IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 121:

  Benet, Inc. uses the net present value method to evaluate capital projects. Bonnet's required rate of return is 10%. Benet is considering two mutually exclusive projects for its manufacturing business. Both projects require an initial outlay of $120,000 and are expected to have a useful life of four years. The projected after-tax cash flows associated with these projects are as follows:

  

  Assuming adequate funds are available, which of the following project options would you recommend that Bennet's management undertake?

  A. Project X only.

  B. Project Y only.

  C. Projects X and Y.

  D. Neither project.

  Correct Answer: A

  The net present value of Project X can be determined using the present value factor for an annually

  (3.170) because the cash flows are even over the life of the project. An ordinarqannuilyof$401000 discounted at 10% for the next four years has a present value of $1 26800. The cash inflows of Project Y are uneven and so must be discounted with individual factors for each of the four years as follows: Since the projects are mutually exclusive, the one with the higher net present value is the correct choice.

  

• Question 122:

  Gibber Corporation has an opportunity' to sell newly developed product in the United States for a period of five years. The product license would be purchased from New Group Company. Gibber would be responsible for all distribution and product promotion costs. New Group has the option to renew the agreement, with modifications, at the end of the initial five-year term. Gibber has developed the following estimated revenues and costs that would be associated with the new product:

  

  The working capital required to support the new product would be released for investment elsewhere if the product licensing agreement is not renewed. Using the net present value method of analysis and ignoring the effects of income taxes, the net present value of this product agreement, assuming Gibber has a 20% cost of capital, would be

  A. $7,720

  B. $(64,064)

  C. $(72,680)

  D. $(127,320)

  Correct Answer: A

  The net present value of a capital project is derived by calculating three amounts and discounting them at the appropriate interest rate: the net initial investment (for which the rate is always 0%), the annual cash inflows, and the termination cash inflows. The net initial investment itself consists of three components: the purchase of new equipment, the increase in working capital, and the proceeds from the disposal of any old equipment. For this project, this amount is $320000 ($120,000 + 200,000 + $0). Since this amount is paid out today, its present value is $320,000, i.e., no discounting is performed. The second element of the project as a whole is the annual cash inflows. This has two components: the cash inflows from operations and the depreciation tax shield arising from the purchase of new equipment. Since the effects of income taxes are not relevant to this problem, only the first of these components requires calculation. The annual net operating revenue is $80,000 ($400,000--$250,000--$70,000). Discounted as an ordinary annuilyfor5 years at 20%, its present value is $239,280 ($80,000 x 2.991). The third and final element is the cash flows upon termination of the project, consisting of the proceeds from the disposal of the equipment involved in the project (again, the effects of income taxes are ignored for this problem) and the recovery of working capital. For this project, this amount is $220,000 ($20,000 + $200,000). Discounted as a single amount to be received in 5 years at 20%, its present value is $88,440 ($220,000 x 0.402). Gibber's total net present value for this capital project can therefore be calculated as follows:

  

• Question 123:

  Wilkinson, Inc., which has a cost of capital of 12%, invested in a project with an internal rate of return (IRR) of 14%. The project is expected to have a useful life of four years, and it will produce net cash inflows as follows:

  

  The initial cost of this project amounted to

  A. $7,483

  B. $9,647

  C. $11,000

  D. $12,540

  Correct Answer: A

  The internal rate of return (IRP) of a capital project is the rate at which the net present value (NPV) of its future cash flows equals zero. To find this project's NPV, therefore, it is necessary to discount the cash flows at the appropriate rate (14%) as follows:

  

• Question 124:

  Assume that the interest rate is greater than zero. Which of the following cash-inflow streams should you prefer?

  

  A. Option A

  B. Option B

  C. Option C

  D. Option D

  Correct Answer: A

  The concept of present value gives greater value to inflows received earlier in the stream. Thus, the declining inflows would be superior to increasing inflows, or even inflows.

