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Financial CMA Exam (page: 44)
Financial Certified Management Accountant
Updated on: 25-Dec-2025

Viewing Page 44 of 270
CMA PDF 1336 Questions

Details: Risk Analysis and Real Options 20

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.

  1. l only.
  2. l & ll.
  3. Ill only.
  4. l, II,& III.

Answer(s): B

Explanation:

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.




Details: Risk Analysis and Real Options 20

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

  1. Opportunity cost.
  2. Sunk cost.
  3. Incremental cash flow.
  4. Net initial investment.

Answer(s): A

Explanation:

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).




Details: Risk Analysis and Real Options 20

Post-investment audits

  1. Complete a stage in the capital budgeting process.
  2. Serve as a control mechanism.
  3. Allow the outcome of a project to be evaluated as soon as possible.
  4. Deter managers from proposing profitable investments.

Answer(s): B

Explanation:

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.




Details: Risk Analysis and Real Options 20

The accounting rate of return

  1. Is synonymous with the internal rate of return.
  2. Focuses on income as opposed to cash flows.
  3. Is inconsistent with the divisional performance measure known as return on investment.
  4. Recognizes the time value of money.

Answer(s): B

Explanation:

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.




Details: Risk Analysis and Real Options 20

When using the net present value method for capital budgeting analysis1 the required rate of return is called all of the following except the

  1. Risk-free rate.
  2. Cost of capital.
  3. Discount rate.
  4. Cutoff rate.

Answer(s): A

Explanation:

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.



Viewing Page 44 of 270



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