only $5,000 of the fixed operating costs will
be eliminated.

Instructions
Do you concur with the new accountant's recommendation? Present a schedule to support your
answer.
Ans: N/A, LO: 2, Bloom: E, Difficulty: Medium, Min: 20, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 187 (20–25 min.)

Net Income
Continue Eliminate Increase (Decrease)
Sales revenue $480,000 $ -0- $(480,000)
Variable Expenses
Cost of goods sold 260,000 -0- 260,000
Operating expenses 35,000 -0- 35,000
Total Variable 295,000 -0- 295,000
Contribution Margin 185,000 -0- (185,000)
Fixed Expenses
Cost of goods sold 140,000 140,000 -0-
Operating expenses 105,000 100,000 5,000
Net Income (Loss) $ (60,000) $(240,000) $(180,000)

The accountant is not correct. If the Northern Division is eliminated, the net income will be
$180,000 less, not $60,000 greater.

The reduction in income is the result of the loss of the contribution margin less the avoidable fixed
costs of $5,000.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 57

Ex. 188
Siesta Company estimates the following cash flows and depreciation on a project that will cost
$200,000 and will last 10 years with no salvage value:

Revenues
Sales revenue $80,000
Operating expenses
Salary expense $32,000
Depreciation expense 20,000
Miscellaneous expenses 8,000 60,000
Net Income $20,000

Instructions
(a) Calculate the expected annual rate of return on this project showing calculations to support
your answer.
(b) Calculate the cash payback on this project showing calculations to support your answer.
Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 9, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 188 (9–14 min.)

(a) Annual rate of return is 10%.

$200,000
Average investment = ———— = $100,000
2

$20,000
Annual rate of return = ———— = 20%
$100,000

(b) Cash payback period is 5 years.

Investment $200,000
Annual cash inflow ($20,000 + $20,000) $40,000
Cash payback = $200,000 ÷ $40,000 = 5 years

Ex. 189
Wayton Medical Center is considering purchasing an ultrasound machine for $1,135,000. The machine
has a 10-year life and an estimated salvage value of $40,000. Installation costs and freight
charges will be $24,300 and $700, respectively. The Center uses straight-line depreciation.

The medical center estimates that the machine will be used five times a week with the average
charge to the patient for ultrasound of $850. There are $10 in medical supplies and $40 of
technician costs for each procedure performed using the machine.

Instructions
(a) Compute the payback period for the new ultrasound machine.
(b) Compute the annual rate of return for the new machine.
Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 16, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

For Instructor Use Only

26 - 58 Test Bank for Accounting Principles, Twelfth Edition

Solution 189 (16–22 min.)

(a) Cost of the ultrasound machine: $1,135,000 + $24,300 + $700 = $1,160,000

Annual Cash Flow:

Number of procedures: 52 × 5 = 260
Contribution margin per procedure: $850 – $10 – $40 = $800
Total annual cash flow: 260 × $800 = $208,000
$1,160,000
Cash payback: ————— = 5.6 years
$208,000

(b) $1,160,000 + $40,000

Average Investment: —————————— = $600,000
2
$1,160,000 – $40,000
Annual Depreciation: —————————— = $112,000
10 years
Annual Net Income: $208,000 – $112,000 = $96,000
$96,000
Average Annual Rate of Return: ———— = 16%
$600,000
Ex. 190
Hooverville Service Center just purchased an automobile hoist for $16,900. The hoist has a 5-
year life and an estimated salvage value of $1,250. Installation costs were $3,770, and freight
charges were $960. Hooverville uses straight-line depreciation.
The new hoist will be used to replace mufflers and tires on automobiles. Hooverville estimates
that the new hoist will enable his mechanics to replace four extra mufflers per week. Each muffler
sells for $84.50 installed. The cost of a muffler is $46.50, and the labor cost to install a muffler is
$13.
Instructions
(a) Compute the payback period for the new hoist.
(b) Compute the annual rate of return for the new hoist. (Round to one decimal.)
Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 10, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 190 (10 min.)

