Test Prep Test Prep Certifications BUSINESS-ENVIRONMENT-AND-CONCEPTS Questions & Answers

• Question 221:

  Super Sets, Inc. manufactures and sells television sets. All sales are finalized on credit with terms of 2/10, n/30. Seventy percent of Super Set customers take discounts and pay on day 10, while the remaining 30% pay on day 30. What is the average collection period in days?

  A. 10

  B. 16

  C. 24

  D. 40

  Correct Answer: B

  Choice "b" is correct. The average collection period represents the weighted average of the periods that accounts receivable are outstanding and is computed as follows:

  

  Choice "a" is incorrect, per the above computation.

  Choice "c" is incorrect. This proposed solution mismatches the percentages and the days and represents

  the sum of the products of 30 x 70 % and 10 x 30%.

  Choice "d" is incorrect. This proposed solution is purely the sum of the two customer payment patterns

  presented, 10 and 30.

• Question 222:

  All of the following capital budgeting analysis techniques use cash flows as the primary basis for the calculation, except for the:

  A. Net present value.

  B. Internal rate of return.

  C. Discounted payback period.

  D. Accounting rate of return.

  Correct Answer: D

  Choice "d" is correct. The accounting rate of return does not use cash flows as the primary basis for the calculation. It measures the accrual accounting return instead of cash flows:

  

  Choice "a" is incorrect. Net present value method discounts cash flows for an investment over its life to time period zero using a desired or minimum rate of return. Choice "b" is incorrect. Internal rate of return (IRR) determines the compound interest rate of an investment where the present value of the cash inflows equals the present value of the cash outflows. The IRR is the discount rate that results in a net present value of zero. Choice "c" is incorrect. The discounted payback period is the time period required for discounted cash inflows to equal the initial investment. The time value of money is considered.

• Question 223:

  During 1994, Deet Corp. experienced the following power outages:

  

  Each power outage results in out-of-pocket costs of $400. For $500 per month, Deet can lease an auxiliary generator to provide power during outages. If Deet leases an auxiliary generator in 1995, the estimated savings (or additional expenditures) for 1995 would be:

  A. ($3,600)

  B. ($1,200)

  C. $1,600

  D. $1,900

  Correct Answer: C

  Choice "c" is correct.

  

  Choice "a" is incorrect. The estimated savings is dependent on the number of outages and on the number of months, since there are two costs involved. Choice "b" is incorrect. The estimated savings is not the difference between the out-of-pocket costs and cost of generator, times 12 months. Choice "d" is incorrect. The cost of the generator is a monthly cost, not dependent on the number of power outages.

• Question 224:

  What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt?

  A. To cause the price of the company's stock to rise.

  B. To lower the company's bond rating.

  C. To reduce the risk for existing bondholders.

  D. To reduce the interest rate on the bonds being sold.

  Correct Answer: D

  Note: The material tested in this question does not appear specifically on-point in our textbook, as the topic has rarely shown up on the CPA exam. The topics are covered in general in parts of our textbook, so we believe that our students would have answered this question correctly given the information they had. However, we have expanded our of this question to provide you with more detailed information.

  Choice "d" is correct. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is to reduce the interest rate on NEW bonds being sold. A debt covenant is a provision in a bond indenture (contract between the bond issuer and the bond holders) that the bond issuer will either do (affirmative covenants) or not do (negative covenants) certain things. In this question, the issuer would agree not to issue bonds in the future over a certain percentage of its long-term debt. Such a provision would be good for the potential bondholders and would probably reduce the interest rate on the bonds being sold.

  Choice "a" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to cause the price of the company's stock to rise. Bond covenants affect bonds, not equity (at least not directly).

  Choice "b" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to lower the company's bond rating. Such a covenant might raise, not lower, a company's bond rating because there would be less risk. Besides, why would a bond covenant be signed if it would lower the company's bond rating?

  Choice "c" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to reduce the risk of existing bondholders, although a reduction in the risk of the existing bondholders certainly might result from such a covenant. As a general rule, more debt means more risk, less debt means less risk. So less debt would reduce the risk of all bondholders. This answer is a very close second.

• Question 225:

  A vendor offered Wyatt Co. $25,000 compensation for losses resulting from faulty raw materials. Alternately, a lawyer offered to represent Wyatt in a lawsuit against the vendor for a $12,000 retainer and 50% of any award over $35,000. Possible court awards with their associated probabilities are:

  

  Compared to accepting the vendor's offer, the expected value for Wyatt to litigate the matter to verdict provides a:

  A. $4,000 loss.

  B. $18,200 gain.

  C. $21,000 gain.

  D. $38,000 gain.

  Correct Answer: A

  Choice "a" is correct.

  

  Choices "b", "c", and "d" are incorrect based on the above Explanation.

• Question 226:

  Under frost-free conditions, Cal Cultivators expects its strawberry crop to have a $60,000 market value. An unprotected crop subject to frost has an expected market value of $40,000. If Cal protects the strawberries against frost, then the market value of the crop is still expected to be $60,000 under frostfree conditions and $90,000 if there is a frost. What must be the probability of a frost for Cal to be indifferent to spending $10,000 for frost protection?

