CMA II 2016 Study Materials CMA Part 2 M

15/05/2016 CMA II 2016 Study Materials: CMA Part 2 Mock Exam
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CMA Part 2 Mock Exam
Review of attempt 1
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Started on Sunday, 15 May 2016, 01:15 PM
Completed on Sunday, 15 May 2016, 01:54 PM
Time taken 38 mins 54 secs
Raw score 32/100 (32%)
Grade 3.2 out of a maximum of 10
1
Marks: 1 Birch Corporation had income available to common shareholders for the year of $101,504 and a simple capital
structure. At the beginning of the year, there were 24,000 shares outstanding. On March 1, 5,400 new shares
were issued for cash. On July 1, 6,600 new shares were issued for cash. On December 1, the company reacquired
960 Treasury shares.
Basic Earnings Per Share, rounded to the nearest cent, were
Choose one a. $3.20
answer.
b. $3.45
c. $3.26
d. $2.90
The correct answer is A
The income available to common shareholders needs to be divided by the weighted average number of common
shares outstanding. The weighted average number of common shares outstanding is:
The income available to common shareholders of $101,504 divided by the weighted average number of common
shares outstanding of 31,720 equals the Basic EPS of $3.20.
Incorrect
Marks for this submission: 0/1.
2
Marks: 1 Which of the following ratios should be used in evaluating the effectiveness with which the company uses its
assets?
Receivables Turnover / Dividend Payout Ratio
Choose one a. No / No
answer.
b. Yes / Yes
c. Yes / No
d. No / Yes
Correct
3
Are the following ratios useful in assessing the liquidity position of a company?
http://www.edupristine.com/infrastructure/mod/quiz/review.php?attempt=124481 1/37
Marks: 1
Current Ratio / Return on Shareholders' Equity
Choose one a. No / Yes
answer.
b. No / No
c. Yes / No
d. Yes / Yes
The correct answer is C
The current ratio is relevant to the liquidity of the company as it addresses the ability of the company to meet its
current liabilities with its current assets. Return on shareholders’ equity, however, has nothing to do with
liquidity.
Correct
4
Marks: 1 In a comparison of 20X9 with 20X8, Neir Co.'s inventory turnover ratio increased substantially, although sales
and inventory amounts were essentially unchanged. Which of the following statements explains the increased
inventory turnover ratio?
Choose one a. Accounts receivable turnover increased.
answer.
b. Gross profit percentage decreased.
c. Total asset turnover increased.
d. Cost of goods sold decreased.
The correct answer is B
The inventory turnover is calculated as the cost of sales divided by the average inventory. Therefore, in order for
this number to increase, either the numerator had to get bigger or the denominator had to get smaller, or both.
If the gross profit percentage decreased, this would mean that less of each sale was profit, meaning that the cost
of goods sold increased. If this is the case, inventory would remain unchanged and sales would remain
unchanged, but the inventory turnover number would increase.
Incorrect
5
Marks: 1 A useful tool in financial statement analysis is the commonsize financial statement. What does this tool enable
the financial analyst to do?
Choose one a. Determine which companies in the same industry are at approximately the same
answer. stage of development.
b. Evaluate financial statements of companies within a given industry of approximately
the same value.
c. Ascertain the relative potential of companies of similar size in different industries.
d. Compare the mix of assets, liabilities, capital, revenue, and expenses within a
company over time or between companies within a given industry without respect to
relative size.
The correct answer is D
Common size financial statements enable companies of different sizes and the same company over time to be
evaluated and compared.
Correct
6
Marks: 1 ABC Sales had the following gross profit calculation in its last accounting period:
Average inventory during that period was $10,000.
In the next accounting period, sales revenue is expected to increase by 50% and the rate of inventory turnover is
expected to double. If average inventory remains at $10,000, the markup on cost will be:
Choose one a. 28.9%
answer.
answer. b. 71.1%
c. 40.6%
d. 87.9%.
To answer this question, we need to calculate what sales revenue and cost of goods sold are expected to be in the
next accounting period. Sales revenue is expected to increase by 50%, so sales should be $150,000 × 1.5, which
equals $225,000. We know that the inventory turnover ratio is expected to double while inventory remains the
same. The inventory turnover ratio is cost of goods sold divided by average inventory. Cost of goods sold is given
as $80,000 and average inventory is given as $10,000, so the inventory turnover ratio for the previous
period was $80,000 ÷ $10,000 = 8 times. To calculate what cost of goods sold will be if inventory
remains the same and the turnover ratio doubles from 8 to 16, we use the following formula
Correct
7
Marks: 1 Birch Corporation had income available to common shareholders for the year of $101,504 and a simple capital
structure. At the beginning of the year, there were 24,000 shares outstanding. On March 1, 5,400 new shares
were issued for cash. On June 30, the company issued a 20% stock dividend. On July 1, 6,600 new shares were
issued for cash. On December 1, the company reacquired 960 Treasury shares.
Basic Earnings Per Share, rounded to the nearest cent, were
Choose one a. $2.48
answer.
b. $2.29
c. $2.67
d. $2.71
The income available to common shareholders needs to be divided by the weighted average number of common
shares outstanding. The weighted average number of common shares outstanding is adjusted for the 20% stock
dividend by multiplying each transaction that occurred before the stock dividend was issued on June 30 by 1.20.
Transactions that occurred after the stock dividend was issued on June 30 are not adjusted, because they did not
participate in the stock dividend and thus were not affected. The weighted average number of common shares
outstanding is:
The income available to common shareholders of $101,504 divided by the weighted average number of common
shares outstanding of 37,420 equals the Basic EPS of $2.71.
Incorrect
8
Marks: 1 Gil Corp. has current assets of $90,000 and current liabilities of $180,000. Which of the following transactions
would improve Gil's current ratio?
Choose one a. Paying $20,000 of shortterm accounts payable.
answer.
b. Purchasing $50,000 of merchandise inventory with a shortterm account payable.
c. Collecting $10,000 of shortterm accounts receivable.
d. Refinancing a $30,000 longterm mortgage with a shortterm note.
This transaction will increase both current assets and current liabilities by $50,000, making the current ratio
$140,000 ÷ $230,000, or .609. This is higher than the current .50.
Incorrect
9
Marks: 1 In comparing the current ratios of two companies, why is it invalid to assume that the company with the higher
current ratio is the better company?
