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Free CMA Exam Braindumps (page: 74)

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Don Adams Breweries is considering an expansion project with an investment of $1,500,000. The equipment will be depreciated to zero salvage value on a straight-line basis over 5 years. The expansion will produce incremental operating revenue of $400,000 annually for 5 years. The company's opportunity cost of capital is 12%. Ignore taxes. What is the payback period of the project?

  1. 2years.
  2. 2.14 years.
  3. 3.75years.
  4. 5 years.

Answer(s): C

Explanation:

First, calculate the annual earnings and cash flows:


The payback period in this case is equal to the investment divided by the annual operating cash flows that result from that investment. Thus, the payback period is 3.75 years ($1,500,000 ÷ $400,000).



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Tonya, Inc. has a cost of capital of 15% and is considering the acquisition of a new machine that costs $800,000 and has a useful life of 5 years. Tonya projects that earnings and cash flow will increase as follows:


What is the payback period of this investment?

  1. 1.Syears.
  2. 3.Oyears.
  3. 3.3 years.
  4. 4.0 years.

Answer(s): B

Explanation:

The payback method is simply the time required to recover the investment. It does not consider the time value of money or returns after the payback period. When cash flows are not uniform, a cumulative calculation is necessary. Thus, 3.0 years is the payback period ($320,000 in the first year, $280,000 in the second year, and $200,000 in the third year).



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Tonya, Inc. has a cost of capital of 15% and is considering the acquisition of a new machine that costs $800,000 and has a useful life of 5 years. Tonya projects that earnings and cash flow will increase as follows:


The net present value of this investment is

  1. $(128,000)
  2. $200,000
  3. $37,200
  4. $400,000

Answer(s): C

Explanation:

The NPV is calculated by discounting the after-tax cash flows from an investment by the cost of capital:


Subtracting the $800,000 initial cost from the $837,200 present value of the future inflows produces an NPV of $37,200.



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Tonya, Inc. has a cost of capital of 15% and is considering the acquisition of a new machine that costs $800,000 and has a useful life of 5 years. Tonya projects that earnings and cash flow will increase as follows:


What is the profitability index for the investment?

  1. 0.05
  2. 0.96
  3. 1.05
  4. 1.25

Answer(s): C

Explanation:

The profitability index is the present value of the future net cash flows divided by the present value of the net initial investment. The present value of the future net cash flows is $837,200. Dividing the $800,000 initial cost of the investment into the $837,200 present value of the future net cash inflows produces a profitability index of approximately 1 .05. Any profitability index greater than one is considered acceptable.






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