  A. .167

  B. .200

  C. .250

  D. .333

  Correct Answer: B

  Choice "b" is correct. If there is no frost, then there is no difference between Cal's income with or without

  the insurance-the crop is worth $60,000 either way. However, if the insurance is purchased and a frost

  occurs, Cal earns $50,000 more with insurance ($90,000 - $40,000) than he would without the insurance.

  The expected value of having the insurance is therefore:

  Probability of frost x $50,000 + Probability of no frost x $0

  Cal will be indifferent to spending $10,000 for frost protection when the expected value of the insurance

  equals the cost of the insurance:

  Probability of frost x $50,000 = $10,000

  Probability = 20%

  Choices "a", "c", and "d" are incorrect based on the above Explanation.

• Question 227:

  Which tool would most likely be used to determine the best course of action under conditions of uncertainty?

  A. Cost-volume-profit analysis.

  B. Expected value (EV).

  C. Program evaluation and review technique (PERT).

  D. Scattergraph method.

  Correct Answer: B

  Choice "b" is correct. Probability and expected value formulate quantitative models to address the issue of

  appropriate course of action in an environment of uncertainty. The expected value is a weighted average of

  all values and variables.

  The course of action with the highest expected monetary value should be selected.

  Choice "a" is incorrect. Cost-volume profit analysis is a method used to evaluate operating decisions.

  Choice "c" is incorrect. PERT is a technique used in project management that focuses on the time required

  to complete each step in a project. It allows a project manager to monitor a project's progress and identify

  potential bottlenecks or delays that will postpone the completion date.

  Choice "d" is incorrect. The scattergraph method is used in statistical analysis toplot relationships between

  variables to determine a line function that best describes those relationships.

• Question 228:

  In situations when management must decide on accepting or rejecting one-time-only special orders, where there is sufficient idle capacity, which one of the following is not relevant to the decision?

  A. Absorption costs.

  B. Direct costs.

  C. Variable costs.

  D. Incremental costs.

  Correct Answer: A

  Choice "a" is correct. Absorption costs are not relevant in situations when management must decide on accepting or rejecting one-time-only special orders, and where there is sufficient idle capacity. All of the following costs are relevant in such situations:

  B. Direct costs

  C. Variable costs

  D. Incremental costs

• Question 229:

  Dough Distributors has decided to increase its daily muffin purchases by 100 boxes. A box of muffins costs

  $2 and sells for $3 through regular stores. Any boxes not sold through regular stores are sold through

  Dough's thrift store for $1.

  Dough assigns the following probabilities to selling additional boxes:

  

  What is the expected value of Dough's decision to buy 100 additional boxes of muffins?

  A. $28

  B. $40

  C. $52

  D. $68

  Correct Answer: C

  Choice "c" is correct. The expected value of a decision is computed by multiplying the probability of each outcome by its value or profit. Each outcome is then added. There is a 60% probability that Dough will sell 60 of the 100 additional boxes through regular stores and that means that Dough would have a 60% chance of making a profit of $20 (60 boxes at a $1 profit ($3 - $2) sold through the regular stores and 40 boxes at a $1 loss ($1 - $2) sold through the thrift stores). There is a 40% probability that Dough will have a profit of $40 (100 boxes at a $1 profit through the regular store sales and zero boxes sold at a loss through the thrift store).

  

  Choice "a" is incorrect. The expected value of a decision is computed by multiplying the probability of each outcome by its value or profit. Choice "b" is incorrect. The expected value of a decision is computed by multiplying the probability of each outcome by its value or profit. Choice "d" is incorrect. The expected value of a decision is computed by multiplying the probability of each outcome by its value or profit.

• Question 230:

  Eugene Entrepreneur developed his waste collections and disposal business from one truck 20 years ago to a fleet of 2,000 trucks serving an entire region today. Gene is looking to retire and knows that he cannot find a suitable buyer for the entire business. Gene has developed a series of short range plans with his senior management group that include generous bonuses, funded in part by deferred repair and maintenance expenses and prior earnings, sales of business segments where possible or transfers of assets to the counties and municipalities that had engaged the waste collection and disposal service. Gene has frozen all new capital investment. The mission that Eugene Entrepreneur has mapped out for his company can best be described as:

  A. Build.

  B. Hold.

  C. Harvest.

  D. Sunset.

  Correct Answer: C

  Choice "c" is correct. Eugene Entrepreneur has mapped out a harvest mission for his company. As Gene retires and pulls assets and value from the company, he is clearly taking a short-term view toward reaping immediate benefit. Choice "a" is incorrect. A "build" mission anticipates that the business is positioned to expand markets or market share and is characterized by a long-term view that promotes investment. Choice "b" is incorrect. A "hold" mission contemplates that the business is trying to hold on to current market share and is characterized by appropriate investment and competitive positioning. Choice "d" is incorrect. The term "sunset" mission is a distracter.