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Financial CMA Exam
Certified Management Accountant (Page 21 )

Updated On: 1-Feb-2026
Page 21 of 270
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An advantage of the net present value method over the internal rate of return model in discounted cash flow analysis is that the net present value method

  1. Computes a desired rate of return for capital projects.
  2. Can be used when there is no constant rate of return required for each year of the project.
  3. Uses a discount rate that equates the discounted cash inflows with the outflows.
  4. Uses discounted cash flows whereas the internal rate of return model does not.

Answer(s): B

Explanation:

The NPV method calculates the present values of estimated future net cash inflows and compares the total with the net cost of the investment. The cost of capital must be specified. If the NPV is positive, the project should be accepted. The IRR method computes the interest rate at which the NPV is zero. The IRR method is relatively easy to use when cash inflows are the same from one year to the next. However, when cash inflows differ from year to year, the IRR can be found only through the use of trial and error. In such cases, the NPV method is usually easier to apply. Also, the NPV method can be used when the rate of return required for each year varies. For example, a company might want to achieve a higher rate of return in later years when risk might be greater. Only the NPV method can incorporate varyinq levels of rates of return.



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A project requires an initial cash investment at its inception of $10,000, and no other cash outflows are necessary. Cash inflows from the project over its 3-year life are $6,000 at the end of the first year, $5,000 at the end of the second year, and $2,000 at the end of the third year. The future value interest factors for an amount of $1 at the firm's desired rate of return of 8% are


The modified IRR (MIRR)for the project is closest to

  1. 8%
  2. 9%
  3. 10%
  4. 12%

Answer(s): D

Explanation:

The MIRR is the interest rate at which the present value of the cash outflows discounted at the firm's desired rate of return equals the present value of the terminal value. The terminal value is the future value of the cash inflows assuming they are reinvested at the firm's desired rate of return. The present value of the outflows is $10,000 because no future outflows occur. The terminal value is $14,396 [($6,000 x 1.166) + ($5,000 x 1.08) + ($2,000 x 1.00)]. Accordingly, the present value of $1 interest factor for the rate at which the present value of the outflows equals the present value of the terminal value is .695 ($10,000 ÷ $14,396). This factor is closest to that for 12%.



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The net present value method of capital budgeting assumes that cash flows are reinvested at

  1. The risk-free rate.
  2. The cost of debt.
  3. The rate of return of the project.
  4. The discount rate used in the analysis.

Answer(s): D

Explanation:

The NPV method assumes that periodic cash inflows earned over the life of an investment are reinvested at the company's cost of capital (i.e., the discount rate used in the analysis). This is contrary to the assumption under the internal rate of return method, which assumes that cash inflows are reinvested at the internal rate of return. As a result of this difference, the two methods will occasionally give different rankings of investment alternatives.



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All of the following are the rates used in net present value analysis except for the

  1. Cost of capital.
  2. Hurdle rate.
  3. Discount rate.
  4. Accounting rate of return.

Answer(s): D

Explanation:

The NPV is the excess of the present values of the estimated cash inflows over the net cost of the investment. The discount rate used is sometimes the cost of capital or other hurdle rate designated by management. This rate is also called the required rate of return. The accounting rate of return is never used in NPV analysis because it ignores the time value of money; it is computed by dividing the accounting net income by the investment.



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The internal rate of return is

  1. The breakeven borrowing rate for the project in question.
  2. The yield rate/effective rate of interest quoted on long-term debt and other instruments.
  3. Favorable when it exceeds the hurdle rate.
  4. All of the answers are correct.

Answer(s): D

Explanation:

The internal rate of return (IRR) is the discount rate at which the present value of the cash flows equals the original investment. Thus, the NPV of the project is zero at the IRR. The IRR is also the maximum borrowing cost the firm could afford to pay for a

specific project. The IRR is similar to the yield rate/effective rate quoted in the business media.



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