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Financial CMA Exam
Certified Management Accountant (Page 14 )

Updated On: 1-Feb-2026
Page 14 of 270
PDF with 1336 Questions
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Gibber Corporation has an opportunity' to sell newly developed product in the United States for a period of five years. The product license would be purchased from New Group Company. Gibber would be responsible for all distribution and product promotion costs. New Group has the option to renew the agreement, with modifications, at the end of the initial five-year term. Gibber has developed the following estimated revenues and costs that would be associated with the new product:


The working capital required to support the new product would be released for investment elsewhere if the product licensing agreement is not renewed. Using the net present value method of analysis and ignoring the effects of income taxes, the net present value of this product agreement, assuming Gibber has a 20% cost of capital, would be

  1. $7,720
  2. $(64,064)
  3. $(72,680)
  4. $(127,320)

Answer(s): A

Explanation:

The net present value of a capital project is derived by calculating three amounts and discounting them at the appropriate interest rate: the net initial investment (for which the rate is always 0%), the annual cash inflows, and the termination cash inflows. The net initial investment itself consists of three components: the purchase of new equipment, the increase in working capital, and the proceeds from the disposal of any old equipment. For this project, this amount is $320000 ($120,000 + 200,000 + $0). Since this amount is paid out today, its present value is $320,000, i.e., no discounting is performed. The second element of the project as a whole is the annual cash inflows. This has two components: the cash inflows from operations and the depreciation tax shield arising from the purchase of new equipment. Since the effects of income taxes are not relevant to this problem, only the first of these components requires calculation. The annual net operating revenue is $80,000 ($400,000--$250,000--$70,000). Discounted as an ordinary annuilyfor5 years at 20%, its present value is $239,280 ($80,000 x 2.991). The third and final element is the cash flows upon termination of the project, consisting of the proceeds from the disposal of the equipment involved in the project (again, the effects of income taxes are ignored for this problem) and the recovery of working capital. For this project, this amount is $220,000 ($20,000 + $200,000). Discounted as a single amount to be received in 5 years at 20%, its present value is $88,440 ($220,000 x 0.402). Gibber's total net present value for this capital project can therefore be calculated as follows:



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Wilkinson, Inc., which has a cost of capital of 12%, invested in a project with an internal rate of return (IRR) of 14%. The project is expected to have a useful life of four years, and it will produce net cash inflows as follows:


The initial cost of this project amounted to

  1. $7,483
  2. $9,647
  3. $11,000
  4. $12,540

Answer(s): A

Explanation:

The internal rate of return (IRP) of a capital project is the rate at which the net present value (NPV) of its future cash flows equals zero. To find this project's NPV, therefore, it is necessary to discount the cash flows at the appropriate rate (14%) as follows:



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Assume that the interest rate is greater than zero. Which of the following cash-inflow streams should you prefer?

  1. Option
  2. Option
  3. Option
  4. Option

Answer(s): A

Explanation:

The concept of present value gives greater value to inflows received earlier in the stream. Thus, the declining inflows would be superior to increasing inflows, or even inflows.



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Which one of the following statements about the payback method of investment analysis is correct? The payback method

  1. Does not consider the time value of money.
  2. Considers cash flows after the payback has been reached.
  3. Uses discounted cash flow techniques.
  4. Generally leads to the same decision as other methods for long-term projects.

Answer(s): A

Explanation:

The payback method calculates the amount of time required to complete the return of the original investment, i.e.1 the time it takes for a new asset to pay for itself. Although the payback method is easy to calculate, it has inherent problems. The time value of money and returns after the payback period are not considered.



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The present value may be calculated for discounted cash Inflows Outflows Annuities

  1. Yes Yes Yes
  2. Yes No Yes
  3. No Yes No
  4. No No Yes

Answer(s): A

Explanation:

The present value concept may be applied both to dollars-in (inflows) and to dollars-out (outflows). Thus, individual cash inflows and cash outflows or a series thereof (an annuity') may be discounted to time: zero (the present). Net present value is the sum of discounted cash inflows minus any discounted cash outflows. Net present value may be either positive or negative.



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