Section A: Basic Financial Statement Analysis

Question 1
The CFO of James Jeans Co. has asked you to prepare a vertical analysis of the recent year's financial
statements. You have identified the following: Gross profit as a percentage of net sales increased from
30.2% last year to 35% this year, net income increased from 9.4% to 10% of net sales, and James Jeans’
closest competitor had net income this year at 11.8% of sales. What would you propose as an
explanation for these results?

A. James Jeans is an overall profitable business and has improved its profitability; however, the
company is still less profitable than its closest competitor.
B. James Jeans was successful in growing the business and bottom line and should be able to
overtake its closest competitor to become more profitable.
C. James Jeans is doing a better job running its business and improving profitability than its closest
competitor.
D. James Jeans has done a successful job negotiating raw materials prices and compensating the
sales team to improve financial results, but its competitor may be doing this better.

Question 2
Chicago Trading Company reports the following results for the past four years (all amounts in millions):

If Year 1 is the base year, what is the percentage increase in net income from Year 2 to Year 4 (round
your answer to the nearest whole percentage)?

A. 10%
B. 5%
C. 7%
D. 8%

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Question 3
If a company's gross profit as a percentage of net sales increases by 5%,

A. its cost of goods as a percentage of net sales decreased.

B. its cost of goods as a percentage of net sales increased.
C. its selling and administrative expenses as a percentage of net sales increased.
D. its net sales returns as a percentage of net sales increased.

Question 4
Because horizontal analysis compares the same amounts over a specified period of time, it is also
referred to as:

A. trend analysis.
B. static analysis.
C. ratio analysis.
D. income analysis.

Question 5
A common-size statement is helpful:

A. for determining the next investment the company should make.

B. for considering whether to buy or sell assets.
C. in comparing companies of different sizes.
D. for figuring out how assets are allocated.

Question 6
James Jeans Co. is evaluating the business performance for last year. They are assessing if inventory is
being properly managed. Which of the following vertical analysis approaches would be the most
effective way to summarize this activity?

A. Collect the balance sheet data for the last two years, obtain the values for inventory and total
assets, calculate the balance sheet percentage by dividing inventory by total assets for each
year, and summarize the observations for the relative size of inventory to total assets for each
year and the percentage change from year-to-year.
B. Collect the balance sheet data for the last two years, obtain the values for inventory and
summarize the observations for the relative size of the inventory balance for each year.
C. Contact competitors to find out best practices about inventory management, summarize these
best practices and compare to James Jeans Co.’s processes, and provide a set of
recommendations on proposed changes.

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 D. Engage an outside expert to review the methods James Jeans Co. uses to manage inventory,
provide ratios about inventory turnover and inventory carrying cost, and identify steps to
improve inventory management.

Question 7
You would like to determine if a greater proportion of assets are comprised of inventory compared to
last year. What is the best approach to analyze this?

A. Compare inventory in the current year as a percentage of total assets to last year.
B. Compare total inventory this year to last year.
C. Review whether FIFO or LIFO is the best inventory method.
D. Determine how much inventory was sold.

Question 8
Atlas Airlines has reported the following quarter 1 (Q1) results for each of the past four years:

Under horizontal analysis, changes in net income for Q1 for Years 2, 3, and 4, respectively, will be shown
as

A. 3.26%, 5.58%, and (2.16%).

B. 3.37%, 5.91%, and (2.12%).
C. 3.37%, 9.47%, and 7.16%.
D. 38.07%, 10.33%, and 4.57%.

3
Section A: Financial Ratios

Question 9
Cerulean Corporation had accounts receivable of $105,000 at the beginning of the year and $115,000 at
the end of the year. What would be the company's average collection period if it reported net sales of
$950,000 and one can assume 365 days a year?

A. 44.2 days
B. 42.3 days
C. 40.6 days
D. 46.2 days

Question 10
A company has $100,000 of sales, $60,000 of variable costs, and $30,000 of fixed costs. The degree of
operating leverage is

*Retired ICMA CMA Question

A. 0.1.
B. 0.3.
C. 0.4.
D. 4.0.

Question 11
Davis Retail Inc. has total assets of $7,500,000 and a current ratio of 2.3 times before purchasing
$750,000 of merchandise on credit for resale. After this purchase, the current ratio will:

A. be lower than 2.3 times.

B. remain at 2.3 times.
C. be higher than 2.3 times.
D. be exactly 2.53 times.

Question 12
Which of the following will help decrease a company's total debt-to-equity ratio, if all else is equal?