(a) Cost of hoist: $16,900 + $3,770 + $960 = $21,630.
Net annual cash flow:
Number of extra mufflers: 4 × 52 weeks (a) 208
Contribution margin per muffler ($84.50 – $46.50 – $13) (b) $ 25
Total net annual cash flow: (a) × (b) $5,200
Cash payback = $21,630 ÷ $5,200 = 4.2 years.

(b) Average investment: ($21,630 + $1,250) ÷ 2 = $11,440.

Annual depreciation: ($21,630 – $1,250) ÷ 5 = $4,076.
Annual net income: $5,200 – $4,076 = $1,124.
Average annual rate of return = $1,124 ÷ $11,440 = 9.8% (rounded).
For Instructor Use Only
 Incremental Analysis and Capital Budgeting 26 - 59

Ex. 191
Rosco Manufacturing Company is considering three new projects, each requiring an equipment
investment of $20,000. Each project will last for 3 years and produce the following cash inflows.

Year AA BB CC
1 $ 7,000 $ 9,600 $11,000
2 9,000 9,600 10,000
3 15,000 9,600 9,000
Total $31,000 $28,800 $30,000

The equipment's salvage value is zero. Rosco uses straight-line depreciation. Rosco will not
accept any project with a payback period over 2 years. Rosco 's minimum required rate of return
is 12%.

Instructions
(a) Compute each project's payback period, indicating the most desirable project and the least
desirable project using this method. (Round to two decimals.)
(b) Compute the net present value of each project. Does your evaluation change? (Round to
nearest dollar.)
Ans: N/A, LO: 3, 4, Bloom: E, Difficulty: Medium, Min: 25, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 191 (25 min.)

(a)
AA
Annual Net Cumulative Net
Year Cash Flow Cash Flow
1 $ 7,000 $ 7,000
2 9,000 16,000
3 15,000 31,000

Cash payback 2.27 years

$20,000 – $16,000 = $4,000
$4,000 ÷ $15,000 = .27

BB
20,000 ÷ (28,800 ÷ 3) = 2.08 years

CC
Year
1 $11,000 $11,000
2 10,000 21,000
3 9,000 30,000

Cash payback 1.9 years

$20,000 – 11,000 = $9,000
$9,000 ÷ $10,000 = .9

For Instructor Use Only

26 - 60 Test Bank for Accounting Principles, Twelfth Edition

Solution 191 (Cont.)

The most desirable project is CC because it has the shortest payback period. The least desirable
project is AA because it has the longest payback period. As indicated, only CC is acceptable
because its cash payback is 1.9 years.

(b)
AA BB CC
Net Net
Annual Annual
Discount Cash Present Cash Present Net Cash Present
Year Factor Flow Value Flow Value Flow Value
1 .89286 $ 7,000 $ 6,250 $9,600 $ 8,572 $11,000 $ 9,821
2 .79719 9,000 7,175 9,600 7,653 10,000 7,972
3 .71178 15,000 10,677 9,600 6,833 9,000 6,406
Total present value 24,102 23,058(1) 24,199
Investment 20,000 20,000 20,000
Net present value $ 4,102 $ 3,058 $ 4,199

(1) This total may also be obtained from Table 2: $9,600  2.40183 = $23,058. Project CC is still
the most desirable project. Also, on the basis of net present values, all of the projects are
acceptable. Project BB is the least desirable.

Ex. 192
Messina Company is considering a capital investment of $300,000 in additional productive
facilities. The new machinery is expected to have a useful life of 5 years with no salvage value.
Depreciation is by the straight-line method. During the life of the investment, annual net income
and cash inflows are expected to be $30,000 and $80,000, respectively. Messina has an 11%
cost of capital rate, which is the minimum acceptable rate of return on the investment.

