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Financial CMA Exam
Certified Management Accountant (Page 50 )

Updated On: 30-Jan-2026
Page 50 of 270
PDF with 1336 Questions
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The profitability index approach to investment analysis

  1. Fails to consider the timing of project cash flows.
  2. Considers only the project's contribution to net income and does not consider cash flow effects.
  3. Always yields the same accept/reject decisions for independent projects as the net present value method.
  4. Always yields the same accept/reject decisions for mutually exclusive projects as the net present value method.

Answer(s): C

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 net present value (NPV) method and facilitates the comparison of different-sized investments. Because it is based on the NPV method, the profitability index will yield the same decision as the NPV for independent projects. However, decisions may differ for mutually exclusive projects of different sizes.



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Barker, Inc. has no capital rationing constraint and is analyzing many independent investment alternatives. Barker should accept all investment proposals

  1. If debt financing is available for them.
  2. That have positive cash flows.
  3. That provide returns greater than the before-tax cost of debt.
  4. That have a positive net present value.

Answer(s): D

Explanation:

A company should accept any investment proposal, unless some are mutually exclusive, that has a positive net present value or an internal rate of return greater than the company's desired rate of return.



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Which mutually exclusive project would you select if both are priced at $1,000 and your discount rate is 14%: Project A, with three annual cash flows of $1 .000, Project B, with three years of zero cash flow followed by three years of $1,500 annually?

  1. Project
  2. Project
  3. The IRRs are equal, hence you are indifferent.
  4. The NPVs are equal, hence you are indifferent.

Answer(s): B

Explanation:

Project A's VPV is calculated as follows:


Since Project B has a slightly higher NPV , it should be selected.



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Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year


Which project(s) should Maloney undertake during the upcoming year assuming it has no budget restrictions?

  1. All of the projects.
  2. Projects 1, 2 and 3.
  3. Projects 1, 2 and 4.
  4. Projects 1 and 2.

Answer(s): C

Explanation:

A company using the net present value (NPV) method should undertake all projects with positive NPVs that are not mutually exclusive. Given that Projects 1, 2, and 4 have positive NPVs, those projects should be undertaken. Furthermore, a company using the internal rate of return (IRR) as a decision rule ordinarily chooses projects with a return greater than the cost of capital. Given a 12% cost of capital. Projects 1, 2, and 4 should be chosen using an IRR criterion if they are not mutually exclusive. Use of the profitability index yields a similar decision because a project with an index greater than 100% should be undertaken.



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Maloney Company uses a 12% hurdle rate for all capital expenditures and has done the following analysis for four projects for the upcoming year


Which projects should Maloney undertake during the upcoming year if it has only $12,000,000 of investment funds available?

  1. Projects 1 and 3.
  2. Projects 1, 2, and 4.
  3. Projects 1 and 4.
  4. Projects 1 and 2.

Answer(s): D

Explanation:

With only $12,000,000 available and each project costing $4,000,000 or more, no more than two projects can be undertaken. Accordingly, projects should be selected because they have the greatest NPVs and profitability lily indexes.



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