Choose one a. A high current ratio may indicate inefficient use of some assets.
answer.
b. A high current ratio may indicate inadequate inventory on hand.
c. The current ratio includes assets other than cash.
d. The two companies may define working capital in different terms.
It is possible for the current ratio to be too high. This is because the current ratio measures current assets, which
do not provide a return. Therefore, a company may be better off moving excess current assets into longerterm
items and earning a return on these assets.
Incorrect
10
Marks: 1 At December 30, 20X0, Solomon Co. had a current ratio greater than 1:1 and a quick ratio less than 1:1. On
December 31, 20X0, all cash was used to reduce accounts payable. How did these cash payments affect the
ratios?
Current Ratio / Quick Ratio
Choose one a. Decreased / Decreased
answer.
b. Increased / Decreased
c. Increased / Increased
d. Decreased / Increased
The easiest way to figure out this question is to make up some balance sheet numbers that meet the ratios
given: a current ratio greater than 1:1 and a quick ratio less than 1:1. Then change them to reflect the use of all
the cash to reduce accounts payable and see how the ratios are affected.
The current ratio has increased from 1.29 to 1.40, while the quick ratio has decreased from .86 to .80.
Incorrect
11
Marks: 1 Ray Corporation has longterm debt of $1,200,000 and equity of $1,000,000. The board of directors has set a
goal of 1:1 for the company’s debtequity ratio. Which of the following could the company employ to achieve this
goal?
Choose one a. Issuing rights to purchase new common stock.
answer.
b. Paying a stock dividend to the existing shareholders.
c. Issuing new bonds.
d. Paying a dividend on its common stock.
The debtequity ratio measures how much longterm debt a company has compared to its total equity. A ratio in
excess of 1:1 indicates more reliance on longterm debt financing than on equity financing. Issuing rights to
purchase new common stock would result in increased equity, which could decrease the debtequity ratio.
Correct
12
Marks: 1 CMA Petroleum has the following items in its financial statements as of 12/31/X4 and12/31/X5 (in 000s):
Assuming continuity in the rate of sales, how many days' worth of sales does the business have in inventory at
yearend 12/31/X5 to the nearest day, using a 365day year?
Choose one a. 35 days
answer.
b. 68 days
c. 64 days
d. 71 days
This is an example of a question you must read very carefully. Ordinarily in calculating the Days Sales in
Inventory, we use average inventory. However, this question asks how
Incorrect
13
Marks: 1 ABC Corporation offers its customers terms of 45 days. However, an analysis of its June30, 20X4 financial
statements revealed that its accounts receivable collection period was 100 days. Which one of the following would
not be a possible cause of this discrepancy?
Choose one a. Poor followup of delinquent accounts
answer.
b. A large credit sale made on June 15, 20X4
c. A general downturn in the economy
d. ABC’s largest competitor is on the verge of going bankrupt.
Bankruptcy of ABC Corporation’s largest competitor would not affect ABC’s accounts receivable collection period.
(However, bankruptcy of ABC’s largest customer would affect ABC’s accounts receivable collection period, if the
customer owed a large amount to ABC.)
Incorrect
14
Marks: 1 Which of the following statements is true about inherent risk?
Choose one a. Management can eliminate inherent risk by taking mitigating actions.
answer.
b. Inherent risk is the level of risk that remains after management has taken actions to
mitigate the risk.
c. Inherent risks result in greater losses than operational risks.
d. Inherent risk is risk that exists because of the nature of a company’s business.
Inherent risk is risk that exists simply due to the nature of a company’s business. It cannot be eliminated, but it
can be addressed through mitigating actions.
Incorrect
15
Marks: 1 The balance sheet of AZ Products appears below.
What is the company’s Financial Leverage Ratio, and what does it mean?
Choose one a. The Financial Leverage Ratio is 0.53, and it means the company has 53¢ of debt for
answer. every $1 of equity.
b. The Financial Leverage Ratio is 1.54, and it means that for every $1 of common
equity, the company has $1.54 in assets, so 54¢ of the $1.54 in assets are financed with
debt.
c. The Financial Leverage Ratio is 1.60, and it means that for every $1 of common
equity, the company has $1.60 in assets.
d. The Financial Leverage Ratio is 0.35, and it means the company has 35¢ of debt for
every $1 of assets.
The Financial Leverage Ratio is Total Assets ÷ Total Equity. Total assets are $3,995,000, and total equity is
$2,600,000, and the Financial Leverage Ratio is therefore 1.54. A company with no liabilities whatsoever would
have a Financial Leverage Ratio of 1.00. A company with twice as much liabilities as common equity would have a
Financial Leverage Ratio of 3.00. This company’s Financial Leverage Ratio of 1.54 is very good. It is making use of
debt but is not overusing it to such an extent that it puts the shareholders’ investments at too much of a risk.
Incorrect
16
Marks: 1 Which of the following is not included in the Fraud Triangle, the theory of conditions that must be present for
trusted employees to embezzle funds from their employers?
Choose one a. Opportunity.
answer.
b. Pressure.
c. Rationalization.
d. Dishonesty.
The three “legs” of the Fraud Triangle are (1) pressure, or a financial problem the employee cannot share and
cannot solve through legitimate means; (2) opportunity, or a way to use the employee’s position to solve the
problem in such a way that the employee believes he or she will not get caught; and (3) rationalization, or the
ability to justify the crime, Dishonesty is not one of the conditions that must be present for a trusted employee to
embezzle funds from an employer.
Correct
17
Marks: 1 MNC Corporation, with headquarters in New York, has operations all over the world. Which of the following is not
a political risk that MNC faces in its international operations?
Choose one a. Expropriation of its facilities.
answer.
b. Declaration of war in a host country.
c. A high level of inflation in a host country.
d. Inability to transfer funds to the headquarters due to fund transfers being blocked by
a host country’s government.
All of the answer choices except for “a high level of inflation in a host country” describe political risks. Inflation in
a host country is not a political risk. A high level of inflation in a host country would be a financial risk due to
increasing input (labor and materials) costs.
Correct
18
Marks: 1 According to the IMA’s Statement of Ethical Professional Practice, IMA members have a responsibility to avoid
real or apparent conflicts of interest. Is this statement included in one of the principles or in one of the standards,
and which one?
Choose one a. The principle of responsibility.
answer.
b. The standard of competence.
c. The standard of integrity.
d. The principle of honesty.
