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Financial CMA Exam
Certified Management Accountant (Page 16 )

Updated On: 1-Feb-2026
Page 16 of 270
PDF with 1336 Questions
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The bailout payback method

  1. Is used by firms with federally insured loans.
  2. Calculates the payback period using the sum of the net cash flows and the salvage value.
  3. Calculates the payback period using the difference between net cash inflow and the salvage value.
  4. Estimates short-term profit ability.

Answer(s): B

Explanation:

The bailout payback period is the length of time required for the sum of the cumulative net cash inflow from an investment and its salvage value to equal the original investment. The bailout payback method measures 11the risk to the investor if the investment must be abandoned. The shorter the period, the lower the risk.



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When ranking two mutually exclusive investments with different initial amounts, management should give first priority to the project

  1. That generates cash flows for the longer period of time.
  2. Whose net after-tax flows equal the initial investment?
  3. That has the greater accounting rate of return.
  4. That has the greater profitability index.

Answer(s): D

Explanation:

The profitability (excess present value) index facilitates the comparison of investments that have different initial costs. The profitability index equals the present value of future net cash inflows divided by the initial cash investment. The investment with the greater profitability index will be the preferred investment. However, if investments are mutually exclusive, the net present value method may be the better way of ranking projects. The excess present value index indicates the best return per dollar invested but does not consider the alternative possibilities for unused funds. Thus, the smaller of the mutually exclusive projects may have the higher index, but the incremental investment in the larger project may make it the better choice. For example, an $8,000,000 project may be a better use of funds than a combination of a $6,000,000 project with a higher index and the best alternative use of the remaining $2,000,000.



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Fitzgerald Company is planning to acquire a $250,000 machine that will provide increased efficiencies, thereby reducing annual operating costs by $80,000. The machine will be depreciated by the straight-line method over a 5-year life with no salvage value at the end of 5 years. Assuming a 40% income tax rate, the machine's payback period is

  1. 3l3years.
  2. 8.33 years.
  3. 3.68 years.
  4. 5.21 years.

Answer(s): C

Explanation:

The payback period is the number of years required to complete the return of the original investment. This measure is computed by dividing the net investment required by the average expected net cash inflow to be generated. The first step is to determine the annual cash flow. The $80,000 cost reduction will be offset by the tax expense on the savings. The full $80,000, however, will not be taxable because depreciation can be deducted before computing income taxes. Allocating the $250,000 cost evenly over 5 years produces an annual depreciation expense of $50000. Thus, taxable income will be $30,000 ($80,000 -- $50,000). At a 40% tax rate, the tax on $30,000 is $12,000. The net annual cash inflow is therefore $68,000 ($80,000-- $12,000), and the payback period is 3.68 years ($250,000 investment + $68,000).



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The Dickins Corporation is considering the acquisition of a new machine at a cost of $180,000. Transporting the machine to Dickenss' plant will cost $12,000. Installing the machine will cost an additional $18,000. It has a 10-year life and is expected to have a salvage value of $10,000. Further more, the machine is expected to produce 4,000 units per year with a selling price of $500 and combined direct materials and direct labor costs of $450 per unit. Eederal tax regulations permit machines of this type to be depreciated using the straight-line method over 5 years with no estimated salvage value. Dickins has a marginal tax rate of 40%. What is the approximate payback period on Dickins' new machine?

  1. 1.05years.
  2. 1.S4years.
  3. 1.33years.
  4. 2.22 years.

Answer(s): B

Explanation:

When annual cash inflows are uniform, the payback period is calculated by dividing the initial investment ($210,000) by the annual net cash inflows ($136,800). Dividing $210,000 by $136,800 produces a payback period of 1.54 years.



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The bailout payback method

  1. Incorporates the time value of money.
  2. Equals the recovery period from normal operations.
  3. Eliminates the disposal value from the payback calculation.
  4. Measures the risk if a project is terminated.

Answer(s): D

Explanation:

The payback period equals the net investment divided by the average expected cash flow, resulting in the number of years required to recover the original investment. The bailout payback incorporates the salvage value of the asset into the calculation. It determines the length of the payback period when the periodic cash inflows are combined with the salvage value. Hence, the method measures risk. The longer the payback period, the more risks' the investment.



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