IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 151:

  Jackson Corporation uses net present value techniques in evaluating its capital investment projects. The company is considering a new equipment acquisition that will cost $100,000, fully installed, and have a zero salvage value at the end of its five-year productive life. Jackson will depreciate the equipment on a straight-line basis for both financial and tax purposes. Jackson estimates $70,000 in annual recurring operating cash income and $20,000 in annual recurring operating cash expenses. Jackson's desired rate of return is 12% and its effective income tax rate is 40%. What is the net present value of this investment on an after-tax basis?

  A. $28,840

  B. $8,150

  C. $36,990

  D. $80,250

  Correct Answer: C

  Annual cash outflow for taxes is $12,000 {[$70,000 inflows -- $20,000 cash operating expenses `-($100,000 ?5) depreciation] x 40%}. The annual net cash inflow is therefore $38,000 ($70,000 --$20,000-$12,000). The present value of these net inflows for a 5-year period is $136,990 ($38,000 x 3.605 present value of an ordinary annually for 5 years at 12%)1 and the NPV of the investment is $36,990 ($136,990 -$100,000 investment).

• Question 152:

  In order to increase production capacity, Gunning Industries is considering replacing an existing production

  machine with a new technologically improved machine effective January 1. The following information is

  being considered by Gunning Industries:

  The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost

  an additional $30,000.

  The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.

  Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.

  The investment in the new machine will require an immediate increase in working capital of $35,000. This

  cash outflow will be recovered after 5 years.

  Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new

  machine has an estimated useful life of 5 years and zero salvage value.

  Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to

  analyze investments and will employ the following factors and rates:

  

  The overall discounted cash flow impact of Gunning Industries' working capital investment for the new production machine would be

  A. $(7,959)

  B. $(10,080)

  C. $(13,265)

  D. $(35,000)

  Correct Answer: C

  The $35,000 of working capital requires an immediate outlay for that amount, but it will be recovered in 5 years. Thus, the net discounted cash outflow is $13,265 [$35,000 initial investment--($35,000 future 1inflow x .621 PV of $1 for 5 years at 10%)].

• Question 153:

  In order to increase production capacity, Gunning Industries is considering replacing an existing production

  machine with a new technologically improved machine effective January 1. The following information is

  being considered by Gunning Industries:

  The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost

  an additional $30,000.

  The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.

  Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.

  The investment in the new machine will require an immediate increase in working capital of $35,000. This

  cash outflow will be recovered after 5 years.

  Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new

  machine has an estimated useful life of 5 years and zero salvage value.

  Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to

  analyze investments and will employ the following factors and rates:

  

  The acquisition of the new production machine by Gunning Industries will contribute a discounted net-oftax contribution margin of

  A. $242,624

  B. $303,280

  C. $363,936

  D. $454,920

  Correct Answer: D

  The new machine will increase sales by 20,000 units a year. The increase in the pretax total contribution margin will be $200,000 per year [20,000 units x ($40 SP -- $30 VC)], and the annual increase in the after tax contribution margin will be $120,000 [$200,000 x (1.0-- .4)]. The present value of the after-tax increase in the contribution margin over the 5-year useful life of the machine is $454,920 ($120,000 x 3.791 PV o f an ordinary annuity for 5 years at 10%).

• Question 154:

  In order to increase production capacity, Gunning Industries is considering replacing an existing production

  machine with a new technologically improved machine effective January 1.The following information is

  being considered by Gunning Industries:

  The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost

  an additional $30,000.

  The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.

  Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.

  The investment in the new machine will require an immediate increase in working capital of $35,000. This

  cash outflow will be recovered after 5 years.

  Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new

  machine has an estimated useful life of 5 years and zero salvage value.

  Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to

  analyze investments and will employ the following factors and rates:

  

  Gunning Industries' discounted annual depreciation tax shield for the year of replacement is

  A. $13,817

  B. $16,762

  C. $20,725

  D. $22,800

  Correct Answer: A

  Gunning uses straight-line depreciation. Thus, the annual charge is $38,000 [($160,000 ?$30,000) + 5 years], and the tax savings is $15,200 ($38,000 x 40%). That benefit will be received in 1 year, so the present value is $13,817 ($15,200 tax savings x .909 present value of $1 for 1 year at 10%).

