COM Financial Management & Budgeting 3 — Questions and Answers
Question 1: What is the weighted average cost of capital (WACC) used for in capital budgeting?
- To determine employee compensation packages
- To set the discount rate for evaluating investment projects (Correct answer)
- To calculate depreciation of fixed assets
- To measure accounts receivable turnover
Correct answer: To set the discount rate for evaluating investment projects
WACC represents the minimum return a company must earn on investments to satisfy its debt and equity holders, used as the discount rate in NPV analysis.
Question 2: An unfavorable labor efficiency variance most likely indicates that:
- Workers were paid more than the standard wage rate
- More labor hours were used than the standard hours allowed (Correct answer)
- Fewer units were produced than budgeted
- Overtime was paid at a premium rate
Correct answer: More labor hours were used than the standard hours allowed
Labor efficiency variance measures the difference between actual hours worked and standard hours allowed, multiplied by the standard rate.
Question 3: Which of the following is a sunk cost and therefore irrelevant to future capital investment decisions?
- The salvage value of replaced equipment
- A $200,000 feasibility study already completed and paid for (Correct answer)
- Future maintenance costs of the new asset
- Opportunity cost of capital tied up in the project
Correct answer: A $200,000 feasibility study already completed and paid for
Sunk costs are already spent and cannot be recovered, so they should not influence future investment decisions.
Question 4: A company uses activity-based costing (ABC). Which step comes first in implementing ABC?
- Assign overhead costs to products
- Calculate unit product costs
- Identify the activities that consume resources (Correct answer)
- Select cost drivers for each product line
Correct answer: Identify the activities that consume resources
ABC implementation begins by identifying all activities performed, then tracing costs to those activities before assigning them to products.
Question 5: Days Sales Outstanding (DSO) of 75 days compared to an industry average of 45 days suggests:
- The company collects receivables faster than peers
- The company may have credit or collection problems (Correct answer)
- The company offers fewer credit sales than competitors
- The company has superior inventory management
Correct answer: The company may have credit or collection problems
A DSO significantly above the industry average signals the company is slower to collect payment, which ties up working capital.
Question 6: In a master budget, the production budget is prepared directly after the:
- Cash budget
- Direct materials budget
- Sales budget (Correct answer)
- Capital expenditure budget
Correct answer: Sales budget
The production budget is driven by the sales forecast; it calculates the units that must be produced to meet sales demand plus desired ending inventory.
Question 7: What is the primary risk of relying exclusively on the payback period method for capital investment decisions?
- It overstates profitability by ignoring costs
- It ignores cash flows occurring after the payback period and time value of money (Correct answer)
- It requires complex discounting calculations
- It overweights long-term strategic benefits
Correct answer: It ignores cash flows occurring after the payback period and time value of money
The payback period ignores all cash flows beyond the break-even point and does not discount future cash flows for time value.
COM Financial Management & Budgeting 3
What is the weighted average cost of capital (WACC) used for in capital budgeting?