The standard of integrity states that each member has a responsibility to mitigate actual conflicts of interest,
regularly communicate with business associates to avoid apparent conflicts of interest, and advise all parties of
any potential conflicts.
Correct
19
Marks: 1 Nathan Lane is analyzing the impacts of various accounting choices for MNB Corporation. In particular, he is
interested in assessing the liquidity effects of MNB Corp.’s inventory accounting method. Assume the following for
MNB Corp.:
•LIFO Reserve is equal to $600
•Taxes paid are $200 lower using LIFO rather than FIFO.
•Tax rate is 40%.
•Sales are $1,500.
•Deferred Taxes are $50.
State whether using LIFO rather than FIFO understates or overstates working capital and the dollar amount of
the under or overstatement.
Working capital / Dollar impact
Choose one a. Overstated / $400
answer.
b. Understated / $400
c. Overstated / $450
d. Understated / $450
Inventory will be lower by $600 because of the LIFO reserve. The impact on net working capital: Understated by
$600 because of using LIFO rather than FIFO.
Correct
20
Marks: 1 BOX Packaging recently purchased equipment for $75 million with an estimated useful life of 15 years and a
salvage value of $5 million. BOX recorded depreciation expense of $8.75 million for the first year. After the first
year of use, management decided to change to the straightline depreciation method. As compared to BOX’s
financial results had it not changed depreciation methods, determine the impact management’s decision will have
on the company’s turnover ratios and return on equity over the next several years.
Turnover ratios / Return on Equity
Choose one a. Higher / Higher
answer.
b. Higher / Lower
c. Lower / Higher
d. Lower / Lower
The turnover ratios this question is referring to are the Total Asset Turnover ratio (Sales ÷ Average Total Assets)
and the Fixed Asset Turnover ratio (Sales ÷ Average Net Plant, Property & Equipment). Return on Equity is Net
Income ÷ Average Total Equity.
Incorrect
21
Marks: 1 Sanders Company includes data on leased equipment in its financial statements. Sanders treats the transaction
as an operating lease. One of the company’s analysts believes that Sanders should treat its operating lease as a
capital lease. Assuming that the analyst is correct, indicate whether Sander’s debt to equity and return on equity
ratios will most likely be higher or lower in the early years of the lease’s life because the lease is being accounted
for as an operating lease than they would be if itwere accounted for as a capital lease.
Debt to equity ratio / Return on Equity ratio
Choose one a. Higher / Higher
answer.
b. Higher / Lower
c. Lower/ Higher
d. Lower / Lower
Since the lease is being accounted for as an operating lease instead of a capital lease, the company will have less
debt on its balance sheet and its debt to equity ratio will be lower than it would be if they were accounting for it
as a capital lease. If a lease is accounted for as a capital lease and particularly if an accelerated form of
depreciation is used, expense will be higher and net income lower in the early years of the lease than would be
the case if the lease is accounted for as an operating lease. Therefore, since the lease is being accounted for as an
operating lease instead of a capital lease, net income will be higher in the early years of the lease’s life than it
would be if the lease were being accounted for as a capital lease. Since net income will be higher, the return on
equity ratio will be higher.
Correct
22
Marks: 1 Keller Company is an apparel manufacturer. The following information is provided:
An analyst made the following statement: “Common size financial statements are very useful for making
historical comparisons of a single company’s year over year performance, but they are ineffective tools for
comparing different companies.”
State whether Keller’s liquidity position has fallen or remained unchanged and indicate whether the analyst’s
statement is correct or incorrect.
Liquidity position / Analyst’s statement
Choose one a. Fallen / Correct
answer.
b. Unchanged / Correct
c. Fallen / Incorrect
d. Unchanged / Incorrect
“Liquidity” reflects the ability of a firm to meet its shortterm obligations by using its assets that are most readily
converted into cash without significant loss in value. Therefore, the more that cash and accounts receivable make
up a greater portion of a company’s total current assets, the more liquid the firm is. In 2008, cash accounted for
10% of the company’s total current assets and accounts receivable accounted for 20%. In 2009, cash accounted
for only 5% of the company’s total current assets and accounts receivable accounted for 15%. In 2009, both
classifications have fallen to lower levels in terms of proportion of total current assets. Therefore, the firm’s
liquidity position in 2009 has fallen.
The analyst’s statement is incorrect. It can be very helpful to compare the common size financial statements for a
company with those of other companies in the same industry.
Commonsize financial statements are available for various industries so that a
particular company’s commonsize financial statements can be compared with others in the same
or similar industry. This comparison can indicate areas where a particular company’s operations
may be out of line with those of
the industry it is in. For example, an analyst might compare a company’s commonsize income
statement with industry commonsize income statements to reveal a problem. For instance, if cost
of goods sold as a percentage of total sales is significantly higher than the norm for other firms in
the same line of business, it could indicate that “inventory shrinkage” (i.e., theft) is taking place
Correct
23
Marks: 1 Over the past year, Ardmore Company reported sales of $5.1 million and cost of goods sold of $3.6 million. On
average, inventory was sold in 65 days and receivables were collected in 43 days. Beginning inventory was
$625,000 and ending inventory was $985,000. If the cash conversioncycle was 58 days, calculate Ardmore’s
average accounts payable using a 360day year.
Choose one a. $500,000
answer.
b. $550,000
c. $820,000
d. $2,350,000
The operating cycle is the number of days that inventory is held before it is sold plus the number of days that
accounts receivable are outstanding before collection. The cash conversion cycle is the operating cycle minus the
average age of accounts payable. Thus, the cash conversion cycle is:
Days Sales in Inventory + Days Sales in A/R – Days Purchases in A/P = Cash Conversion Cycle
We are given Days Sales in Inventory and Days Sales in Accounts Receivable and the Days in the CashConversion
Cycle, so we can calculate the Days Purchases in A/P, as follows:
65 + 43 – X = 58
Solving for X, we get X = 50 days purchases in payables.
Days Purchases in Payables = Average Accounts Payable ÷ Average Daily Purchases
Using the beginning and ending inventory amounts and cost of goods sold given in the problem, we can calculate
the annual purchases and then use that to calculate the average daily purchases, which we can then use to
calculate average accounts payable.
