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Free CMA Exam Braindumps (page: 75)

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The Keego Company is planning a $200,000 equipment investment which has an estimated 5-year life with no estimated salvage value. The company has projected the following annual cash flows for the investment.


Assuming that the estimated cash inflows occur evenly during each year, the payback period for the investment is

  1. 1.67years.
  2. 4.91 years.
  3. 2.50 years.
  4. 1.96years.

Answer(s): C

Explanation:

The payback period is the number of years required to complete the return of the original investment. The principal problems with the payback method are that it does not consider the time value of money and the inflows after the payback period. The inflow for the first year is $120,000, the second year is $60,000, and the third year is $40,000, a total of $220,000. Given an initial investment of $200,000. the payback period must be between 2 and 3 years. If the cash inflows occur evenly throughout the year, $20,000 ($200,000 --$120,000-- $60,000) of cash inflows are needed in year 3, which is 50% of that year's total. Thus, the answer is 2.5 years.



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The Keego Company is planning a $200,000 equipment investment which has an estimated 5-year life with no estimated salvage value. The company has projected the following annual cash flows for the investment.


The net present value for the investment is

  1. $18,800
  2. $218,800
  3. $100,000
  4. $91,743

Answer(s): A

Explanation:

The NPV is defined as the excess of the present value of the net cash inflows over the net cost of the investment. Discounting the future cash inflows by the present value factors results in an $18,800 NPV ($218,800 --$200,000).



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Willis, Inc. has a desired rate of return of 15% and is considering the acquisition of a new machine which costs $400,000 and has a useful life of 5 years. Willis projects that earnings and cash flow will increase as follows:


What is the payback period of Willis' investment?

  1. 1.5 years.
  2. 3.0 years.
  3. 3.3 years.
  4. 4.0 years.

Answer(s): B

Explanation:

The payback method calculates the number of years required to complete the return of the original investment. The initial cost is $400,000, so Willis will recoup its investment in 3 years ($160,000 in year 1 + $140,000 inyear2 + $100,000 in year 3).



View Related Case Study

Willis, Inc. has a desired rate of return of 15% and is considering the acquisition of a new machine which costs $400,000 and has a useful life of 5 years. Willis projects that earnings and cash flow will increase as follows:


The net present value of Willis' investment is

  1. Negative, $64,000.
  2. Negative, $14,000.
  3. Positive, $18,600.
  4. Positive, $200,000.

Answer(s): C

Explanation:

The NPV is calculated by discounting the after-tax cash flows by the desired rate of return. The cash flows of this company constitute an annuity of $100,000 per year plus additional flows of $60,000 in Year 1 and $40,000 in Year 2. Thus, the present value of these flows is $418,600 [($100,000 x 3.36 PV of an annuity of $1 for 5 periods at 15%) + ($60,000 x .87 PV of $1 for 1 period at 15%) + ($40,000 x .76 PV of $1 for 2 periods at 15%)]. The NPV is therefore $18,600 ($418,600 --$400,000).






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