IIA IIA Certifications IIA-CIA-PART3 Questions & Answers

• Question 411:

  A competitive factor that may lead to overbuilding in an industry is:

  A. The need of large customers to know that capacity exists to meet their long-term requirements.

  B. The lack of a credible market leader.

  C. The advantage held by the capacity leader.

  D. The existence of high entry barriers.

  Correct Answer: B

  The lack of a credible market leader makes for a less orderly expansion. A stronger leader can retaliate effectively against inappropriate expansion by others. The following are other such factors:

  (1) many firms with the ability to add capacity are seeking to improve market share; (2) new entrants, possibly encouraged by low entry barriers and favorable economic conditions, may cause or intensify overcapacity; and (3) first mover advantages may be significant; thus, shorter lead times for ordering equipment, lower costs, and the ability to exploit an excess of demand over supply may encourage too many firms to expand.

• Question 412:

  A technological factor that may lead to overbuilding in an industry is:

  A. The need to add capacity in large increments.

  B. The lack of a credible market leader.

  C. Changes in industry structure.

  D. Inflated future expectations.

  Correct Answer: A

  The need to add capacity in large increments is a technological factor that may lead to overbuilding. The following are other such factors:

  (1)

  the presence of economies of scale or a steep learning curve encourages preemption:

  (2)

  long lead times for adding capacity increase the risk of competitive inferiority if a firm does not act quickly to begin raising its capacity; (3) when the minimum efficient scale increases, large plants are becoming more efficient even though demand is not growing; and

  (4)

  changes in production technology result in new construction while old plants remain in operation, particularly when exit barriers are high.

• Question 413:

  Many factors cause firms to overbuild, resulting in industry overcapacity. The structural factor that may lead to overbuilding is:

  A. A reduction in supplier prices.

  B. A shallow learning curve.

  C. An absence of exit barriers.

  D. The presence of a strong market leader.

  Correct Answer: A

  Suppliers of capital, equipment, materials, etc., face their own competitive pressures. Thus, lower supplier prices, government subsidies, favorable interest rates, and similar incentives may promote expansion by customer industries.

• Question 414:

  A firm is performing an analysis of a capacity expansion decision. The simplest element of the analysis is

  A. Choosing the expansion method.

  B. Determining the expansion plans of rival firms.

  C. Calculating the net present value.

  D. Estimating total long-term demand.

  Correct Answer: C

  The formal capital budgeting process entails predicting future cash flows related to the expansion project, discounting them at an appropriate interest rate, and determining whether the net present value (NPV) is positive. This process permits comparison with other uses of the firm's resources. The apparent simplicity of this process is deceptive because it depends upon, among many other things, which expansion method is chosen, developments in technology, and profitability. Profitability in turn depends on such uncertainties as total long-term demand and the expansion plans of rival firms. However, once the assumptions of the NPV model have been determined, the calculation is straightforward.

• Question 415:

  When demand uncertainty is low, firms tend to adopt a strategy of preemptive expansion. The conditions for successful preemption expansion include which of the following?

  A. The firm should avoid market signals that alert competitors to the firm's plans.

  B. The expansion should be small relative to the market to minimize risk.

  C. Economies of scale should be large relative to demand.

  D. The business should be strategically vital to competitors.

  Correct Answer: C

  Economies of scale should be large in relation to demand, or the learning-curve effect should give an initial large investor a permanent cost advantage. For example, the preemptive firm may be able to secure too much of the market to allow a subsequent firm to invest at the efficient scale. That is, the residual demand available to be met by the later firm is less than the efficient scale of production. The later firm therefore must choose between intense competition at the efficient scale or a cost disadvantage.

• Question 416:

  What is the key strategic issue when a firm is considering capacity expansion?

  A. Forecasting long-term demand.

  B. Analyzing the behavior of competitors.

  C. Identifying options.

  D. Avoiding industry overcapacity.

  Correct Answer: D

  Whether to expand capacity is a major strategic decision because of the capital required, the difficulty of forming accurate expectations, and the long time frame of the lead times and the commitment. The key forecasting problems are long-term demand and behavior of competitors. The key strategic issue is avoidance of industry overcapacity. Under capacity in a profitable industry tends to be a short-term issue. Profits ordinarily lure additional investors. Overcapacity tends to be a long-term problem because firms are more likely to compete intensely rather than reverse their expansion.

• Question 417:

  Which of the following is achieved by acquiring a minority common stock interest in a supplier?

  A. Quasi-integration.

  B. Tapered integration.

  C. Downstream integration.

  D. Forward integration.

  Correct Answer: A

  Quasi-integration is something more than a long-term contract and less than full ownership. It may be achieved by a minority common stock interest, debt guarantees, cooperation in RandD, an exclusive dealing arrangement, etc. Buyer and seller may, as a result, have a special community of interest leading to lower costs, smoothing of supply/demand fluctuations, or mitigating against bargaining power. Quasi-integration may avoid commitment to an adjacent business with its investment and management requirements. But many benefits of full integration may not be achievable in this way.

• Question 418:

  Forward integration most likely results in:

  A. Product standardization.

  B. Reduced access to distribution channels.

  C. Obtaining less information about demand.

  D. Higher price realization.

  Correct Answer: D

  Forward integration may permit higher price realization, for example, by moving into businesses in which the price elasticity of demand is relatively high and lower prices must be set. When demand is elastic, raising prices decreases revenue. Thus, the firm may benefit by acquiring customers with highelasticitywhile selling to customers with lowelasticity.

• Question 419:

  The advantages of vertical integration include:

  A. Increases in incentives.

  B. The ability to apply the same managerial methods to all subunits.

  C. The need to balance the operations of subunits.

  D. Stable relationships between internal sellers and buyers.

  Correct Answer: D

  Stable relationships between internal sellers and buyers create economies because they need not fear loss of the related buyers and sellers. They also need not fear undue economic pressure from each other. Furthermore, because the relationship is locked in, more efficient procedures for their relationship (e.g., dedicated controls and records) may be implemented. Another advantage is that internal sellers and buyers may more fully adapt to each other's needs than they would or could in dealings with outsiders.

• Question 420:

  The generic strategic costs of vertical integration include:

  I . Reduction of operating leverage

  II. Need to overcome mobility barriers

  Ill. A decrease in exit barriers

  IV.

  Loss of access to supplier technology

  A.

  I and Ill only.

  B.

  II and IV only.

  C.

  II, Ill, and IV only.

  D.

  I, II, Ill, and IV.

  Correct Answer: B

  Integration is a special case of entry into a new business. Thus, the firm must incur costs to overcome mobility barriers to enter the adjacent business:economies of scale, proprietary technology, capital investment, sources of materials, etc. Integration also increases fixed costs and operating leverage, which is in itself a cause of increased business risk. Thus, an integrated firm is exposed to fluctuations affecting any of its components. For example, sales of an upstream component depend on sales of downstream components. Moreover, integration may increase the difficulty of leaving the industry (exit barriers). Finally, integration may foreclose access to supplier or customer technology. The integrated firm may have to create its own technology rather than taking advantage of supplier/customer expertise.