IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 251:

  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 reality, they probably occur on the average at mid-year.

• Question 252:

  Carco, Inc. wants to use discounted cash flow techniques when analyzing its capital investment projects. The company is aware of the uncertainly involved in estimating future cash flows. A simple method some

  companies employ to adjust for the uncertainly inherent in their estimates is to

  A. Prepare a direct analysis of the probability of outcomes.

  B. Use accelerated depreciation.

  C. Adjust the minimum desired rate of return.

  D. Increase the estimates of the cash flows.

  Correct Answer: C

  Uncertainly can be compensated for by adjusting the desired rate of return. If projects have relatively uncertain returns, a higher rate should be required. A lower rate of return may be acceptable given greater certainly. The concept is that with increased risk should come increased rewards1 i.e., a higher rate of return.

• Question 253:

  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 profitability index.

  Correct Answer: C

  The IRR 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. Thus, the higher the PR, the more favorable the ranking of the project.

• Question 254:

  When using the net present value method for capital budgeting analysis1 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 risk1ree 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 255:

  The accounting rate of return

  A. Is synonymous with the internal rate of return.

  B. Focuses on income as opposed to cash flows.

  C. Is inconsistent with the divisional performance measure known as return on investment.

  D. Recognizes the time value of money.

  Correct Answer: B

  The accounting rate of return (also called the unadjusted rate of return or book value rate of return) is calculated by dividing the increase in accounting net income by the required investment. Sometimes the denominator is the average investment rather than the initial investment. This method ignores the time value of money and focuses on income as opposed to cash flows.

• Question 256:

  Post-investment audits

  A. Complete a stage in the capital budgeting process.

  B. Serve as a control mechanism.

  C. Allow the outcome of a project to be evaluated as soon as possible.

  D. Deter managers from proposing profitable investments.

  Correct Answer: B

  Post-investment audits should be conducted to serve as a control mechanism and to deter managers from proposing unprofitable investments. Actual-to-expected cash flow comparisons should be made, and unfavorable variances should be explained. Individuals who supplied unrealistic estimates should have to explain differences.

• Question 257:

  The maximum benefit forgone by using a scarce resource for a given purpose and not for the next-best alternative is called

  A. Opportunity cost.

  B. Sunk cost.

  C. Incremental cash flow.

  D. Net initial investment.

  Correct Answer: A

  An opportunity' cost is the maximum benefit forgone by using a scarce resource for a given purpose and not for the next-best alternative. In capital budgeting, the most basic application of this concept is the desire to place the company's limited funds in the most promising capital project(s).

• Question 258:

  Book rate of return is an unsatisfactory guide to selecting capital projects because

  I. It uses accrual accounting numbers.

  II.

  It compares a single project against the average of capital projects. Ill. It uses cash flows to gauge the desirability of the project.

  A.

  l only.

  B.

  l and ll.

  C.

  Ill only.

  D.

  l, II,and III.

  Correct Answer: B

  A common misstep in regard to capital budgeting is the temptation to gauge the desirability of a project by using accrual accounting numbers instead of cash flows. Net income and book value are affected by the company's choices of accounting methods. A project's true rate of return cannot be dependent on bookkeeping decisions. Another distortion inherent in comparing a single project's book rate of return to the current one for the company as a whole is that the latter is an average of all of a firm's capital projects. Embedded in that average number may be a handful of good projects making up for a large number of poor investments.

• Question 259:

  The capital budgeting process contains several stages. At which stage are financial and non financial factors addressed?

  A. Identification and definition.

  B. Selection.

  C. Search.

  D. Information-acquisition.

  Correct Answer: D

  During the information-acquisition stage of the capital budgeting process, quantitative financial factors are given the most scrutiny. These include initial investment and periodic cash inflow. Nonfinancial measures, both quantitative and qualitative, are also identified and addressed. Examples include the need for additional training on new equipment and uncertainty about technological developments and competitors' actions.

• Question 260:

  Which of the following is not a category of relevant cash flows?

  A. Annual net cash flows.

  B. Project termination cash flows.

  C. Incremental cash flows.

  D. Net initial investment.

  Correct Answer: C

  Relevant cash flows are a much more reliable guide when judging capital projects, since only they provide a true measure of a project's potential to affect shareholder value. The relevant cash flows can be divided into three categories: (1) net initial investment, (2) annual net cash flows, and (3) project termination cash flows. An incremental cash flow is the difference in cash received or disbursed resulting from selecting one option instead of another. It is not a category of relevant cash flows.