A. Buying Treasury stock

B. Lowering the dividend payout ratio
C. Paying cash dividends to stockholders
D. Converting long-term debt to short-term debt

4
Question 13
Rayco, Inc. sells 10,000 units at a price of $5 per unit. Rayco's fixed costs are $8,000, interest expense is
$2,000, variable costs are $3 per unit, and EBIT is $12,000. Rayco's degree of total leverage (DTL) is
closest to:

A. 1.33.
B. 5.00.
C. 3.34.
D. 2.00.

Question 14
Selected information from the comparative financial statements of Faure Company for the year ended
December 31, appears here.

Compare the average days in inventory for the two years (20x3 and 20x4), rounding to two decimal
places.

A. During 20x4, average days in inventory decreased by 53.50 days.

B. During 20x4, average days in inventory decreased by 37.29 days.
C. During 20x4, average days in inventory decreased by 39.99 days.
D. During 20x4, average days in inventory decreased by 21.25 days.

5
Question 15

A creditor is investigating the liquidity of four companies. Based on their liquidity, which company is the
creditor most likely to extend credit to?

A. A company with current assets of $2.7 million and current liabilities of $1.3 million
B. A company with current assets of $672 million and current liabilities of $429 million
C. A company with current assets of $268 million and current liabilities of $94 million
D. A company with current assets of $43 million and current liabilities of $18 million

Question 16
LMN Corporation has return on common equity of 10% and return on total assets of 7%. The average
financial leverage index for LMN's industry is 1.25. Which of the following statements is true?

A. The financial leverage index is 0.7, which is considered a good value.

B. The financial leverage index is 0.7, which is considered a poor value.
C. The financial leverage index is 1.43, which is considered a poor value.
D. The financial leverage index is 1.43, which is considered a good value.

Section A: Profitability Ratios

Question 17
In 20x7, Kaplan Commodities had a profit margin of 5.7% and an asset turnover of 1.29. What was
Kaplan's return on assets for 20x7?

A. 22.63
B. 4.42%
C. 9.49%
D. 7.35%

Question 18
Using the Edgar database and a Morningstar subscription, Amy has been able to assess the relative
performance of Jones & Jennings as compared to its top competitors and the industry as a whole. Like
most of the industry, Jones & Jennings has a current ratio that varies in the region of 1.3–1.5 and a quick
ratio that varies in the region of 1.15–1.4. What industry is Jones & Jennings in?

A. Manufacturing
B. Antiques auction house
C. Retail bookstore
D. Wholesale dry goods

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Question 19
Gordon has had the following financial results for the last four years.

Which one of the following is the most likely conclusion you can draw from this information?

A. Gordon should consider raising prices because the cost of goods sold (COGS) has gone up faster
than sales.
B. Gordon should seek additional outlets for its goods to increase profitable sales.
C. Customers continue to see Gordon's products as a good value for the price.
D. The sales growth may have been caused by inflation, not more effective marketing.

Question 20
Consider the following projections for The Van Horn Corporation for the upcoming year:

The expected common stock dividend per share for The Van Horn Corporation is:

A. $4.40 per share.

B. $2.40 per share.
C. $1.10 per share.
D. 9.60 per share.

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Question 21
Kelly Homegoods Manufacturer is looking to expand. The firm was advised to calculate its sustainable
growth rate to see if it would need to borrow money to finance this growth. Based on the following key
information, how much growth can Kelly finance internally?

A. 10.0%
B. 7.3%
C. 2.8%
D. 2.0%

Section A: Special Issues

Question 22
All of the following are limitations to the information provided on the statement of financial position
except the:

A. judgments and estimates used regarding the collectability, salability, and longevity of assets.
B. lack of current valuation for most assets and liabilities.
C. omission of items that are of financial value to the business such as the worth of the employees.
D. quality of the earnings reported for the enterprise.

