IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 131:

  The internal rate of return on an investment

  A. Usually coincides with the company's hurdle rate.

  B. Disregards discounted cash flows.

  C. May produce different rankings from the net present value method on mutually exclusive projects.

  D. Would tend to be reduced if a company used an accelerated method of depreciation for tax purposes rather than the straight-line method.

  Correct Answer: C

  Investment projects may be mutually exclusive under conditions of capital rationing (limited capital). In other words, scarcity of resources will prevent an entity from undertaking all available profitable activities. Under the IRR method, an interest rate is computed such that the present value of the expected future cash flows equals the cost of the investment (NPV = 0). The IRR method assumes that the cash flows will be reinvested at the IRR. The NPV is the excess of the present value of the estimated net cash inflows over the net cost of the investment. The cost of capital must be specified in the NPV method. An assumption of the NPV method is that cash flows from the investment will be reinvested at the particular project's cost of capital. Because of the difference in the assumptions regarding the reinvestment of cash flows, the two methods will occasionally give different answers regarding the ranking of mutually exclusive projects. Moreover, the IRR method may rank several small, short-lived projects ahead of a large project with a lower rate of return but with a longer life span. However, the large project might return more dollars to the company because of the larger amount invested and the longer time span over which earnings will accrue. When faced with capital rationing, an investor will want to invest in projects that generate the most dollars in relation to the limited resources available and the size and returns from the possible investments. Thus, the NPV method should be used because it determines the aggregate present value for each feasible combination of projects.

• Question 132:

  High-Tech Industries is considering the acquisition of a new state-of-the-art manufacturing machine to replace a less efficient machine. Hi-Tech has completed a net present value analysis and found it to be favorable. Which one of the following factors should not be of concern to Hi-Tech in its acquisition considerations?

  A. The availability of any necessary financing.

  B. The probability of near-term technological changes to the manufacturing process.

  C. The investment tax credit.

  D. Maintenance requirements, warranties, and availability of service arrangements.

  Correct Answer: C

  The investment tax credit is of no concern because it no longer exists. The 1986 Tax Reform [Act eliminated the investment tax credit.

• Question 133:

  The accountant of Ronier, Inc. has prepared an analysis of a proposed capital project using discounted cash flow techniques. One manager has questioned the accuracy of the results because the discount factors employed in the analysis have assumed the cash flows occurred at the end of the year when the cash flows actually occurred uniformly throughout each year. The net present value calculated by the accountant will

  A. Not be in error.

  B. Be slightly overstated.

  C. Be unusable for actual decision making.

  D. Be slightly understated but usable.

  Correct Answer: D

  The effect of assuming cash flows occur at the end of the year simply understates the present values of the future cash flows; in realist', they probably occur on the average at mid-year.

• Question 134:

  The internal rate of return for a project can be determined

  A. If the internal rate of return is greater than the firm's cost of capital.

  B. Only if the project cash flows are constant.

  C. By finding the discount rate that yields a net present value of zero for the project.

  D. By subtracting the firm's cost of capital from the project's profit ability index.

  Correct Answer: C

  The IPR is a capital budgeting technique that calculates the interest rate that yields a net present value equal to $0. It is the interest rate that will discount the future cash flows to an amount equal to the initial cost of the project. Thus1 the higher the IRR, the more favorable the ranking of the project.

• Question 135:

  When using the net present value method for capital budgeting analysis, the required rate of return is called all of the following except the

  A. Risk-free rate.

  B. Cost of capital.

  C. Discount rate.

  D. Cutoff rate.

  Correct Answer: A

  The rate used to discount future cash flows is sometimes called the cost of capital, the discount rate, the cutoff rate, or the hurdle rate. A risk-free rate is the rate available on risk-free investments such as government bonds. The risk-free rate is not equivalent to the cost of capital because the latter must incorporate a risk premium.

• Question 136:

  Project 1 has an expected NPV of $120,000 and a standard deviation of $200,000. Project 2 has an expected NPV of $100,000 and a standard deviation of $150,000. The correlation between these two projects is 0.80. What is the coefficient of variation for the portfolio of projects?

  A. 1.67

  B. 1.59

  C. 1.51

  D. 0.63

  Correct Answer: C

  The coefficient of variation is useful when the rates of return and standard deviations of two investments differ. It measures the risk per unit of return by dividing the standard deviation by the expected return. Thus, for Project 1, dividing $200,000 by $120,000 produces a coefficient of 1.67. For Project 2, the calculation is to divide $150,000 by $100,000, or 1.50. If the two projects had perfect correlation (=1.0), then you could combine the calculations ($350,000 + $220,000 = 1.59). However, with a correlation of less than one, the risk will be something less than 1.59.

• Question 137:

  Assume that the probability distribution of Nap's is normal. The firm considers true risk occurring if the project results in a NPV that is zero or less. If the expected NPV is $1,000 and the standard deviation of NPV is $500, what is the probability that the project has an NPV of 0 or less?

  A. Less than 3%.

  B. Greater than 3%, but less than 9%.

  C. Greater than 9%, but less than 16%.

  D. Greater than 16%.

  Correct Answer: A

  Since three standard deviations incorporate over 99% of all observations, and two standard deviations incorporate over 95% of observations, it means less than 5% will not be included within two standard deviations, and this is divided between both ends of the normal curve. Therefore, less than 2.5% of the observations will be in the negative portion of the curve.

• Question 138:

  Drillers Inc. is evaluating a project to produce a high-tech deep-sea oil exploration device. The investment required is $80 million for a plant with a capacity of 15.000 units a year for 5 years. The device will be sold for a price of $12,000 per unit. Sales are expected to be 12,000 units per year. The variable cost is $7,000 and fixed costs, excluding depreciation, are $25 million per year. Assume Drillers employs straight-line depreciation on all depreciable assets, and assume that they are taxed at a rate of 36%. If the required rate of return is 12%, what is the approximate NPV of the project?

  A. $17,225,000

  B. $21511,000

  C. $26.780000

  D. $56117000

  Correct Answer: B

  

  

• Question 139:

  

  The following forecasts have been prepared for a new investment by Oxford Industries of $20 million with an 8-year life:

  

  Assume that Oxford employs straight-line depreciation, and that they are taxed at 35%. Assuming an opportunity cost of capital of 14%, what is the NPV of this project, based on expected outcomes?

  A. $2,626,415

  B. $4,563,505

  C. $6,722,109

  D. $8,055,722

  Correct Answer: B

  The first step is to calculate the annual cash flows from the project for the base case (the expected values). These may be calculated as shown:

  

  This level of cash flow occurs for each of the 8 years of the project. The present value of an 8-year, $1 annuity is 4.639 at 14%. The NPV of the project is therefore given by:

• Question 140:

  Pena Company is considering a project that calls for an initial cash outlay of $50,000. The expected net cash inflows from the project are $7,791 for each of 10 years. What is the PR of the project?

  A. 6%

  B. 7%

  C. 8%

  D. 9%

  Correct Answer: D