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Free CMA Exam Braindumps (page: 70)

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McLean, Inc. is considering the purchase of a new machine that will cost $160,000. The machine has an estimated useful life of 3 years. Assume that 30% of the depreciable base will be depreciated in the first year1 40% in the second year, and 30% in the third year. The new machine will have a $10000 resale value at the end of its estimated useful life. The machine is expected to save the company $85000 per year in operating expenses. McLean uses a 40% estimated income tax rate and a 16% hurdle rate to evaluate capital projects. Discount rates for a 16% rate are as follows:


The payback period for this investment would be

  1. 1.88years.
  2. 3.00 years.
  3. 2.23years.
  4. 1.62 years.

Answer(s): C

Explanation:

The payback period is the number of years required for the cumulative undiscounted net cash inflows to equal the original investment. The future net cash inflows consist of $69,000 in Year 1 and 3, $75,000 in Year 2, and $10,000 upon resale. After 2 years, the cumulative undiscounted net cash inflow equals $144,000. Thus, $16,000 ($160,000 -- $144,000) is to be recovered in the Year 3, and payback should be complete in approximately 2.23 years [2 years + ($16,000 ÷ $69,000 net cash inflow in third year)]



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A proposed investment is not expected to have any salvage value at the end of its 5-year life. Because of realistic depreciation practices, the net carrying amount and the salvage value are equal at the end of each year. For present value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% after-tax target rate of return.


The accounting rate of return based on the average investment is

  1. 84.9%
  2. 344%
  3. 40.8%
  4. 12%

Answer(s): B

Explanation:

The accounting rate of return (the unadjusted rate of return or rate of return on the carrying amount) equals the increase in accounting net income divided by either the initial or the average investment. It ignores the time value of money. The average income over 5 years is $86,000 [($70,000 + $78,000 + $86,000 + $94000 + $102,000) + 5] Dividing the $86,000 average net income by the $250,000 average investment ($500,000 cost + 2) produces an accounting rate of return of 34.4%.



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A proposed investment is not expected to have any salvage value at the end of its 5-year life. Because of realistic depreciation practices, the net carrying amount and the salvage value are equal at the end of each year. For present value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% after-tax target rate of return.


The net present value is

  1. $304,060
  2. $212,320
  3. $(70,000)
  4. $712,320

Answer(s): B

Explanation:

The NPV method discounts the expected cash flows from a project using the required rate of return. A project is acceptable if its NPV is positive. Based on the interest factors for the present value of $1 at 12% and the annual after4ax cash flows, the NPV of the project over its 5-year life is



View Related Case Study

A proposed investment is not expected to have any salvage value at the end of its 5-year life. Because of realistic depreciation practices, the net carrying amount and the salvage value are equal at the end of each year. For present value purposes, cash flows are assumed to occur at the end of each year. The company uses a 12% after-tax target rate of return.


The traditional payback period is

  1. Over5years.
  2. 2.23years.
  3. 1.65years.
  4. 2.83 years.

Answer(s): B

Explanation:

The payback period is the number of years required to complete the return of the original investment. The cash flows are not time adjusted. When the annual cash flows are not uniform, a cumulative computation is necessary. Thus, the total paybackafter2years is $456,000 ($240,000 + $216,000), and another $44,000 ($500,000 -- $456,000) must be recovered in the third year. The third year fraction is found by assuming that cash flows occur evenly throughout the period. Dividing $44,000 by the $192,000 of third year inflows yields a ratio of .23. Hence, the payback period is 2.23 years.






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