Incorrect
24
Marks: 1 As the CFO of a company, you decide to allow customers 40 days to pay their bills. Currently, your firm requires
payment in 30 days. All else being equal, this will
Choose one a. increase the firm’s days’ sales in inventory and increase the firm’s operating cycle.
answer.
answer. b. increase the firm’s days’ sales in accounts receivable and increase the firm’s days’
sales in inventory.
c. increase the firm’s operating cycle and increase the firm’s cash cycle.
d. increase the firm’s cash cycle and increase the firm’s days’ sales in inventory.
Permitting customers to take longer to make payment will increase the average number of days’ sales in
receivables, which will increase both the operating cycle and the cash cycle.
Correct
25
Marks: 1 Cleveland Masks and Costumes Inc. (CMC) has a majority of its customers located in the states of California and
Nevada. Keystone National Bank, a major west coast bank, has agreed to provide a lockbox system to CMC at a
fixed fee of $50,000 per year and a variable fee of $0.50 for eachpayment processed by the bank. On average,
CMC receives 50 payments per day, each averaging$20,000. With the lockbox system, the company’s collection
float will decrease by 2 days. The annual interest rate on money market securities is 6%. If CMC makes use of
the lockbox system, what would be the net benefit to the company? Use 365 days per year.
answer.
b. $60,875
c. $111,750
d. $120,875
If CMC receives 50 payments per day, each averaging $20,000, then it receives an average of $1,000,000 per
day. Since CMC’s collections are expected to speed up by 2 days and the annual interest rate on money market
funds is 6%, CMC could earn $120,000 interest on the increased money market balances per year, calculated as
follows: $1,000,000 × 0.06 × 2 days = $120,000. The expense to earn this additional $120,000 is $59,125,
calculated as follows: Fixed fee of $50,000 per year plus [$0.50 × (50 payments per day × 365 days per year)] =
$59,125. The net annual benefit is
$120,000 ? $59,125 = $60,875.
Incorrect
26
Marks: 1 The difference between traditional risk management and enterprise risk management is
Choose one a. in traditional risk management, each department or division is concerned with its own
answer. risk assessment and management, whereas enterprise risk management approaches risk
management not only from the perspective of the individual department but also from
that of the organization as a whole.
b. management of risk in the investment portfolio is a part of enterprise risk
management but not a part of traditional risk management.
c. traditional risk management is concerned only with risk in individual departments,
whereas enterprise risk management is concerned only with risk to the organization as a
whole.
d. traditional risk management utilizes portfolio theory to eliminate risk, whereas
enterprise risk management does not.
Enterprise risk management is differentiated from traditional risk management because enterprise risk
management is a process for developing a topdown view of the risks facing the organization. Enterprise risk
management is concerned not only about individual department risks but also about the risks to the organization
as a whole.
Incorrect
27
Marks: 1 Keller Industries currently has a capital structure consisting of 40% debt and 60% equity, which it believes is the
optimal structure. The common stock produced a 12% capital gain in the recent12month period and paid a 5%
dividend. Keller’s effective income tax rate is 30%. Its debt is rated AAand the issues outstanding are as follows.
•$20 million of 7% coupon bonds with a yield to maturity of 10%
•$20 million of 12% coupon bonds with a yield to maturity of 11%
Keller’s investment banker informed the firm that longterm AA rated debt is currently being issued to yield
11%. The banker also estimates that equity investors currently require a 20% pretax yield. Keller’s marginal
cost of capital is approximately
Choose one a. 12.8%
answer.
b. 13.1%
c. 14.7%
d. 15.1%
This is a problem that offers a lot of unneeded information. In order to determine the marginal cost of capital, we
need to use the cost of new debt and new equity in the same proportions as the present debt and equity,
adjusting the interest rate of the new debt to the taxequivalent rate. Therefore the marginal cost of capital is
(0.40 × [0.11 × (1 ? 0.30)]) + (0.60 × 0.20) = 0.1508 = 15.1%.
Correct
28
Marks: 1 For the year just ended, James Co. had average accounts receivable of $880,000 from total credit sales of
$4,800,000 for the year. Throughout the year, a factor purchased the receivables from the firm at a 2% discount.
Using a 360day year, what was the firm’s effective interest rate?
Choose one a. 2.0%
answer.
b. 11.2%
c. 11.1%
d. 12.9%
The effective interest rate is the total interest paid for the year divided by the average balance of funds
outstanding for the year. The total interest paid is the total credit sales of $4,800,000 multiplied by the discount
rate of 0.02, which is $96,000. The average balance of funds outstanding for the year is the average accounts
receivable of $880,000 multiplied by (1 – the discount rate of 0.02), which is $862,400. The effective interest
rate $96,000 ÷ $862,400 = 0.111 or 11.1%.
Incorrect
29
Marks: 1 Your company has a $100,000 line of credit at a local bank. The bank requires an 8% compensating balance and
charges 10% on the amount borrowed against the line of credit. If the company needs $55,000 to purchase
inventory, what is the minimum amount you must put into thecompensating balance account?
answer.
b. $4,400
c. $4,783
d. $5,500
If the company requires a net amount of $55,000 after the compensating balance is subtracted from the loan
proceeds, it will need to borrow a gross amount of $59,783 ($55,000 ÷ [1 ? 0.08]). The amount of the
compensating balance will be $59,783 ? $55,000, or $4,783.
Incorrect
30
Marks: 1 All else being equal, which of the following will likely increase a company’s cash cycle?
I. Changing credit terms to require payment in 30 days instead of 20.
II. Purchasing inventory in smaller amounts and more frequently, reducing the number of days’sales
in inventory by 5 days.
III. Delaying payment on the firm’s payables by 10 additional days.
IV. Offering a larger cash discount for purchases of the company’s goods.
Choose one a. I and IV only.
answer.
answer. b. II and III only.
c. I, II and III only.
d. I only.
Changing credit terms to require payment in 30 days instead of 20 days will increase the number of days of sales
in accounts receivable, which will increase the cash cycle.
Incorrect
31
Marks: 1 An analysis of a company's financial statements at year end revealed that the number of days' sales in inventory
was 70 days. The average for companies in the same industry was 30 days. Which of the following is least likely
to account for the company’s variance from the industry’s level?
Choose one a. The company's business is seasonal.
answer.
b. Sales have decreased and the company has a lot of unsold inventory.
c. A large purchase was made just before year end for a job to be delivered in the first
month of the year.
d. The company is planning to introduce a new product in the first quarter of the
following year.The new product will be an addition to its product line (not a replacement
for an existing product), and management anticipates high demand for the new
product.