Instructions
(Round to two decimals.)
(a) Compute (1) the annual rate of return and (2) the cash payback period on the proposed
capital expenditure.
(b) Using the discounted cash flow technique, compute the net present value.
Ans: N/A, LO: 3,4, Bloom: AP, Difficulty: Medium, Min: 16, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA
PC: Problem Solving, IMA: Investment Decisions

Solution 192 (16 min.)

(a) (1) Annual rate of return: $30,000 ÷ [(300,000 + $0) ÷ 2] = 20%
(2) Cash payback: $300,000 ÷ $80,000 = 3.75 years.

(b)
Item Amount Years PV Factor Present Value
Net annual cash flows $ 80,000 1-5 3.60478 $288,382
Capital investment $300,000 Now 1.00000 300,000
Negative net present value $ (11,618)

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 61

Ex. 193
Mc Gee Corporation recently purchased a new machine for its factory operations at a cost of
$840,000. The investment is expected to generate $250,000 in annual cash flows for a period of
five years. The required rate of return is 12%. The new machine is expected to have zero salvage
value at the end of the five-year period.

Instructions
Calculate the internal rate of return. (Table 2 from Appendix C is needed.)
Ans: N/A, LO: 4, Bloom: AP, Difficulty: Medium, Min: 4, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 193 (4 min.)

IRR = Capital investment ÷ Annual cash inflows = Factor
$840,000 ÷ $250,000 = 3.36. This factor is found in the PVA table at n = 5 periods.
IRR = 15%

Ex. 194
Grayson Company is considering two new projects, each requiring an equipment investment of
$72,000. Each project will last for three years and produce the following annual net income.
Year TIP TOP
1 $ 8,000 $ 9,000
2 9,000 9,000
3 14,000 9,000
$31,000 $27,000

The equipment will have no salvage value at the end of its three-year life. Grayson Company
uses straight-line depreciation. Grayson requires a minimum rate of return of 12%. Present value
data are as follows:
Present Value of 1 Present Value of an Annuity of 1
Period 12% Period 12%
1 .893 1 .893
2 .797 2 1.690
3 .712 3 2.402
Instructions
(a) Compute the net present value of each project.
(b) Which project should be selected? Why?
Ans: N/A, LO: 4, Bloom: E, Difficulty: Medium, Min: 22, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 194 (22–27 min.)

(a) Project TIP
Year Annual Cash Inflows* Present Value of 1 Present Value
1 $ 32,000 .893 $28,576
2 33,000 .797 26,301
3 38,000 .712 27,056
$103,000 $81,933
*Net income plus annual depreciation of $24,000.

For Instructor Use Only

26 - 62 Test Bank for Accounting Principles, Twelfth Edition

Solution 194 (Cont.)

Present value of future cash inflows $81,933
Capital investment 72,000
Positive net present value $ 9,933

Project TOP
Present value of future cash inflows ($33,000 × 2.402) $79,266
Capital investment 72,000
Positive net present value $ 7,266

(b) Both projects are acceptable because both show a positive net present value. Project TIP is
the preferred project because its positive net present value is greater than project TOP's net
present value.

Ex. 195
Jonah Company is considering investing in a project that will cost $136,520 and have no salvage
value at the end of its 5-year life. It is estimated that the project will generate annual cash inflows
of $36,000 each year. The company has a hurdle or cutoff rate of return of 8% and uses the
following compound interest table:

Present Value of an Annuity of 1

Period 6% 8% 10% 12% 15%
5 4.212 3.993 3.791 3.605 3.352

Instructions
Using the internal rate of return method, determine if this project is acceptable by calculating an
approximate interest yield for the project.
Ans: N/A, LO: 4, Bloom: E, Difficulty: Medium, Min: 6, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 195 (6–11 min.)