• Question 125:

  The present value may be calculated for discounted cash Inflows Outflows Annuities

  A. Yes Yes Yes

  B. Yes No Yes

  C. No Yes No

  D. No No Yes

  Correct Answer: A

  The present value concept may be applied both to dollars-in (inflows) and to dollars-out (outflows). Thus, individual cash inflows and cash outflows or a series thereof (an annuity') may be discounted to time: zero (the present). Net present value is the sum of discounted cash inflows minus any discounted cash outflows. Net present value may be either positive or negative.

• Question 126:

  Basic time value of money concepts concern Interest Factors Risk Cost of capital

  A. Yes Yes No

  B. Yes No Yes

  C. No Yes No

  D. No No Yes

  Correct Answer: A

  The time value of money is concerned with two issues: (1)the investment value of money, and (2) the risk (uncertainty) inherent in any executor agreement. Thus, a dollar today is worth more than a dollar in the future, and the longer one waits for a dollar, the more uncertain the receipt is. The cost of capital involves a specific, 1application of the time value of money principles; It is not a basic concept thereof.

• Question 127:

  An advantage of the net present value method over the internal rate of return model in discounted cash flow analysis is that the net present value method

  A. Computes a desired rate of return for capital projects.

  B. Can be used when there is no constant rate of return required for each year of the project.

  C. Uses a discount rate that equates the discounted cash inflows with the outflows.

  D. Uses discounted cash flows whereas the internal rate of return model does not.

  Correct Answer: B

  The NPV method calculates the present values of estimated future net cash inflows and compares the total with the net cost of the investment. The cost of capital must be specified. If the NPV is positive, the project should be accepted. The IRR method computes the interest rate at which the NPV is zero. The IRR method is relatively easy to use when cash inflows are the same from one year to the next. However, when cash inflows differ from year to year, the IRR can be found only through the use of trial and error. In such cases, the NPV method is usually easier to apply. Also, the NPV method can be used when the rate of return required for each year varies. For example, a company might want to achieve a higher rate of return in later years when risk might be greater. Only the NPV method can incorporate varyinq levels of rates of return.

• Question 128:

  In evaluating a capital budget project, the use of the net present value (NPV) model is generally not affected by the

  A. Method of funding the project.

  B. Initial cost of the project.

  C. Amount of added working capital needed for operations during the term of the project.

  D. Project's salvage value.

  Correct Answer: A

  The NPV method computes the present value of future cash inflows to determine whether they are greater than the initial cash outflow. Future cash inflows include any salvage value on facilities. Included in the initial investment are the cost of new equipment and other facilities, and additional working capital needed for operations during the term of the project. The discount rate (cost of capital or hurdle rate) must be known to discount the future cash inflows. If the NPV is positive, the project should be accepted. The method of funding a project is a decision separate from that of whether to invest.

• Question 129:

  All of the following are the rates used in net present value analysis except for the

  A. Cost of capital.

  B. Hurdle rate.

  C. Discount rate.

  D. Accounting rate of return.

  Correct Answer: D

  The NPV is the excess of the present values of the estimated cash inflows over the net cost of the investment. The discount rate used is sometimes the cost of capital or other hurdle rate designated by management. This rate is also called the required rate of return. The accounting rate of return is never used in NPV analysis because it ignores the time value of money; it is computed by dividing the accounting net income by the investment.

• Question 130:

  The internal rate of return is

  A. The breakeven borrowing rate for the project in question.

  B. The yield rate/effective rate of interest quoted on long-term debt and other instruments.

  C. Favorable when it exceeds the hurdle rate.

  D. All of the answers are correct.

  Correct Answer: D

  The internal rate of return (IRR) is the discount rate at which the present value of the cash flows equals the original investment. Thus, the NPV of the project is zero at the IRR. The IRR is also the maximum borrowing cost the firm could afford to pay for a specific project. The IRR is similar to the yield rate/ effective rate quoted in the business media.