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Financial CMA Exam (page: 13)
Financial Certified Management Accountant
Updated on: 25-Dec-2025

Viewing Page 13 of 270
CMA PDF 1336 Questions

Details: Ranking Investment Projects 19

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

  1. $13,817
  2. $16,762
  3. $20,725
  4. $22,800

Answer(s): A

Explanation:

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%).




Details: Ranking Investment Projects 19

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-of-tax contribution margin of

  1. $242,624
  2. $303,280
  3. $363,936
  4. $454,920

Answer(s): D

Explanation:

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%).




Details: Ranking Investment Projects 19

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

  1. $(7,959)
  2. $(10,080)
  3. $(13,265)
  4. $(35,000)

Answer(s): C

Explanation:

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%)].




Details: Ranking Investment Projects 19

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?

  1. $28,840
  2. $8,150
  3. $36,990
  4. $80,250

Answer(s): C

Explanation:

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).




Details: Ranking Investment Projects 19

A weakness of the internal rate of return (IPP) approach for determining the acceptability of investments is that it

  1. Does not consider the time value of money.
  2. Is not a straightforward decision criterion.
  3. Implicitly assumes that the firm is able to reinvest project cash flows at the firm's cost of capital.
  4. Implicitly assumes that the firm is able to reinvest project cash flows at the project's internal rate of return.

Answer(s): D

Explanation:

The IRR is the rate at which the discounted future cash flows equal the net investment (NPV = 0). One disadvantage of the method is that inflows from the early years are assumed to be reinvested at the IRP. This assumption may not be sound. Investments in the future may not earn as high a rate as is currently available.



Viewing Page 13 of 270



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