Incremental analysis and capital budgeting



 1. An important step in management’s decision-making process is to determine and evaluate 

possible courses of action. 


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



 3. In incremental analysis, total variable costs will always change under alternative courses 

of action, and total fixed costs will always remain constant. 


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

consideration in choosing among alternatives. 


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


 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. 


 7. A special one-time order should never be accepted if the unit sales price is less than the 

unit variable cost. 


 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. 


 9. A company should never accept an order for its product at less than its regular sales 



 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. 


 11. An opportunity cost is the potential benefit obtained by using resources in an alternative 

course of action. 


 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 



 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. 


 14. It is always better to sell now rather than process further because of the time value of 



 15. In a decision concerning replacing old equipment with new equipment, the book value of 

the old equipment can be considered a sunk cost. 


 16. In a decision to retain or replace old equipment, the salvage value of the old equipment is 

relevant in incremental analysis. 


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


 18. From a quantitative standpoint, a segment should be eliminated if its contribution margin 

is less than the fixed costs that can be eliminated. 


 19. The elimination of an unprofitable product line may adversely affect the remaining product 



 20. When a company has limited resources to manufacture products, it should manufacture 

those products which have the highest contribution margin per unit of limited resource. 


 21. If a company has only a certain number of machine hours available for production, it is 

generally more profitable to produce and sell the product with the highest unit contribution 



 22. Capital budgeting decisions usually involve large investments and can have a significant 

impact on a company’s future profitability. 


 23. The annual rate of return technique requires dividing a project’s annual cash inflows by 

the economic life of the project. 


 24. A hurdle rate is the rate of return set by applying ideal standards. 


 25. A major advantage of the annual rate of return technique is that it considers the time value 

of money. 


 26. The cash payback capital budgeting technique is a quick way to calculate a project’s net 

present value. 


 27. The cash payback method is frequently used as a screening tool but it does not take into 

consideration the profitability of a project. 


 28. Using the net present value method, a net present value of zero indicates that the project 

would be acceptable. 


 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. 


 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 



Additional True-False Questions 


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

reports that review the actual impact of the decision. 


 32. The process used to identify the financial data that change under alternative courses of 

action is called allocation of limited resources. 


 33. If a company is operating at full capacity, the incremental costs of a special order will likely 

include fixed manufacturing costs. 


 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. 


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

recognize that net income could decrease by eliminating the unprofitable segment. 


 36. The annual rate of return is computed by dividing expected annual net income by average 



 37. The discounted cash flow technique considers estimated total cash inflows from the 

investment but not the time value of money



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