Although seasonal business can result in a high number of days sales in inventory just before the selling season
begins, it should not cause the company’s number of days of inventory to be out of line with that of its industry,
because all members of the industry should experience the same seasonal increase in inventory. Furthermore,
when a company’s business is seasonal, the proper way to analyze its inventory days is to calculate them
quarterly or even monthly if necessary, not annually. To calculate number of days sales in inventory on less than
an annual basis, the total cost of sales for the period (quarter or month) is divided by the number of days in the
period to get the average daily cost of sales. Then average inventory over the same period is divided by the
average daily cost of sales to calculate number of days of sales in inventory, just as it is done when the number is
calculated using annual cost of sales.
Incorrect
32
Marks: 1 Classic Co. needs to raise $2 million through a rights offering. The subscription price is$2 per share. The firm
currently has 2,000,000 shares outstanding and the current market price is $6. What is the exrights price of the
firm’s stock?
Choose one a. $5.25
answer.
b. $6.00
c. $2.00
d. $4.67
The first step is to calculate the number of new shares that will be sold. That is calculated by dividing the funds
needed ($2,000,000) by the subscription price ($2), which equals 1,000,000 shares. Next, the number of shares
needed to buy one new share is calculated by dividing the number of existing shares (2,000,000) by the number
of new shares to be sold (1,000,000), which equals 2. Then, the value of the stock right when the stock is selling
rightson is determined. That is the current market price ($6) minus the subscription price ($2) divided by the
number of rights needed to buy one share (2) plus 1. So the formula to determine the value of the stock right
when the stock is selling rightson will be:
Correct
33
Marks: 1 All of the following relationships are true except:
Choose one a. There is an inverse relationship between the value of a bond and changes in the
answer.
answer. investor's required rate of return.
b. Shortterm bonds are more risky than longterm bonds.
c. The market value of a bond will be less than the par value if the investor's required
rate of return is above the coupon rate.
d. Longterm bonds are more risky than shortterm bonds.
The longer the time until maturity, the greater the risk associated with the bond. A shortterm bond is therefore
less risky than a longterm bond.
Incorrect
34
Marks: 1 Firm ABC recently paid a dividend of $1.00 to its common shareholders. The dividends are expected to grow by
3% every year and the firm is expected to pay cash dividend every year to infinity.If the required rate of return is
10%, what will be the value of common stock?
Choose one a. $10.00
answer.
b. $10.30
c. $14.28
d. $14.71
The value of a common share is calculated as the next dividend divided by the required rate of return minus the
expected growth rate. The question tells us that the last dividend paid was $1.00 and the rate of growth of
dividends is expected to be 3% per year. Therefore, thenext dividend will be $1.00 × 1.03, or $1.03. Putting the
information from the question into this formula, we get ($1.03 ÷ (0.10 ? 0.03)). Solving this formula, we get
$14.71 and this is the price of this share.
Incorrect
35
Marks: 1 Firm XYZ pays an annual dividend of $3.75 on its preferred stock. Any additional issues of preferred stock will
cost the firm $1.25 per share in flotation costs. What will be the cost of new preferred stock if the latest closing
price of Firm XYZ preferred stock was $40?
Choose one a. 0.0938%
answer.
b. 0.0968%
c. 9.38%
d. 9.68%
The cost of a preferred share is the amount of the dividend divided by the proceeds from the sale of the share.
The information from this question gives us the following formula: ($3.75 ÷ ($40 ? $1.25)). Solving this we get
0.09677 or 9.68% (rounded).
Incorrect
36
Marks: 1 If a security is undervalued, its expected return will be
Choose one a. above the security market line.
answer.
b. on the security market line.
c. below the security market line.
d. equal to its risk premium.
Securities or portfolios with expected returns that lie above the security market line (i.e., their expected returns
are higher than the point on the security market line relative to their betas) are undervalued. Securities or
portfolios with expected returns that lie below the security market line (i.e., their expected returns are lower than
the point on the security market line relative to their betas) are overvalued.
When we say a security is undervalued, we mean that its market price is lower than we would expect it to be,
given its expected return and its risk as measured by its beta. Because its market price is lower, its expected
return as a percentage of its price will be higher than the point on the security market line relative to its beta. If
a security is undervalued, its expected return will be above the point where it should be on the security market
line relative to its beta because investors in the market have not yet recognized that its expected return is higher
than it should be, given its beta.
Incorrect
37
Marks: 1 An analyst has assembled the following information regarding NetZone Incorporated and the market in general:
The analyst wants to determine the cost of common equity for NetZone’s planned upgrade to its manufacturing
facilities, which should affect the firm’s cash flows for the next 12 years. The appropriate cost of equity using the
CAPM approach is closest to:
Choose one a. 14.2%
answer.
b. 15.4%
c. 16.5%
d. 17.2%
The Capital Asset Pricing Model formula is r = rF +
(rM – rF).The riskfree rate is approximated by the rate for shortterm Treasury Bills, so we use the 30day
Treasury bill yield as the riskfree rate.
Using the other facts given and the CAPM, the cost of equity, which is the investors’ required rate of return, is
r = 0.035 + 1.8(0.107 ? 0.035)
r = 0.1646 or 16.5%
Incorrect
38
Marks: 1 Which of the following best describes an option that gives the owner the right to sell 100 shares of stock only on
the expiration date three months from now at a strike price of $35 when the current stock price is $25? This
option is called an:
Choose one a. Inthemoney American put option.
answer.
b. Inthemoney European put option.
c. Outofthemoney European call option.
d. Outofthemoney American call option.
A European option gives the owner the right to buy or sell an asset, but it is exercisable only on its expiration
date. (In contrast, an American option can be exercised anytime up to and including its expiration date.) A put
option gives the owner the right to sell the asset. The strike price of the stock is $35, and the current stock price
is $25. Therefore, the owner of this option has the right to sell this stock at $35, which is $10 over the current
market price of the stock. A put option has value if the exercise price is above the market value, and the put
option is said to be “inthemoney.” So this is a European put option that is “in the money.”
