22) Identify, in proper sequence, the steps in the process of recognizing and managing constraints.
23) Explain the importance of a bottleneck operation in a production sequence.
Section 3 Break-Even Analysis
1) Fixed costs are those costs that continue even if no units are produced.
2) Break-even analysis identifies the volume at which fixed costs and revenue are equal.
3) Break-even analysis is a powerful analytical tool, but is useful only when the organization produces a
single product.
4) Break-even is the number of units at which:
A) total revenue equals price times quantity.
B) total revenue equals total variable cost.
C) total revenue equals total fixed cost.
D) total profit equals total cost.
E) total revenue equals total cost.
5) Which of the following statements regarding fixed costs is TRUE?
A) Fixed costs rise by a constant amount for every added unit of volume.
B) While fixed costs are ordinarily constant with respect to volume, they can “step” upward if volume
increases result in additional fixed costs.
C) Fixed costs are those costs associated with direct labor and materials.
D) Fixed costs equal variable costs at the break-even point.
E) Fixed cost is the difference between selling price and variable cost.
6) Which of the following costs would be incurred even if no units were produced?
A) raw material costs
B) direct labor costs
C) transportation costs
D) building rental costs
E) purchasing costs
7) Basic break-even analysis typically assumes that:
A) revenues increase in direct proportion to the volume of production, while costs increase at a
decreasing rate as production volume increases.
B) variable costs and revenues increase in direct proportion to the volume of production.
C) both costs and revenues are made up of fixed and variable portions.
D) costs increase in direct proportion to the volume of production, while revenues increase at a
decreasing rate as production volume increases because of the need to give quantity discounts.
E) All of the above are assumptions in the basic break-even model.
8) Fabricators, Inc. wants to increase capacity by adding a new machine. The fixed costs for machine A
are $90,000, and its variable cost is $15 per unit. The revenue is $21 per unit. What is the break-even point
for machine A?
A) $90,000 dollars
B) 90,000 units
C) $15,000 dollars
D) 15,000 units
E) 4,286 units
9) Break-even analysis can be used by a firm that produces more than one product, but:
A) the results are estimates, not exact values.
B) the firm must allocate some fixed cost to each of the products.
C) each product has its own break-even point.
D) the break-even point depends upon the proportion of sales generated by each of the products.
E) None of these statements is true.
10) The basic break-even model can be modified to handle more than one product. This extension of the
basic model requires:
A) price and sales volume for each product.
B) price and variable cost for each product, and the percent of sales that each product represents.
C) that the firm have very low fixed costs.
D) that the ratio of variable cost to price be the same for all products.
E) sales volume for each product.
11) A product sells for $5, and has unit variable costs of $3. This product accounts for $20,000 in annual
sales, out of the firm’s total of $60,000. When performing multiproduct break-even analysis, what is the
weighted contribution of this product?
A) 0.133
B) 0.200
C) 0.40
D) 0.667
E) $1.667
12) ________ analysis finds the point at which costs equal revenues.
13) ________ cost is the cost that continues even if no units are produced.
14) Multiproduct break-even analysis calculates the ________ of each product, ________ it in proportion
to each product’s share of total sales.
15) Define fixed costs.
16) Define variable costs. What special assumption is made about variable costs in the textbook?
17) How is break-even analysis useful in the study of the capacity decision? What limitations does this
analytical tool have in this application?
18) A product is currently made in a process-focused shop, where fixed costs are $9,000 per year and
variable cost is $50 per unit. The firm sells the product for $200 per unit. What is the break-even point for
this operation? What is the profit (or loss) on a demand of 200 units per year?
19) A product is currently made in a process-focused shop, where fixed costs are $8,000 per year and
variable cost is $40 per unit. The firm currently sells 200 units of the product at $200 per unit. A manager
is considering a repetitive focus to lower costs (and lower prices, thus raising demand). The costs of this
proposed shop are fixed costs = $24,000 per year and variable costs = $10 per unit. If a price of $80 will
allow 400 units to be sold, what profit (or loss) can this proposed new process expect? Do you anticipate
that the manager will want to change the process? Explain.