Question 23
On June 27, Year 4, Brite Co. distributed to its common stockholders 100,000 outstanding common
shares of its investment in Quik, Inc., an unrelated party. The carrying amount on Brite's books of Quik's
$1 par common stock was $2 per share. Immediately after the distribution, the market price of Quik's
stock was $2.50 per share. In its income statement for the year ended June 30, Year 4, what amount
should Brite report as gain before income taxes on disposal of the stock?

A. $50,000
B. $250,000
C. $200,000
D. $0

8
Question 24

On December 8, 20X1, Andrews Corporation, a U.S. company whose financial statements are
denominated in USD, purchased component parts from an unaffiliated foreign entity in Europe for
20,000 Euro when the exchange (spot) rate was 1.25 USD to 1.00 Euro. The spot rate was 1.15 on
December 31, 20X1. Andrews paid the invoice on January 8, 20X2, when the spot rate was 1.10. What
amount should Andrews report as a foreign currency transaction gain in its December 31, 20X1 income
statement?

A. $0.
B. $2,000.
C. $1,000.
D. $3,000.

Section B: Raising Capital

Question 25
Arch Inc. has 200,000 shares of common stock outstanding. Net income for the recently ended fiscal
year was $500,000, and the stock has a price/earnings (P/E) ratio of eight. The Board of Directors has
just declared a three-for-two stock split. For an investor who owns 100 shares of stock before the split,
the approximate value (rounded to the nearest dollar) of the investment in Arch stock immediately after
the split is:

A. $4,000.
B. $2,000.
C. $1,333.
D. $3,000.

Question 26
Split-Div Inc. has issued quarterly dividends of $0.10 per share each quarter over the last few years. This
quarter the company initiated a 2-for-1 stock split. What is the minimum quarterly dividend the
company's board should approve to avoid sending a bad signal to the investors?

A. $0.02 per share

B. $0.05 per share
C. $0.10 per share
D. $0.20 per share

9
Question 27
A firm is making an initial public offering. The investment bankers agree to a firm underwriting
commitment of 500,000 shares priced to the public at $50 a share. The underwriter's spread is 12%. In
addition, the underwriter charges $600,000 in legal fees. On the first day of trading, the firm's stock
closed at $61. What were the total costs of the issue?

A. $3,000,000
B. $5,500,000
C. $600,000
D. $9,100,000

Question 28
Star Corporation, an auto fuel cell maker, is planning a new plant and needs to raise $30 million to
finance it. The company plans to raise the money through a general cash offering priced at $25.00 a
share. Star's underwriters charge a 4% spread. How many shares does the company have to sell to
achieve its goal? (Round your final answer to the nearest unit of share.)

A. 1,200,000 shares
B. 1,250,000 shares
C. 1,153,846 shares
D. 1,198,083 shares

Section B Long-term Financial Management

Question 29
An investor was issued a stock warrant that allowed him to purchase 10 new shares at an exercise price
of $55 within two years upon issuance. After a year of holding, the market price of shares rose to $37.
What is the intrinsic value of the stock warrant?

A. $0
B. −$18
C. $180
D. −$180

Question 30
Which of the following changes, when considered individually, will increase the value of a call option?

A. The value of the underlying asset becomes more volatile.

B. The price of the underlying asset goes down.
C. The expiration date gets closer (the passage of time).
D. The strike price is higher.

10
Question 31
Neunlay Inc. is a manufacturer of residential air conditioning equipment. Air conditioning equipment
requires a lot of copper. In six months the company will purchase its copper supply for the next two
years. Management is very concerned about the volatility of copper prices. Assume the risk-free rate of
interest is 0%. Which of the following transactions will ensure the company does not have to pay more
than $6,100 per ton of copper six months from now?

A. The company purchases a put option for the necessary amount of copper with a strike price of
$6,000 per ton, a premium of $100 per ton, and an expiration date six months from now.
B. The company purchases a call option for the necessary amount of copper with a strike price of
$6,000 per ton, a premium of $100 per ton, and an expiration date six months from now.
C. The company sells a put option for the necessary amount of copper with a strike price of $6,000
per ton, a premium of $100 per ton and an expiration date six months from now.
D. The company sells a call option for the necessary amount of copper with a strike price of $6,000
per ton, a premium of $100 per ton, and an expiration date six months from now.