Correct
39
Marks: 1 Jack Saunders is analyzing Barco Inc., an industrial conglomerate company. Saunders is estimating the intrinsic
value for Barco Inc. by forecasting the company’s earnings per share and earnings multiple. Which of the
following attributes of Barco is least likely to increase the company’s earnings multiple?
Choose one a. Barco has never had a restructuring charge in its history.
answer.
b. Barco’s earnings move in tandem with overall economic growth.
c. Barco consistently generates free cash flow.
d. Barco’s dividend has been increasing for the last 30 years.
An “earnings multiple” is a P/E ratio that has been adjusted for perceived risk, either upward if perceived risk is
low or downward if perceived risk is high. The adjusted P/E ratio is used to calculate a valuation for the business.
(See your HOCK textbook, Vol. 2, under the heading “Other Valuation Methods – The P/E Model” for more
information.) When the P/E ratio has been adjusted for perceived risk, it is called an “earnings multiple” instead
of a P/E ratio. In the example given in the book, the earnings multiple is 10.7 ($32 ÷ $3).
Incorrect
40
Marks: 1 An analyst is using the following information to value AGF Company’s preferred and common stock:
Preferred Stock: AGF’s 6%, $100 preferred stock is currently yielding 8%.
Common Stock: AGF paid a dividend of $1.90 per share last year. Dividends are expected to grow at 6%forever.
The risk free rate is 5%, the market risk premium is 7%, and the stock’s beta is 1.3.
The value of AGF Company’s preferred and common stock is closest to:
Preferred stock / Common stock
Choose one a. $75.00 / $23.46
answer.
b. $75.00 / $24.81
c. $133.33 / $24.81
d. $133.33 / $23.46
The value of a share of preferred stock is the annual dividend divided by the investors’ required rate of return.
The investor’s required rate of return is 8%. The annual dividend is 6% of $100, or $6. $6 ÷ 0.08 = $75.
The common stock’s valuation is calculated by using both the CAPM and the Dividend Growth Model. The CAPM
formula is:
r = rF +
(rM – rF)
(rM – rF) is the market risk premium. Since the riskfree rate is 5% and the market risk premium is 7%, the
return to the market is 12%, or 0.05 + 0.07. Instead of calculating the return to the market in order to subtract
the riskfree rate from it, we can simply use 0.07 as the market risk premium in the Capital Asset Pricing Model:
r = 0.05 + 1.3(0.07)
r = 0.141 or 14.1%
Next, we use 0.141 in the Dividend Growth Model to calculate the value of a share of stock. The Dividend Growth
Model is:
P0 = d1 / (r ? g)
Remember that d1 is the next dividend to be paid. Last year’s dividend was $1.90, and dividends are expected to
grow at 6% per year. Therefore, the next dividend will be $1.90 × 1.06, or $2.014 or $2.01 rounded.
r is the investors’ required rate of return calculated with the CAPM, or 0.141. g is the expected growth rate of
0.06. Therefore, the value of the company’s common stock is:
P0 = $2.01 / (0.141 ? 0.06) P0 = $24.81
Incorrect
41
Marks: 1 For the previous year, Thunderbird Company reported net income of $512 million and the company had 100
million common shares outstanding. Thunderbird also had 2 million shares of 10%,$25 par value noncumulative
preferred stock and 5 million shares of 8%, $25 par value cumulative preferred stock. The company’s stock
traded at an average $50 per share and the company did not declare any dividends for the year. Thunderbird had
10 million outstanding warrants during the year. Each warrant is convertible into one common share at $25 per
share. Calculate Thunderbird’s basic EPS for the year and calculate the number of shares needed to calculate
Thunderbird’s diluted EPS.
Basic EPS /# Shares for Diluted EPS
Choose one a. $4.97 per share / 105 million shares
answer.
b. $5.02 per share / 105 million shares
c. $4.97 per share / 110 million shares
d. $5.02 per share / 110 million shares
No noncumulative preferred dividends were declared. Cumulative preferred dividends earned were 8% of $25 ×
5,000,000 shares, or 8% of $125,000,000, which is $10,000,000. Therefore,
IAC = $512,000,000 ? $10,000,000 = $502,000,000.
Basic EPS = IAC ÷ WANCSO
The problem tells us that WANCSO for BEPS was 100,000,000 shares.
Therefore, Basic EPS = $502,000,000 ÷ 100,000,000 = $5.02 per share
For purposes of calculating DEPS, the amount of additional shares as a result of the warrants is a three step
process. The three steps in this process are:
1) Assume that all of the options were actually exercised on January 1 of the current year. As a result, there will
be a number of new shares “issued.” (Remember that they have not actually been issued but just that we are
pretending that they have been.) In this process of exercising the warrants and options, the company has also
received as cash the exercise price of the warrant or option.
2) The company then takes the money received from the exercise of the options or warrants, and uses it to
repurchase its own shares from the market at the average price for the year. This reduces the number of shares
“issued” from the exercise of the options or warrants.
3) Finally, the company nets together the number of shares that were issued as part of the exercise of the
warrants or options and the number of shares that were repurchased. This gives the net number of shares that
were “issued” as a result of warrants or options. Again, no shares have actually been issued or repurchased; this
has all been hypothetical.
Incorrect
42
Marks: 1 An analyst is analyzing operating and financing liabilities of Brazil Oil in order to determine if there are any
potential liquidity issues that he should be aware of. Below is selected balance sheet information from Brazil Oil
that the analyst wants to review in more detail.
Assuming revenues grew at 5% from 20X8 to 20X9, which of the following statements best describes a situation
that could signal the start of a liquidity crisis?
Choose one a. A rise in cash advances from customers.
answer.
b. A movement of debt from accounts payable to longterm debt.
c. A rise in shortterm debt.
d. A rise in total debt.
In 20X8, the company had $150 in accounts payable. In 20X9, it had only $50 in accounts payable, and long
term debt had increased from $100 to $190 (total longterm debt is the total of longterm debt and current
portion of longterm debt). This could indicate that the company is having trouble paying its suppliers on time. A
problem paying suppliers may indicate a liquidity crisis.
Incorrect
43
Marks: 1 The silo approach to risk management
Choose one a. attempts to make certain that the organization is secure and protected against risks
answer. in much the same way as an agricultural silo secures and protects grain.
b. involves evaluating risks as individual portfolios of events.
c. evaluates risks as individual, standalone events.
d. is similar to an agricultural silo in that potential risk events are input at the top and
the resulting expected losses are output at the bottom.