20) A firm sells two products. Product R sells for $20; its variable cost is $6. Product S sells for $50; its
variable cost is $30. Product R accounts for 60 percent of the firm’s sales, while S accounts for 40 percent.
The firm’s fixed costs are $4 million annually. Calculate the firm’s break-even point in dollars.
21) A graphic design studio is considering three new computers. The first model, A, costs $5000. Model B
and C cost $3000 and $1000 respectively. If each customer provides $50 of revenue and variable costs are
$20/customer, find the number of customers required for each model to break even.
22) A firm is considering adding a second secretary to answer phone calls and make appointments. The
cost of the secretary will be $10/hour and she will work 200 hours each month. If each new client adds
$400 of profit to the firm, how many clients must the secretary arrange for the firm to break even?
23) A local business owner is considering adding another employee to his staff in an effort to increase the
number of hours that the store is open per day. If the employee will cost the owner $4,000 per month and
the store takes in $50/hour in revenue with variable costs of $15/hour, how many hours must the new
employee work for the owner to break even?
24) A firm produces three products in a repetitive process facility. Product A sells for $60; its variable
costs are $20. Product B sells for $200; its variable costs are $80. Product C sells for $25; its variable costs
are $15. The firm has annual fixed costs of $320,000. Last year, the firm sold 1000 units of A, 2000 units of
B, and 10,000 units of C. Calculate the break-even point of the firm. The firm has some idle capacity at
these volumes, and chooses to cut the selling price of A from $60 to $45, believing that its sales volume
will rise from 1000 units to 2500 units. What is the revised break–even point?
25) A firm produces three products. Product A sells for $60; its variable costs are $20. Product B sells for
$200; its variable costs are $120. Product C sells for $25; its variable costs are $10. Last year, the firm sold
1000 units of A, 2000 units of B, and 10,000 units of C. The firm has fixed costs of $320,000 per year.
Calculate the break-even point of the firm.
Section 4 Reducing Risk with Incremental Changes
1) Changes in capacity may lead, lag, or straddle the demand.
2) Of the four approaches to capacity expansion, the approach that “straddles” demand:
A) uses incremental expansion.
B) uses one-step expansion.
C) at some times leads demand, and at other times lags.
D) works best when demand is not growing but is stable.
E) Choices A and C are both correct.
3) Which of the following is FALSE regarding capacity expansion?
A) “Average” capacity sometimes leads demand, sometimes lags it.
B) If “lagging” capacity is chosen, excess demand can be met with overtime or subcontracting.
C) Total cost comparisons are a rather direct method of comparing capacity alternatives.
D) Capacity may only be added in large chunks.
E) In manufacturing, excess capacity can be used to do more setups, shorten production runs, and drive
down inventory costs.
4) Lag and straddle strategies for increasing capacity have what main advantage over a leading strategy?
A) They are cheaper.
B) They are more accurate.
C) They delay capital expenditure.
D) They increase demand.
E) All of the above are advantages.
5) What is a common method used to increase capacity with a lag strategy?
A) overtime
B) subcontracting
C) new facilities
D) new machinery
E) A and B
6) The capacity planning strategy that delays adding capacity until capacity is below demand, then adds
a capacity increment so that capacity is above demand, is said to ________ demand.
Section 5 Applying Expected Monetary Value (EMV) to Capacity Decisions
1) Possible decision alternatives found in capacity EMV problems are future demands or market
favorability.
2) A retailer is considering building a large store. If the local economy experiences expansion, the firm
expects the store to earn a $2,000,000 profit next year. If the local economy experiences a contraction, the
firm expects the store to lose $400,000 next year. Analysts estimate a 20% chance for the local economy to
experience an expansion next year (hence an 80% chance for contraction). What is the expected monetary
value (EMV) of building the large store?
A) $1,600,000
B) $720,000
C) $2,000,000
D) $80,000
E) $1,520,000
3) Describe how EMV might be used to analyze a capacity decision.