Question 32
Which of the following scenarios would justify entering into forward contracts?

A. A retail investor desires to avoid counterparty risk and has no means of finding a counterparty
to arrange a contract specific to his needs.
B. Liquidity and the option to easily exit from the contract is among the priority features in
consideration.
C. A firm has enough funds to keep a maintenance margin for daily settlement of cash
transactions.
D. A company wants to have flexibility in negotiating the terms of the contract, including the
expiration date, units of underlying asset and settlement provisions, among others.

Question 33
Tunerecord Unit Co. stock was trading last year at $24. There were two types of options available on the
stock. Call options with a strike price of $24, which expire at the end of the year, were trading at $9.60.
Put options with a strike price of $24, which expire at the end of the year, were trading for $2.40.
Berniss invested $144 in common stock. Jewel invested $144 in the call options. Reynardo invested $144
in the put options. At the end of one year the price of Tunerecord Unit stock is $20.00. How much
money did Jewel make or lose from this investment?

A. $0
B. $144 loss
C. $204 loss
D. $204 profit

11
Section B Working Capital Management

Question 34
James Smith is the new manager of inventory at American Electronics, a major retailer. He is developing
an inventory control system, and knows he should consider establishing a safety stock level. The safety
stock can protect against all of the following risks, except for the possibility that:

A. shipments of merchandise from the manufacturers is delayed by as much as one week.

B. new competition may open in the company's market area.
C. the distribution of daily sales will have a large variance, due to holidays, weather, advertising,
and weekly shopping habits.
D. customers cannot find the merchandise they want, and they will go to the competition.

Question 35
A company obtained a short-term bank loan of $500,000 at an annual interest rate of 8%. As a condition
of the loan, the company is required to maintain a compensating balance of $50,000 in its checking
account. The checking account earns interest at an annual rate of 3%. The company maintains a balance
of $50,000 in its checking account. What is the effective interest rate of the loan?

A. 8.56%
B. 9.25%
C. 8.88%
D. 7.70%

Question 36
Consider the following factors affecting a company as it is reviewing its trade credit policy.

Which of the above factors would indicate that the company should liberalize its credit policy?

A. II and III only

B. I, II, and III only
C. III and IV only
D. I and II only

12


Question 37
Garner Products is considering a new accounts payable and cash disbursement process which is
projected to add 3 days to the disbursement schedule without having significant negative effects on
supplier relations. Daily cash outflows average $1,500,000. Garner is in a short-term borrowing position
for 8 months of the year and in an investment position for 4 months. On an annual basis, bank lending
rates are expected to average 7% and marketable securities yields are expected to average 4%. What is
the maximum annual expense that Garner could incur for this new process and still break even?

A. $315,000
B. $180,000
C. $150,000
D. $270,000

Question 38
The Dixon Corporation has an outstanding one-year bank loan of $300,000 at a stated interest rate of
8%. In addition, Dixon is required to maintain a 20% compensating balance in its checking account,
which it does. Assuming the bank does not pay interest on balances in checking accounts, the effective
nterest rate on the loan is:

A. 9.6%.
B. 10.0%
C. 8.0%.
D. 6.4%.

Section B Corporate Restructuring

Question 39
In which of the following types of business divestitures does a firm sell a minority interest in the newly
created firm?

A. Spin-off
B. Equity carve-out
C. Split-up
D. Tracking stock

13
Question 40
A transaction in which a buyer of a company borrows a major portion of the purchase price using the
purchased assets as collateral for the borrowing is also known as a:

A. conglomerate.
B. merger.
C. acquisition.
D. leveraged buyout.

Question 41
Which of the following is a defense against corporate takeovers that still results in the firm being
acquired by another firm?

A. Golden parachute
B. Leveraged recapitalization
C. White knight defense
D. Poison pill

Section B International Finance

Question 42
Which type of foreign exchange system determines exchange rates solely based on market supply and
demand?