Capital Investment
————————— = Internal Rate of Return Factor
Annual Cash Inflows

$136,520
————- = 3.792
$36,000

Since the calculated internal rate of return factor of 3.792 is very near the factor 3.791 for five
periods and 10% interest, this project has an approximate interest yield of 10%, and is therefore
acceptable because it is greater than the company's cutoff rate of 8%.

Ex. 196
Niro Company has money available for investment and is considering two projects each costing
$71,000. Each project has a useful life of 3 years and no salvage value. The investment cash
flows follow:
Project A Project B
Year 1 $ 8,000 $28,000
Year 2 24,000 28,000
Year 3 52,000 28,000
For Instructor Use Only
 Incremental Analysis and Capital Budgeting 26 - 63

Ex. 196 (Cont.)

Instructions
If 8% is an acceptable earnings rate, which project should be selected? Justify your response.
(Table 1 from Appendix C is needed.)
Ans: N/A, LO: 4, Bloom: AP, Difficulty: Medium, Min: 12, AACSB: Analytic, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

Solution 196 (12 min.)

Project B is acceptable since its net present value is positive. This indicates that project B
provides a return greater than the company's minimum expected return of 8%. Project A earns
less than an 8% return.

Project A
Year 1 $8,000 × .926 = $ 7,408
Year 2 $24,000 × .857 = 20,568
Year 3 $52,000 × .794 = 41,288
Present value of cash inflows 69,264
Cash purchase price (71,000)
Net present value of project A $ (1,736)

Project B
Year 1 $28,000 × .926 = $25,928
Year 2 $28,000 × .857 = 23,996
Year 3 $28,000 × .794 = 22,232
Present value of cash inflows 72,156
Cash purchase price (71,000)
Net present value of project B $ 1,156

COMPLETION STATEMENTS
197. An important purpose of management accounting is to provide _____________________
for decision making.
Ans: N/A, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Measurement, AICPA PC:
Interaction, IMA: Business Economics

198. The process used to identify the financial data that change under alternative courses of
action is called __________________ analysis.
Ans: N/A, LO: 1, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

199. In a decision on whether an order should be accepted at a special price when there is
plant capacity available, a major consideration is whether the special price exceeds
__________________.
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

200. The potential benefit that may be obtained by following an alternative course of action is
called an _________________ cost.
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

For Instructor Use Only

26 - 64 Test Bank for Accounting Principles, Twelfth Edition

201. A decision whether to sell a product now or to process it further, depends on whether the
incremental _____________ from processing further are greater than the incremental
processing ______________.
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

202. The ______________ value of old equipment is irrelevant in a decision to replace that
equipment and is often referred to as a _____________ cost.
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Measurement, AICPA PC: Problem
Solving, IMA: Business Economics

203. The process of making capital expenditure decisions in business is called ___________.
Ans: N/A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

204. Three quantitative techniques which are frequently used in capital budgeting decisions are
(1) _________________, (2) _________________, and (3) ___________________.
Ans: N/A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

205. A major limitation of the annual rate of return approach is that it does not consider the
_______________ of money.
Ans: N/A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

206. The technique which identifies the time period required to recover the cost of the
investment is called the ________________ method.
Ans: N/A, LO: 3, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

207. The two discounted cash flow techniques used in capital budgeting are (1) the
_______________________ method and (2) the ______________________ method.
Ans: N/A, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

208. Knowledge of the ______________________ is necessary when discounting future cash

flows under the net present value approach.
Ans: N/A, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

209. In using the net present value approach, a project is acceptable if the project's net present
value is ____________ or _______________.
Ans: N/A, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

210. The internal rate of return method differs from the net present value method in that it
results in finding the ___________________ of the potential investment.
Ans: N/A, LO: 4, Bloom: K, Difficulty: Easy, Min: 1, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 65

Answers to Completion Statements

197. relevant information 205. time value
198. incremental (differential) 206. cash payback
199. variable costs (incremental costs) 207. net present value, internal rate of return
200. opportunity 208. required rate of return
201. revenues, costs 209. zero, positive
202. book, sunk 210. interest yield
203. capital budgeting
204. annual rate of return, cash payback,
discounted cash flow

MATCHING
211. Match the items below by entering the appropriate code letter in the space provided.

