IIA Certified Internal IIA-CIA-PART4 Questions & Answers

• Question 11:

  A firm's capacity expansion decision should be based on the understanding that:

  A. Overcapacity in a profitable industry is a short-term problem.

  B. Under capacity in a profitable industry is a long-term problem.

  C. A key forecasting problem is behavior of competitors.

  D. Prices and cash flows must be estimated to predict market shares and industry capacity.

  Correct Answer: C

  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 longterm demand and behavior of competitors. The key strategic issue is avoidance of industry overcapacity. Analysis of competitors determines when each will expand. The difficulty is that forecasting their behavior depends on knowing their expectations. Another difficulty is that each competitor's actions potentially affect all other competitors' actions, with the industry leader being most influential.

• Question 12:

  Which of the following is not a technological factor that may lead to overbuilding?

  A. Long lead times for adding capacity.

  B. Changes in production technology.

  C. The presence of economies of scale.

  D. High exit barriers.

  Correct Answer: D

  The following are technological factors that may lead to overbuilding:

  (1)

  capacity may need to be added in large increments; (2) the presence of economies of scale or a steep learning curve encourages preemption; (3) long lead times for adding capacity increase the risk of competitive inferiority if a firm does not act quickly to raise capacity;

  (4)

  when the minimum efficient scale increases, large plants are becoming more efficient even though demand is not growing:and

  (5)

  changes in production technology result in new construction while old plants remain in operation. High exit barriers are a structural factor that may lead to overbuilding. The effect of high exit barriers is to extend the period of overcapacity.

• Question 13:

  An information flow factor that may lead to industry overcapacity is:

  A. The need to give assurance to large customers.

  B. Stable industry structure.

  C. Presence of tax incentives.

  D. Untrustworthy market signaling.

  Correct Answer: D

  Market signaling may be ineffective because it is no longer regarded as credible. Firms' signals may no longer be trusted as indicators of planned moves, such as expansion, because of new entrants, a period of bitter rivalry, or other reasons. Credible signaling fosters orderly expansion by allowing all parties to plan effectively.

• Question 14:

  The competitive factor that may lead to industry overcapacity is

  A. A favorable interest rate charged by suppliers of capital.

  B. A short lead time for capacity expansion.

  C. The existence of first mover advantages.

  D. Integration of competitors.

  Correct Answer: C

  First mover advantages may be significant. Thus, short 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 15:

  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 16:

  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 17:

  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 18:

  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 19:

  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 20:

  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 longterm 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.