A. Managed floating exchange rate

B. Floating exchange rate
C. Static exchange rate
D. Fixed exchange rate

Question 43
Palermo, Corp. sold equipment to a French firm. Palermo will be paid €4,275,000 in 90 days. The bank
has given the firm a 90-day forward quote of $1.5487/€ to purchase Euros forward, and $1.5922/€ to
sell Euros forward. Palermo decided to wait 90 days to sell the Euros, when the spot rate was $1.5645/€.
How much additional dollar revenue did Palermo gain or lose by waiting to sell the Euros on the spot
market instead of selling forward the Euros? (Round your final answer to the nearest dollar.)

A. $118,417 gain
B. $118,417 loss
C. $67,545 gain
D. $67,545 loss

14
Question 44
Kapona Industries has purchased equipment from a Korean firm for a total cost of 11,500,000 Korean
won. The firm has to pay in 90 days. J. P. Morgan has given the firm a 90-day forward quote of
$0.0009791/won to purchase Korean won forward, and $0.001022/won to sell Korean won forward.
Kapona decided to wait and purchase the Korean won on the spot market on settlement date. On the
day the payment is due, Kapona purchases the Korean won on the spot market at a rate of $0.001004/
won. How much would Kapona have saved or lost by hedging with a forward contract? (Round your final
answer to the nearest dollar.)

A. $207 loss
B. $207 savings
C. $286 loss
D. $286 savings

Question 45
All of the following contributed to the high value of the U.S. dollar during the 1980s except for:

A. relatively low inflation.

B. a stable U.S. government and currency.
C. U.S. demand for foreign goods
D. relatively high, real interest rates.

Section C: CVP Analysis

Question 46
Recent economic conditions are forcing MegaCorp to drop its price from $50 to $40 per unit, but the
company expects its sales to rise from 600,000 to 750,000 units. The company produces exactly enough
units to meet sales expectations and the company's current cost of production is $38 per unit. Of that
$38 per unit, $10 per unit is a result of fixed costs, which was calculated by dividing the fixed costs by
expected sales of 600,000. Fixed costs will remain the same despite the price and production changes.
Suppose MegaCorp would like to maintain a 16% target operating income on its sales revenue. To
achieve this target, the company must lower its variable cost of production by:

A. $25.60 per unit.

B. $33.60 per unit.
C. $2.40 per unit.
D. $4.40 per unit.

15
Question 47
A financial manager at BPO Manufacturing Corporation is conducting sensitivity analysis to determine
the relationships between costs, prices, and profits for Product 575. The manager’s goal is to reduce the
breakeven point for Product 575. If fixed costs are $250,000, the unit selling price is $20, and the unit
variable costs are $16, what are the breakeven point (BEP) sales in units if the variable costs are
decreased by $2 per unit?

A. 41,667 units
B. 12,500 units
C. 62,500 units
D. 17,857 units

Question 48
MetalCraft produces three inexpensive socket wrench sets that are popular with do-it-yourselfers.
Budgeted information for the upcoming year is as follows.

Total fixed costs for the socket wrench product line is $961,000. If the company's actual experience
remains consistent with the estimated sales volume percentage distribution, and the firm desires to
generate total operating income of $161,200, how many Model No. 153 socket sets will MetalCraft have
to sell?

A. 54,300.
B. 46,500.
C. 57,713.
D. 181,000.

Question 49
Which of the following examples correctly correlates a unit of activity and a variable cost at a coffee
shop chain?

A. Number of employees and power usage

B. Number of customers and disposable cups
C. Number of tables and pounds of coffee
D. Number of coffee makers and employees

16
Section C: Marginal Analysis

Question 50
Eagle Brand Inc. produces two products. Data regarding these products are presented below.

Eagle Brand has 1,000 pounds of raw materials which can be used to produce Products X and Y.

Which one of the alternatives below should Eagle Brand accept in order to maximize contribution
margin?

A. 200 units of product X and 50 units of product Y.

B. 250 units of product X.
C. 200 units of product X and 20 units of product Y.
D. 100 units of product Y.

Question 51
Harmony is currently producing 100 units of a necessary component part by incurring $60,000 in direct
materials, $12,500 in direct labor, $22,500 in variable overhead, and $15,000 in fixed overhead. If
Harmony purchases the component externally, $10,000 of fixed costs can be avoided. What is the
external price for 100 units at which the company is indifferent between buying and selling?