A. Incremental analysis F. Cash payback technique

B. Opportunity cost G. Hurdle or cutoff rate
C. Discounted cash flow technique H. Net present value method
D. Capital budgeting I. Sunk cost
E. Annual rate of return technique J. Internal rate of return method

____ 1. A cost that cannot be changed by any present or future decision.

____ 2. A capital budgeting technique that considers both the estimated total cash inflows from
the investment and the time value of money.

____ 3. A method used in capital budgeting in which cash inflows are discounted to their
present value and then compared to the capital outlay required by the capital
investment.

____ 4. The process of identifying the financial data that change under alternative courses of
action.

____ 5. A method used in capital budgeting that results in finding the interest yield of the
potential investment.

____ 6. The minimum rate of return management requires on an investment.

____ 7. The determination of the profitability of a capital expenditure by dividing expected

annual net income by the average investment.

____ 8. The potential benefit that may be lost from following an alternative course of action.

____ 9. The process of making capital expenditure decisions in business.

____ 10. A capital budgeting technique that identifies the time period required to recover the
cost of a capital investment from the annual cash inflow produced by the investment.
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 5, AACSB: None, AICPA BB: Industry/Sector Perspective, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Investment Decisions

For Instructor Use Only

26 - 66 Test Bank for Accounting Principles, Twelfth Edition

Answers to Matching

1. I 6. G
2. C 7. E
3. H 8. B
4. A 9. D
5. J 10. F

SHORT-ANSWER ESSAY QUESTIONS

S-A E 212
Management is often faced with the alternative of continuing to make a product or component
internally, or going to an external source and purchasing the product or component. In gathering
relevant information for these two alternatives, briefly identify the quantitative factors that should
be considered. Are there any qualitative factors that should also be considered?
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Business Economics

Solution 212
The quantitative factors to be considered in a make or buy decision include the incremental costs
to make the product, the incremental costs of buying the product, and the opportunity cost
(potential benefit foregone) if the product is made. Generally, all variable production costs are
relevant in a make or buy decision, but only some fixed costs, or no fixed costs, are relevant
because many fixed costs will be incurred regardless of whether the decision is to make or buy.
Qualitative factors include the possible adverse effect on employees and the stability of the
supplier's price and quality.

S-A E 213
Management uses several capital budgeting approaches in evaluating projects for possible
investment. Identify those approaches that are more desirable from a conceptual standpoint, and
briefly explain what features these approaches have that make them more desirable than other
approaches. Also identify the least desirable approach and explain its major weaknesses.
Ans: N/A, LO: 4, Bloom: K, Difficulty: Easy, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution 213
From a conceptual standpoint, the discounted cash flow methods (net present value and internal
rate of return) are considered more desirable because they consider both the estimated cash
flows and the time value of money. The time value of money is critical because of the long-term
impact of capital budgeting decisions. Capital budgeting approaches which do not consider the
time value of money include annual rate of return and cash payback. The cash payback method
is the least desirable because it also ignores the expected profitability of the project.

For Instructor Use Only

 Incremental Analysis and Capital Budgeting 26 - 67

S-A E 214
Define the term "opportunity cost." How may this cost be relevant in a make-or-buy decision?
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 5, AACSB: None, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC: Problem
Solving, IMA: Investment Decisions

Solution 214
Opportunity cost may be defined as the potential benefit that may be obtained by following an
alternative course of action. Opportunity cost is relevant in a make-or-buy decision when the
facilities used to make the part can be used to generate additional income.

