IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 41:

  Garfield, Inc. is considering a 10-year capital investment project with forecasted revenues of $40,000 per year and forecasted cash operating expenses of $29,000 per year. The initial cost of the equipment for the project is $23,000. and Garfield expects to sell the equipment for $9,000 at the end of the tenth year The equipment will be depreciated over 7 years The project requires a working capital investment of $7,000 at its inception and another $5,000 at the end of Year 5. Assuming a 40% marginal tax rate, the expected net cash flow from the project in the tenth year is?

  A. $32,000

  B. $24,000

  C. $20,000

  D. $11,000

  Correct Answer: B

  The project will have an $11,000 before-tax cash inflow from operations in the tenth year ($40,000 -$29,000). Also, $9,000 will be generated from the sale of the equipment. The entire $9,000 will be taxable because the basis of the asset was reduced to zero in the 7th year. Thus, taxable income will be $20,000 ($11,000 + $9,000), leaving a net after-tax cash inflow of $12,000 [$20.000 x (1.0-- .4)] To this $12,000 must be added the $12,000 tied up in working capital ($7,000 + $5,000). The total net cash flow in the 10th year will therefore be $24.O0j

• Question 42:

  Regal Industries is replacing a grinder purchased 5 years ago for $15,000 with a new one costing $25.000 cash. The original grinder is being depreciated on a straight-line basis over 15 years to a zero salvage value; Regal will sell this old equipment to a third party for $6,000 cash, The new equipment will be depreciated on a straight-line basis over 10 years to a zero salvage value Assuming a 40% marginal tax rate. Regale's net cash investment at the time of purchase if the old gander is sold and the new one purchased is

  A. $19,000

  B. $15,000

  C. $17,400

  D. $25,000

  Correct Answer: C

  The old machine has a carrying amount of $10,000 [$15,000 cost--S ($15,000 cost +15 years) depreciation]. The loss on the sale is $4,000 ($10,000-- $6,000 cash received), and the tax savings from the loss is $1,600 ($4,000 x 40%). Thus, total inflows are $7,600 The only outflow is the $25,000 purchase price of the new machine. The net cash investment is therefore $17,400 ($25,000-- $7,600).

• Question 43:

  Kline Corporation is expanding its plant, which requires an investment of $8 million in new equipment. Kline's sales are expected to increase by $6 million per year as a result of the expansion. Cash investment in current assets averages 30% of sales, and accounts payable and other current abilities are 10% of sales, What is the estimated total cash investment for this expansion?

  A. $6.8 million.

  B. $8.6 million.

  C. $9.2 million.

  D. $9.8 million.

  Correct Answer: C

  For capital budgeting purposes, the net investment is the net outlay or cash requirement. This amount includes the cost of the new equipment, minus any cash recovered from the trade or sale of existing assets. The investment required also includes funds to proide for increases in working capital, for example, the additional receivables and inventories resulting from the acquisition of a new manufacturing plant. The investment in working `capital is treated as an initial cost of the investment, although twill be recovered at the end of the project (its salvage value equals its initial cost). For Kline, the additional current assets will be 30% of sales, but current liabilities can be used to fund assets to the extent of 10% of sales. Thus, the initial investment in working capital will equal 20% of the $6 million in sales, or $1,200,000. The total initial cash outlay will consist of the $8 million in new equipment plus $1,200,000 in working capital, a total of $9.2 million.

• Question 44:

  In equipment replacement decisions, which one of the following does not affect the decision-making process?

  A. Current disposal price of the old equipment.

  B. Operating costs of the old equipment.

  C. Original fair value of the old equipment.

  D. Operating costs of the new equipment.

  Correct Answer: C

  All relevant costs should be considered when evaluating an equipment replacement decision. `These include the iniflal investment in the new equipment, any required investment in working capital, the disposal price, of the new equipment, the disposal price of the old equipment, the operating costs of the old equipment, and the operating costs of the new equipment. The original cost or fair value of the old equipment is a sunk cost and is irrelevant to future decisions.

• Question 45:

  Lawson. Inc. is expanding its manufacturing plant, which requires an investment of $4 million in new equipment and plant modifications. Lawson's sales are expected to increase by $3 million per year as a result of the expansion. Cash investment in current assets averages 30% of sales; accounts payable and other current liabilities are 10% of sales. What is the estimated total investment for this expansion?

  A. $3.4 million.

  B. $4.3 million.

  C. $4.6 million.

  D. $5.2 million.

  Correct Answer: C

  The investment required includes increases in working capital (e.g.. additional receivables and inventories resulting from the acquisition of a new manufacturing plant). The additional working capital is an initial cost I of the investment, but one that will be recovered (i.e.. it has a salvage value equal to its initial cost). Lawson can use current liabilities to fund assets to the extent of 10% of sales. Thus, the total initial cash outlay will be $46 million ($4 million + [(30% -- 10%) x $3 million sales].

• Question 46:

  A depreciation tax shield is?

  A. An after-tax cash outflow

  B. A reduction in income taxes.

  C. The cash provided by recording depreciation.

  D. The expense caused by depreciation.

  Correct Answer: B

  A tax shield is something that will protect income against taxation. Thus, a depreciation tax shield is a reduction in income taxes due to a company's being allowed to deduct depreciation against otherwise taxable income.

• Question 47:

  Which one of the following statements concerning cash flow determination for capital budgeting purposes is not correct?

  A. Tax depreciation must be considered because it affects cash payments for taxes.

  B. Book depreciation is relevant because it affects net income.

  C. Sunk costs are not incremental flows and should not be included

  D. Net working capital changes should be included in cash flow forecasts.

  Correct Answer: B

  Tax depreciation is relevant to cash flow analysis because it affects the amount of income taxes that must be paid. However, book depreciation is not relevant because it does not affect the amount of cash generated by an investment.

• Question 48:

  The term that refers to costs incurred in the past that are not relevant to a future decision is?

  A. Discretionary cost

  B. Full absorption cost.

  C. Underallocated indirect cost.

  D. Sunk cost.

  Correct Answer: D

  A sunk cost cannot be avoided because it represents an expenditure that has already been made or an irrevocable decision to incur the cost.

• Question 49:

  In equipment-replacement decisions, which one of the following does not affect the decision-making process?

  A. Current disposal price of the old equipment.

  B. Operating costs of the old equipment.

  C. Original fair market value of the old equipment.

  D. Cost of the new equipment

  Correct Answer: C

  All relevant costs should be considered when evaluating an equipment-replacement decision. These include the cost of the new equipment, the disposal price of the old equipment, and the operating costs of the old equipment versus the operating costs of the new equipment. The original cost or fair market value of the old equipment is a sunk cost and is irrelevant to future decisions. __

• Question 50:

  Of the following decisions, capital budgeting techniques would least likely be used in evaluating the

  A. Acquisition of new aircraft by a cargo company.

  B. Design and implementation of a major advertising program.

  C. Trade for a star quarterback by a football team.

  D. Adoption of a new method of allocating nontraceable costs to product lines.

  Correct Answer: D

  Capital budgeting is the process of planning expenditures for investments on which the returns are expected to occur over a period of more than 1 year. Thus, capital budgeting concerns the acquisition or disposal of long-term assets and the financing ramifications of such decisions. The adoption of a new method of allocating, nontraceable costs to product lines has no effect on a company's cash cows, does not concern the acquisition of long- term asset and is not concerned with financing Hence, capital budgeting is irrelevant to such a decision.