A. $95,000
B. $110,000
C. $105,000
D. $100,000

Question 52
A small delivery company received an order that requires nine deliveries lasting two hours each on the
same day. The company owns two vans that together can make eight trips per day. The company can
rent a van on a daily eight-hour basis for $72, and the fuel cost is $20 per trip. The company has several
van drivers, each of whom earns $30,000 annually and is expected to make 1,000 deliveries each year.
The marginal cost of the ninth delivery is

17
 A. $122.
B. $92.
C. $38.
D. $28.

Question 53
Motor Company manufactures 10,000 units of Part M-1 for use in its production annually. The following
costs are reported:

Valve Company has offered to sell Motor 10,000 units of Part M-1 for $18 per unit. If Motor chooses to
accept the offer and buy the units from Valve Company, some of the facilities presently used by Motor
Company to manufacture Part M-1 could be rented to a third party at an annual rental of $15,000.
Additionally, $4 per unit of the fixed overhead applied to Part M-1 would be totally eliminated. Should
Motor accept Valve's offer, and why?

A. Yes, because it would be $10,000 cheaper to buy the part.

B. No, because it is $5,000 cheaper to make the part.
C. No, because it is $20,000 cheaper to make the part.
D. Yes, because it would be $25,000 cheaper to buy the part.

Section C-3 Pricing

Question 54
A company determines that at a price of $7 it will sell 15,200 units and at a price of $6 it will sell 17,500
units. Using the midpoint formula, what is the price elasticity of demand?

A. 1.09
B. 0.92
C. 1.34
D. 0.74

18
Question 55
If a product's demand is elastic and there is a decrease in price, the effect is:

A. a decrease in total revenue and the demand curve shifts to the left.
B. no change in total revenue.
C. a decrease in total revenue.
D. an increase in total revenue.

Question 56
In the growth stage of a product's life cycle, which of the following statements on pricing methods
makes the most sense?

A. A cost-based pricing method would be unwise since costs per unit would normally increase
throughout the growth stage of a product's life cycle.
B. If competition in the market for this product starts rising, a competition-based pricing approach
could involve keeping the price low in order to discourage new competitor entrants into the
market.
C. Price skimming, a customer-based pricing tactic, is helpful during the growth stage as it
`encourages new customers to experience the product based on a low initial price.
D. A value-based price can be used to appeal to customers’ personal ethical values in order to help
maintain a high level of price elasticity of demand for the product during its growth stage

Question 57
A profit-maximizing company is considering a price increase on a particular product. After extensive
market research, the company has determined that demand for the product is price inelastic. Assuming
all other factors remain constant, determine what course of action the company should take and the
resulting impact on quantity demanded.

*Source: Retired ICMA CMA Exam Questions.

A. Do not increase price; quantity demanded will decrease significantly.

B. Do not increase price; minimal impact on quantity demanded.
C. Increase price; minimal impact on quantity demanded.
D. Increase price; quantity demanded will increase significantly.

19
Section E-1 Capital Budgeting Process

Question 58

Olson Industries needs to add a small plant to accommodate a special contract to supply building
materials over a five-year period. The required initial cash outlays at Time 0 are as follows:

Olson uses straight-line depreciation for tax purposes and will depreciate the building over 10 years and
the equipment over 5 years. Olson's effective tax rate is 40%.

Revenues from the special contract are estimated at $1.2 million annually and cash expenses are
estimated at $300,000 annually. At the end of the fifth year, the assumed sales values of the land and
building are $800,000 and $500,000, respectively. It is further assumed the equipment will be removed
at a cost of $50,000 and sold for $300,000. Do not consider salvage value in the calculation of
depreciation.

As Olson utilizes the net present value (NPV) method to analyze investments, and assuming the land,
new building, and equipment are disposed of at the end of the five-year period, the net cash flow for
period 5 would be:

A. $2,390,000.
B. $1,710,000.
C. $860,000.
D. $2,240,000.

Question 59
Kell Inc. is analyzing an investment for a new product expected to have annual sales of 100,000 units for
the next 5 years and then be discontinued. New equipment will be purchased for $1,200,000 and cost
$300,000 to install. The equipment will be depreciated on a straight-line basis over 5 years for financial
reporting purposes and 3 years for tax purposes. At the end of the fifth year, it will cost $100,000 to
remove the equipment, which can be sold for $300,000. Additional working capital of $400,000 will be
required immediately and needed for the life of the product. The product will sell for $80, with direct
labor and material costs of $65 per unit. Annual indirect costs will increase by $500,000. Kell's effective
tax rate is 40%.