S-A E 215
Sandra Everhart is trying to understand the term "cost of capital." Define the term, and indicate its
relevance to the decision rule under the annual rate of return technique.
Ans: N/A, LO: 3, Bloom: K, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA
PC: Problem Solving, IMA: Investment Decisions

Solution 215
Cost of capital is the rate of return that management expects to pay on all borrowed and equity
funds. The decision rule is: A project is acceptable if its rate of return is greater than or equal to
management's minimum rate of return (which often is its cost of capital), and the project is
unacceptable when the rate of return is less than the minimum rate of return.

S-A E 216 (Ethics)

Selma Bosco is on the capital budgeting committee for her company, Magnificent Tile. Bill
Baumhauer is an engineer for the firm. Bill expresses his disappointment to Selma that a project
that was given to him to review before submission looks extremely good on paper. "I really hoped
that the cost projections wouldn't pan out," he tells his friend. "The technology used in this is pie
in the sky kind of stuff. There are a hundred things that could go wrong. But the figures are very
convincing. I haven't sent it on yet, though I probably should."

"You can keep it if it's really that bad," assures Selma. "Anyway, you can probably get it shot out
of the water pretty easily, and not have the guy who submitted it mad at you for not turning it in.
Just fix the numbers. If you figure, for instance, that a cost is only 50% likely to be that low, then
double it. We do it all the time, informally. Best of all, the rank and file don't get to come to those
sessions. Your engineering genius need never know. He'll just think someone else's project was
even better than his."

Required:
1. Who are the stakeholders in this situation?
2. Is it ethical to adjust the figures to compensate for risk? Explain.
3. Is it ethical to change the proposal before submitting it? Explain.
Ans: N/A, LO: 3, Bloom: K, Difficulty: Easy, Min: 5, AACSB: Ethics, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA PC:
Problem Solving, IMA: Business Economics

Solution 216
1. The stakeholders include:
Bill Baumhauer
Magnificent Tile
the engineer who submitted the proposal.

For Instructor Use Only

26 - 68 Test Bank for Accounting Principles, Twelfth Edition

Solution 216 (Cont.)

2. It is ethical, in general, to adjust projections to compensate for risk. However, it should be

clearly stated that the projections have been adjusted for risk, and the method used should be
available for review. Otherwise, the entire selection process is undermined, and it becomes
entirely subjective.

3. It is probably not ethical to modify a proposal at all; certainly not in the way described. The
engineer submitting the proposal should have the right to know about any changes that were
made, and should have the right to review those changes.

S-A E 217 (Communication)

You are the general accountant for Unlimited Words, Inc., a typing service based in San
Francisco, California. The company has decided to upgrade its equipment. It currently has a
widely used version of a word processing program. The company wishes to invest in more up-to-
date software and to improve its printing capabilities.

Two options have emerged. Option #1 is for the company to keep its existing computer system,
and upgrade its word processing program. The memory of each individual work station would be
enhanced, and a larger, more efficient printer would be used. Better telecommunications
equipment would allow for the electronic transmission of some documents as well.

Option #2 would be for the company to invest in an entirely different computer system. The
software for this system is extremely impressive, and it comes with individual laser printers.
However, the company is not well known, and the software does not connect well with well-known
software. The net present value information for these options follows:

Option #1 Option #2
Initial Investment $(95,000) $(240,000)
Returns Year 1 55,000 80,000
Year 2 30,000 80,000
Year 3 10,000 80,000
Net Present Value 0 0

Required:
Prepare a brief report for management in which you make a recommendation for one system or
the other, using the information given.
Ans: N/A, LO: 2, Bloom: K, Difficulty: Easy, Min: 5, AACSB: Communications, AICPA BB: Resource Management, AICPA FN: Decision Modeling, AICPA
PC: Problem Solving, IMA: Investment Decisions

Solution 217
I recommend that the company accept Option #1, to purchase upgrades to our present system
and to buy a more efficient printer. In the first place, the changes will be easier to implement
because the equipment is similar to that which we already use. Secondly, the company will have
less money invested in the project, which decreases our risk of loss should the project fail. Option
#2 appears to be too risky.

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