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Financial CMA Exam
Certified Management Accountant (Page 49 )

Updated On: 30-Jan-2026
Page 49 of 270
PDF with 1336 Questions
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If income tax considerations are ignored, how is depreciation handled by the following capital budgeting techniques?

  1. Option A
  2. Option B
  3. Option C
  4. Option D

Answer(s): A

Explanation:

If taxes are ignored, depreciation is not a consideration in any of the methods based on cash flows because it is a non-cash expense. Thus, the internal rate of return, net present value, and payback methods would not consider depreciation because these methods are based on cash flows. However, the accounting rate of return is based on net income as calculated on an income statement. Because depreciation is included in the determination of accrual accounting net income, it would affect the calculation of the accounting rate of return.



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The method that divides a project's annual after--tax net income by the average investment cost to measure the estimated performance of a capital investment is the

  1. Internal rate of return method.
  2. Accounting rate of return method.
  3. Payback method.
  4. Net present value (NPV) method.

Answer(s): B

Explanation:

The accounting rate of return uses undiscounted net income (not cash flows) to determine a rate of profitability. Annual after-tax net income is divided by the average carrying amount (or the initial value) of the investment in assets.



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The profitability index (present value index)

  1. Represents the ratio of the discounted net cash outflows to cash inflows.
  2. Is the relationship between the net discounted cash inflows less the discounted cash outflows divided by the discounted cash outflows.
  3. Is calculated by dividing the discounted profits by the cash outflows.
  4. Is the ratio of the discounted net cash inflows to discounted cash outflows.

Answer(s): D

Explanation:

The profitability index, also known as the excess present value index, is the ratio of the present value of future net cash inflows to the initial net cash investment (discounted cash outflows). This tool is a variation of the NPV method that facilitates comparison of different-sized investments.



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The technique used to evaluate all possible capital projects of different dollar amounts and then rank them according to their desirability is the

  1. Profitability index method.
  2. Net present value method.
  3. Payback method.
  4. Discounted cash flow method.

Answer(s): A

Explanation:

The profitability index is the ratio of the present value of future net cash inflows to the initial cash investment; that is, the figures are those used to calculate the net present value (NPV), but the numbers are divided rather than subtracted. This variation of the NPV method facilitates comparison of different-sized investments. It provides an optimal ranking in the absence of capital rationing.



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If an investment project has a profitability index of 1.15,the

  1. Project's internal rate of return is 15%.
  2. Project's cost of capital is greater than its internal rate of return.
  3. Project's internal rate of return exceeds its net present value.
  4. Net present value of the project is positive.

Answer(s): D

Explanation:

The profitability index is the ratio of the present value of future net cash inflows to the initial net cash investment. It is a variation of the NPV method that facilitates comparison of different-sized investments. A profitability index greater than 1.0 indicates a profitable investment or one that has a positive net present value.



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