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Free CMA Exam Braindumps (page: 66)

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The recommended technique for evaluating projects when capital is rationed and there are no mutually exclusive projects from which to choose is to rank the projects by

  1. Accounting rate of return.
  2. Payback.
  3. Internal rate of return.
  4. Profitability index.

Answer(s): D

Explanation:

The profitability index (P1) is often used to decide among investment alternatives when more than one is acceptable. The profitability' index is the ratio of the present value of future net cash inflows to the initial net cash investment. The P1, although a variation of the net present value method, facilitates comparison of different-sized investments.



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The technique that measures the estimated performance of a capital investment by dividing the project's annual after-tax net income by the average investment cost is called the

  1. Bail-out payback method.
  2. Internal rate of return method.
  3. Profitability index method.
  4. Accounting rate of return method.

Answer(s): D

Explanation:

The accounting rate of return (also called the unadjusted rate of return or book value rate return) measures investment performance by dividing the accounting net income by the average investment in the project. This method ignores the time value of money.



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A company has unlimited capital funds to invest. The decision rule for the company to follow in order to maximize shareholders' wealth is to invest in all projects having a(n)

  1. Present value greater than zero.
  2. Net present value greater than zero.
  3. Internal rate of return greater than zero.
  4. Accounting rate of return greater than the hurdle rate used in capital budgeting analyses.

Answer(s): B

Explanation:

If the net present value (NPV) of an investment is positive, the project should be accepted (unless projects are mutually exclusive). If the NPV is negative, the investment should be rejected.



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Future1 Inc. is in the enviable situation of having unlimited capital funds. The best decision rule, in an economic sense, for it to follow would be to invest in all projects in which the

  1. Accounting rate of return is greater than the earnings as a percent of sales.
  2. Payback reciprocal is greater than the internal rate of return.
  3. Internal rate of return is greater than zero.
  4. Net present value is greater than zero.

Answer(s): D

Explanation:

Given unlimited funds1 all projects with a net present value greater than zero should be invested in. Thus, it would be profitable to invest in any company where the rate of return is greater than the cost of capital.






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