In a capital budgeting analysis, what is the cash flow at time 0 (initial investment) that Kell should use to
compute the net present value?

20
 A. $1,500,000.
B. $1,900,000.
C. $1,200,000.
D. $1,600,000.

Question 60
At the conclusion of a capital budgeting project, a piece of equipment is expected to be sold for
$500,000. At the time of sale, the book value of the equipment would be $400,000. If the income tax
rate is 35%, what is the after-tax cash flow from the sale of the machine?

A. $365,000
B. $500,000
C. $465,000
D. $535,000

Question 61
A company operates on a calendar year but maintains four continuous quarterly budgets for up-to-date
budget information. After completing its five-year long-term plan, the company's management decided
to make a capital investment in new equipment. The equipment is expected to have a useful ife of nine
years. Which one of the following is the most appropriate time period for the capital budget for the
evaluation of the capital investment?

A. One year
B. Four continuous quarters
C. Five years
D. Nine years.

Section E-2 Capital Investment Analysis Methods

Question 62
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.

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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:

A. $372,600.
B. $454,920.
C. $380,400.
D. $545,400.

Question 63
Which of the following situations most closely resembles an option to expand?

A. Laurie paid a fee to the building management company which allows her to terminate her lease
early with 30 days’ notice.
B. David paid a fee to the building management company which allows him first choice to purchase
the apartment next door should it become available.
C. Ronald paid a fee to the current owners of a condominium which allows him to defer the closing
date up to six months in the future.
D. Marjorie's ownership agreement allows her to turn her two-level condominium into two
separate units and rent or sell the other unit.

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Question 64
FCN Inc. is considering investing in a new machine which costs $500,000 with a 5-year life and no
salvage value. FCN uses the straight-line method of depreciation. Incremental cash revenues and
expenses are expected to be as follows:

The machine is special and is expected to have zero market value at the end of its useful life. FCN Inc.
uses a discount rate of 12% and a tax rate of 25%. A table of present value factors follows:

Calculate the net present value of the investment in the new machine.

A. $39,430
B. $178,950
C. $238,599
D. $99,079

Question 65
LZ Company ranks projects on the basis of payback. LZ Company only accepts projects with a payback
period of less than 3 years. Project A has an investment of $10,000 and generates incremental cash
flows of $5,000 a year for 10 years. Project B has an investment of $20,000 and generates incremental
cash flows of $8,000 per year for 8 years. Project C has an investment of $30,000 and generates cash
flows of $9,000 per year for 6 years. Assuming LZ Company has $30,000 of capital available and the
projects are mutually exclusive, which project(s) should LZ Company accept?

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 A. Project B only
B. Project C only
C. Project A first then Project B
D. Project A only

Question 66
Bell Delivery Co. is financing a new truck with a loan of $30,000, to be repaid in five annual installments
of $7,900 at the end of each year. What is the approximate annual interest rate Bell is paying?

A. 4%.
B. 10%.
C. 5%.
D. 16%.

Question 67
Annie's Accessories is considering buying a packaging machine that will improve the lead time on its
production process. The machine is expected to cost $72,500. Management estimates its useful life as
six years, with a $2,000 salvage value. If Annie's purchases the machine, management anticipates that
after-tax net cash inflows will increase by $26,500 and that it will need to commit $5,000 of working
capital for the life of the machine. Based on net present value (NPV) and payback period, should Annie's
invest in the machine and why?

Management has established a 9% discount rate and a payback period hurdle of three years for similar
investments.

A. Yes, with an estimated NPV of $42,571 and a payback period of 2.7 years this would be a
profitable investment.
B. Yes, with an estimated NPV of $42,571 and a payback period of 2.9 years this would be a
profitable investment.
C. Yes, with an estimated NPV of $45,551 and a payback period of 2.7 years this would be a
profitable investment.
D. Yes, with an estimated NPV of $45,551 and a payback period of 2.9 years this would be a
profitable investment.

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