The silo approach to risk management evaluates risks as individual, standalone events. The silo approach is in
contrast to the portfolio view of risk, in which risks are evaluated in terms of the way they interrelate with other
risks.
Correct
44
Marks: 1 At the end of last year, Manhattan Corp. reported a cash ratio of 0.4:1 and a quick ratio of 1.2:1. During the first
quarter of this year, Manhattan reduced its accounts payable with a cash payment of $2 million. Holding all else
constant, determine how the cash payment would impact the ratios as reported at the end of the first quarter.
Cash ratio / Quick ratio
Choose one a. No effect / Increase
answer.
b. Decrease / Increase
c. Decrease / No effect
d. Increase / Decrease
There are rules for answering a question like this, and if you can learn them, you will be able to answer this type
of question quickly. But if you can’t learn them, you can always figure out the answer by making up some
numbers that meet the requirements and then changing them as the problem says to do and seeing what
happens to the ratios.
Correct
45
Marks: 1 Tier 1 capital includes
Choose one a. the par value of a company’s outstanding common stock, excluding additional paidin
answer. capital.
b. permanent, nonredeemable preferred stock outstanding.
c. a bank’s permanent, nonredeemable preferred stock outstanding plus its common
stockoutstanding, excluding additional paidin capital.
d. a bank’s common stock accounts, including common stock, additional paidin capital
and retained earnings, and its permanent, nonredeemable preferred stock outstanding.
Tier 1 capital is a measure of the capital adequacy of a financial institution, established by the Basel Committee
on Banking Supervision, an international body of central bankers from around the world. Tier 1 capital is the
bank’s core capital, consisting of its common stock accounts, including retained earnings, as well as perpetual
preferred stock that is nonredeemable and non cumulative.
Incorrect
46
Marks: 1 Able Repairs Company has the following current assets and liabilities as of June 30, 20X4 (in thousands):
When measured against accepted “norms”, the company can be said to have
Choose one a. a high current ratio and a good quick (acid test) ratio.
answer.
b. a good current ratio and a low quick (acid test) ratio.
c. a high current ratio and a low quick (acid test) ratio.
d. current and quick (acid test) ratios that are both good.
The “norms” for the current ratio and the quick, or acid test, ratio are 2:1 and 1:1, respectively. Able has a
current ratio of 2:1 ((105 + 950 + 1,850) ÷ 1,450)), which is equal to the norm of 2:1. Able’s quick ratio is
0.73:1 ((105 + 950) ÷ 1,450)), which is a little below the norm of 1:1. In evaluating ratios against the norm, it
is important to remember that ratios are only a guide, and different industries may have different norms. It is
probably more important to evaluate a company’s ratios against the average ratios for the industry it is in.
Incorrect
47
Marks: 1 The risk of a portfolio of stocks will be lower than the average risk of the individual stocks held in the portfolio
Choose one a. in every instance.
answer.
b. when the correlation of the individual stocks with one another is +1.0 or greater.
c. when the correlation of the individual stocks with one another is less than +1.0.
d. when the correlation of the individual stocks with one another is less than 0.
When the correlation of individual stocks in a portfolio with one another is less than +1.0, the risk of the portfolio
will be lower than the average risk of the individual stocks held in the portfolio.
Incorrect
48
Marks: 1 A business has the following total liabilities and equity (in millions of dollars):
Compared with June 30, 20X3, at June 30, 20X4, its debt to equity ratio has
Choose one a. risen, resulting in greater risk for shareholders and creditors.
answer.
b. risen, resulting in greater security for shareholders but greater risk for creditors.
c. fallen, resulting in greater security for shareholders and creditors.
d. remained the same.
The debt to equity ratio as of June 30, 20X3 was 30 ÷ (10 + 30 + 22) = 0.48. As of June 30, 20X4, it was 50 ÷
(12 + 36 + 12) = 0.83. Therefore, the debt to equity ratio has risen. A higher debt to equity ratio means greater
risk to both shareholders and creditors.
Incorrect
49
Marks: 1 The SarbanesOxley Act defines an organization’s code of ethics as a statement of standards necessary to
promote certain things. Which of the following is not included in the things the code of ethics is to promote?
Choose one a. Prohibition of payments made to foreign officials to obtain or renew business.
answer.
b. Compliance with applicable governmental regulations.
c. Ethical conduct.
d. Full, fair, accurate, timely, and understandable reporting.
The SarbanesOxley Act does not prohibit payments made to foreign officials to obtain or renew business. The
Foreign Corrupt Practices Act is the act that prohibits payments to foreign officials to obtain or renew business.
Incorrect
50
Marks: 1 Sneezing & Sneezing Inc. has a vacant building that it is considering using for one of two projects. Each project
would require the use of the whole building, so the projects are mutually exclusive. Management is considering
what discount rate to use in the capital budgeting analyses. The riskiness of both projects is considered to be the
same as the riskiness of the firm’s existing business. The firm’s cost of capital is 8%. The NPVs of the two
projects at each of three discount rates beingconsidered are as follows:
What is the crossover rate, and what discount rate should Sneezing & Sneezing use for this analysis?
Choose one a. 7%, / 8%
answer.
b. 8%, / 9%
c. 9%, / 8%
d. 9%, / 10%
The crossover rate between two capital budgeting projects is the discount rate at which both projects have the
same NPV. Thus, the crossover rate is 9%. Both projects are considered to have the same amount of risk as the
firm’s regular operations. Therefore, the discount rate to use in the capital budgeting analysis should be the
firm’s cost of capital, which is 8%.
Incorrect
51
Marks: 1 The value of a real option in capital budgeting is
Choose one a. the weighted average of the possible payoffs of the real option.
answer.
b. the standard deviation of the expected returns of the project with the real option.
c. the value of the project with the real option minus the value of the project without
the real option.
d. the amount of future potential project value increases.
The value of a real option on a project is the difference between the value of the project with the real option and
the value of the project without the real option.
Incorrect
52
Marks: 1 The ABC Company manufactures components for use in one of its finished products. When12,000 units are
produced, the full cost per unit is $35, separated as follows:
The XYZ Company has offered to sell 12,000 components to ABC for $37 each. If ABC accepts the offer, some of
the facilities currently being used to manufacture the components can be rented as warehouse space for $40,000.