• Question 155:

  In order to increase production capacity, Gunning Industries is considering replacing an existing production

  machine with a new technologically improved machine effective January 1. The following information is

  being considered by Gunning Industries:

  The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost

  an additional $30,000.

  The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit.

  Incremental operating costs include $30 per unit in variable costs and total fixed costs of $40,000 per year.

  The investment in the new machine will require an immediate increase in working capital of $35,000. This

  cash outflow will be recovered after 5 years.

  Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new

  machine has an estimated useful life of 5 years and zero salvage value.

  Gunning is subject to a 40% corporate income tax rate. Gunning uses the net present value method to

  analyze investments and will employ the following factors and rates:

  

  Gunning Industries' net cash outflow in a capital budgeting decision is

  A. $190,000

  B. $195,000

  C. $204,525

  D. $225,000

  Correct Answer: D

  The machine costs $160,000 and will require $30,000 to install and test. In addition, the company will have to invest in $35,000 of working capital to support the production of the new machine. Thus, the total investment necessary is $225,000.

• Question 156:

  A disadvantage of the net present value method of capital expenditure evaluation is that it

  A. Is calculated using sensitively analysis.

  B. Computes the true interest rate.

  C. Does not provide the true rate of return on investment.

  D. Is difficult to apply because it uses a trial-and-error approach.

  Correct Answer: C

  The NPV is broadly defined as the excess of the present value of the estimated net cash inflows over the net cost of the investment. A discount rate has to be stipulated by the person conducting the analysis. A disadvantage is that it does not provide the true rate of return for an investment, only that the rate of return is higher than a stipulated discount rate (which may be the cost of capital).

• Question 157:

  The NPV of a project has been calculated to be $215000. Which one of the following changes in assumptions would decrease the NPV?

  A. Decrease the estimated effective income tax rate.

  B. Decrease the initial investment amount.

  C. Extend the project life and associated cash inflows.

  D. Increase the discount rate.

  Correct Answer: D

  An increase in the discount rate would lower the net present value, as would a decrease in cash flows or an increase in the initial investment.

• Question 158:

  The use of an accelerated method instead of the straight-line method of depreciation in computing the net present value of a project has the effect of

  A. Raising the hurdle rate necessary to justify the project.

  B. Lowering the net present value of the project.

  C. Increasing the present value of the depreciation tax shield.

  D. Increasing the cash outflows at the initial point of the project.

  Correct Answer: C

  Accelerated depreciation results in greater depreciation in the early years of an asset's life compared with the straight-line method. Thus, accelerated depreciation results in lower income tax expense in the early years of a project and higher income tax expense in the later years. By effectively deferring taxes, the accelerated method increases the present value of the depreciation tax shield.

• Question 159:

  All of the following items are included in discounted cash flow analysis except

  A. Future operating cash savings.

  B. The current asset disposal price.

  C. The future asset depreciation expense.

  D. The tax effects of future asset depreciation.

  Correct Answer: C

  Discounted cash flow analysis, using either the internal rate of return (IRR) or the net present value (NPV) method, is based on the time value of cash inflows and outflows. All future operating cash savings are considered, as well as the tax effects on cash flows of future depreciation charges. The cash proceeds of future asset disposals are likewise a necessary consideration. Depreciation expense is a consideration only to the extent that it affects the cash flows for taxes. Otherwise, depreciation is excluded from the analysis because it is a noncash expense.

• Question 160:

  Amstar Corporation has not yet decided on its hurdle rate for use in the evaluation of capital budgeting projects. This lack of information will prohibit Amstar from calculating a project's

  

  A. Option

  B. Option

  C. Option

  D. Option

  Correct Answer: D

  A hurdle rate is not necessary in calculating the accounting rate of return. That return is calculated by dividing the net income from a project by the investment in the project. Similarly, a company can calculate the internal rate of return (IRR) without knowing its hurdle rate. The IRR is the discount rate at which the net present value is $0. However, the NPV cannot be calculated without knowing the company's hurdle rate. The NPV method requires that future cash flows be discounted using the hurdle rate.