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Financial CMA Exam
Certified Management Accountant (Page 17 )

Updated On: 1-Feb-2026
Page 17 of 270
PDF with 1336 Questions
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Basic time value of money concepts concern Interest Factors Risk Cost of capital

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

Answer(s): A

Explanation:

The time value of money is concerned with two issues: (1)the investment value of money, and (2) the risk (uncertainty) inherent in any executor agreement. Thus, a dollar today is worth more than a dollar in the future, and the longer one waits for a dollar, the more uncertain the receipt is. The cost of capital involves a specific, 1application of the time value of money principles; It is not a basic concept thereof.



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In evaluating a capital budget project, the use of the net present value (NPV) model is generally not affected by the

  1. Method of funding the project.
  2. Initial cost of the project.
  3. Amount of added working capital needed for operations during the term of the project.
  4. Project's salvage value.

Answer(s): A

Explanation:

The NPV method computes the present value of future cash inflows to determine whether they are greater than the initial cash outflow. Future cash inflows include any salvage value on facilities. Included in the initial investment are the cost of new equipment and other facilities, and additional working capital needed for operations during the term of the project. The discount rate (cost of capital or hurdle rate) must be known to discount the future cash inflows. If the NPV is positive, the project should be accepted. The method of funding a project is a decision separate from that of whether to invest.



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A weakness of the internal rate of return (IPP) approach for determining the acceptability of investments is that it

  1. Does not consider the time value of money.
  2. Is not a straightforward decision criterion.
  3. Implicitly assumes that the firm is able to reinvest project cash flows at the firm's cost of capital.
  4. Implicitly assumes that the firm is able to reinvest project cash flows at the project's internal rate of return.

Answer(s): D

Explanation:

The IRR is the rate at which the discounted future cash flows equal the net investment (NPV = 0). One disadvantage of the method is that inflows from the early years are assumed to be reinvested at the IRP. This assumption may not be sound. Investments in the future may not earn as high a rate as is currently available.



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Jackson Corporation uses net present value techniques in evaluating its capital investment projects. The company is considering a new equipment acquisition that will cost $100,000, fully installed, and have a zero salvage value at the end of its five-year productive life. Jackson will depreciate the equipment on a straight-line basis for both financial and tax purposes. Jackson estimates $70,000 in annual recurring operating cash income and $20,000 in annual recurring operating cash expenses. Jackson's desired rate of return is 12% and its effective income tax rate is 40%. What is the net present value of this investment on an after-tax basis?

  1. $28,840
  2. $8,150
  3. $36,990
  4. $80,250

Answer(s): C

Explanation:

Annual cash outflow for taxes is $12,000 {[$70,000 inflows -- $20,000 cash operating expenses `--($100,000 ÷ 5) depreciation] x 40%}. The annual net cash inflow is therefore $38,000 ($70,000 --$20,000-- $12,000). The present value of these net inflows for a 5-year period is $136,990 ($38,000 x 3.605 present value of an ordinary annually for 5 years at 12%)1 and the NPV of the investment is $36,990 ($136,990 -- $100,000 investment).



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In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1. The following information is being considered by Gunning Industries:

· The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000.
· The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.
· The investment in the new machine will require an immediate increase in working capital of $35,000. This cash outflow will be recovered after 5 years. · Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of 5 years and zero salvage value.
· Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to analyze investments and will employ the following factors and rates:


The overall discounted cash flow impact of Gunning Industries' working capital investment for the new production machine would be

  1. $(7,959)
  2. $(10,080)
  3. $(13,265)
  4. $(35,000)

Answer(s): C

Explanation:

The $35,000 of working capital requires an immediate outlay for that amount, but it will be recovered in 5 years. Thus, the net discounted cash outflow is $13,265 [$35,000 initial investment--($35,000 future 1inflow x .621 PV of $1 for 5 years at 10%)].



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