4) A firm is weighing three capacity alternatives: small, medium, and large job shop. Whatever capacity
choice is made, the market for the firm’s product can be “moderate” or “strong.” The probability of
moderate acceptance is estimated to be 40 percent; strong acceptance has a probability of 60 percent. The
payoffs are as follows. Small job shop, moderate market = $24,000; Small job shop, strong market =
$54,000. Medium job shop, moderate market = $20,000; medium job shop, strong market = $64,000. Large
job shop, moderate market = -$2,000; large job shop, strong market = $96,000. Which capacity choice
should the firm make?
5) A firm is about to undertake the manufacture of a product, and it is weighing three capacity
alternatives: small job shop, large job shop, and repetitive manufacturing. The small job shop has fixed
costs of $3,000 per month, and variable costs of $10 per unit. The larger job shop has fixed costs of $12,000
per month and variable costs of $3 per unit. The repetitive manufacturing plant has fixed costs of $30,000
and variable costs of $1 per unit. Demand for the product is expected to be 1,000 units per month with
“moderate” market acceptance, but 2,000 under “strong” market acceptance. The probability of moderate
acceptance is estimated to be 60 percent; strong acceptance has a probability of 40 percent. The product
will sell for $25 per unit regardless of the capacity decision. Which capacity choice should the firm make?
6) Suppose that the market has a 70% chance of being favorable and a 30% chance of being unfavorable. A
favorable market will yield a profit of $300,000, while an unfavorable market will yield a profit of $20,000.
What is the expected monetary value (EMV) in this situation?
Section 6 Applying Investment Analysis to Strategy-Driven Investments
1) One limitation of the net present value approach to investments is that investments with identical net
present values may have very different cash flows.
2) The net present value of $10,000 to be received in exactly three years is considerably greater than
$10,000.
3) Net present value:
A) is gross domestic product less depreciation.
B) is sales volume less sales and excise taxes.
C) is profit after taxes.
D) ignores the time value of money.
E) is the discounted value of a series of future cash receipts.
4) Net present value will be greater:
A) as a fixed set of cash receipts occurs later rather than earlier.
B) if the future value of a cash flow is smaller.
C) for one end-of-year receipt of $1200 than for twelve monthly receipts of $100 each.
D) for a 4% discount rate than for a 6% discount rate.
E) All of the above are true.
5) A capacity alternative has an initial cost of $50,000 and cash flow of $20,000 for each of the next four
years. If the cost of capital is 5 percent, the net present value of this investment is:
A) greater than $80,000 but less than $130,000.
B) greater than $130,000.
C) less than $30,000.
D) impossible to calculate, because no interest rate is given.
E) impossible to calculate, because variable costs are not known.
6) A capacity alternative has an initial cost of $50,000 and cash flow of $20,000 for each of the next four
years. If the cost of capital is 5 percent, what is the approximate net present value of this investment?
A) $20,920
B) $26,160
C) $49,840
D) $70,920
E) $106,990
7) ________ is a means of determining the discounted value of a series of future cash receipts.
8) What are the four limitations of the net present value technique?
9) Health Care Systems of the South is about to buy an expensive piece of diagnostic equipment. The
company estimates that it will generate uniform revenues of $500,000 for each of the next eight years.
What is the present value of this stream of earnings, at an interest rate of 6%? What is the net present
value if the machine lasts only six years, not eight? If the equipment cost $2,750,000, should the company
purchase it?
10) A new machine tool is expected to generate receipts as follows: $5,000 in year one; $3,000 in year two,
nothing in the next year, and $2,000 in the fourth year. At an interest rate of 6%, what is the net present
value of these receipts? Is this a better net present value than $2,500 each year over four years? Explain.
11) Advantage Milling Devices is preparing to buy a new machine for precision milling of special metal
alloys. This device can earn $300 per hour, and can run 3,000 hours per year. The machine is expected to
be this productive for four years. If the interest rate is 6%, what is the net present value of the annual cash
flows? What is the net present value if the interest rate is not 6%, but 9%? Why does present value fall
when interest rates rise?