However, $3 of the fixed overhead currently applied to each component would have to be covered by ABC’s other
products. What is the differential cost to ABC Company of purchasing thecomponents from XYZ Company?
answer.
b. $20,000
c. $24,000
d. $44,000
The differential costs are those costs that differ between the two options. The net cost of purchasing the
component and renting the warehouse space is $404,000 [($37.00 × 12,000) ? $40,000]. The total cost to
manufacture is $384,000 [($30.00 variable cost + $2.00 avoidable fixed cost) × 12,000 units]. The net cost
differential is $20,000 ($404,000 ? $384,000).
Incorrect
53
Marks: 1 Which of the following is not a part of the process of risk assessment in enterprise risk management?
Choose one a. Considering the likelihood of each risk’s occurring.
answer.
b. Analyzing the potential impact of each risk event if it does occur.
c. Calculating the expected loss from each event.
d. Considering the interrelationship of the risks.
Calculating the expected loss from an event is a part of the risk prioritization step in enterprise risk management,
and thus it is not a part of the risk assessment process. In order to prioritize risks, it is necessary to know the
amount of money that could be lost from each risk.
Incorrect
54
Marks: 1 A company produces and sells 3 products:
The company lost its lease and must move to a smaller facility. As a result, total allocated fixed costs will be
reduced by 40%. However, one product must be discontinued. The expected net income after the appropriate
product has been discontinued is
answer.
b. $15,000
c. $20,000
d. $25,000
Allocation of common fixed costs can be arbitrary, or it can be based on some measure such as total revenues, or
it can be based on Activity Based Costing. How fixed costs are being allocated is not important in answering this
question, because the decision as to which product should be discontinued should rest on the revenues and costs
that can be directly traceable to each product—the
Incorrect
55
Marks: 1 The following information is for Questions 5558: Kampit, Inc. is contemplating a 5year capital
investment project with estimated revenues of $80,000 per year and estimated cash operating expenses of
$50,000 per year. The initial cost of the plant and equipment for the project is $50,000, and the company
expects to sell the equipment for $5,000 at the end of the 5th year. P&E will be fully depreciated over 4 years on
a straightline basis for tax purposes. The project requires a working capital investment of $20,000 at its
inception. The cost of capital for Kampit is 10%. Assume a 40% marginal tax rate for the company.
Click Here to open Present Value Table
Question 55
: The payback period for the project is
Choose one a. 2.17 years
answer.
b. 2.04 years
c. 3.04 years
d. 3.17 years
Annual beforetax cash flow is $30,000 ($80,000 expected revenues less $50,000 expected expenses). Aftertax
cash flow is $30,000 × (1 ? 0.40) = $18,000. Annual depreciation for the first four years of the project will be
$50,000 ÷ 4 years = $12,500 per year. The depreciation tax shield is $12,500 × 0.40, or $5,000 per year.
Therefore, the annual net aftertax cash flow for Years 1 through 4 is $23,000. The initial investment is $50,000
P&E plus $20,000 working capital, or $70,000 total. The payback period is calculated as follows: Determine the
last year in which the cumulative cash flow remains negative. Here, that is Year 3: $(70,000) + $23,000 +
$23,000 + $23,000 = $(1,000). Then take the $(1,000) that is the final year’s negative cumulative cash flow and
divide it by the annual cash flow to determine the fraction of the next year until the project breaks even. $1,000
÷ $23,000 = 0.04. Therefore, the payback period is 3.04 years.
Note that the annual cash flows are not discounted when calculating the payback period. Also note that since the
project’s payback occurred prior to its fifth and final year in which the net cash flow would have been different, it
was not necessary for this question to calculate the net cash flow for the fifth year.
Correct
56
Marks: 1 What is the cash flow in the final year?
answer.
b. $21,000
c. $46,000
d. $43,000
The final year’s cash flows will be different from those of the first four years, for several reasons. (1) There will be
no depreciation and thus no depreciation tax shield; (2) There will be cash of $5,000 received from the sale of the
equipment. Tax will be due on the full amount, since the equipment will have been fully depreciated over the first
four years of its life. The cash received, net of income tax, will be $5,000 × (1 ? 0.40) = $3,000. (3) The $20,000
in working capital will be released. Thus the final year’s cash flows will be $18,000 after tax operating cash flow +
$3,000 cash net of tax on disposal + $20,000 released working capital = $41,000.
Incorrect
57
Marks: 1 The IRR for the project is
Choose one a. Less than 10%
answer.
b. Between 20% and 30%
c. Between 10% and 20%
d. More than 30%
We can estimate the IRR, since the IRR is the discount rate at which NPV is zero. Using the rates given in the
problem, we will calculate NPV using a discount rate of 20%, and that will tell us whether the actual IRR is higher
or lower than 20%. If NPV at 20% is positive, that will mean that the IRR is higher than 20%. If NPV at 20% is
negative, the IRR is lower than 20%.
Since the NPV is negative when cash flow is discounted at 30%, we know the IRR must be less than 30%.
Therefore, the correct answer is b – between 20% and 30%.
Correct
58
Marks: 1 The Discounted Payback Period is
Choose one a. 3.82 years
answer.
b. 4.82 years
c. 3.04 years
d. 2.82 years
The payback period based on discounted cash flows is calculated the same way as the payback period, but using
each year’s discounted cash flow instead of the undiscounted cash flow for the year. Here, we need to discount
each year’s cash flow separately using the Present Value of $1 factor, instead of using the Present Value of an
Annuity. This is so because in order to determine the discounted payback period, we need to have a separate
discounted cash flow amount for each individual year of the project, and each year’s discounted cash flow is
different.
The final year in which cumulative discounted cash flow is negative is Year 3. To calculate the fraction of Year 4
required to reach breakeven, divide Year 3’s cumulative cash flow of 12,822 by the Year 4 cash flow of 15,709.
12,822 ÷ 15,709 = 0.82. Therefore, the discounted payback period is 3.82 years.
Incorrect
59
Marks: 1 A risk map is used for
Choose one a. quantitative risk assessment.
answer.
b. determining Value at Risk.
c. qualitative risk assessment.
d. determining loss severity.
A risk map is used for qualitative risk assessment. A risk map pinpoints the risks the organization should focus on
the most because they have the greatest likelihood of occurring and/or they would have the greatest impact if
they were to occur, and it also presents a portfolio view of the organization’s risks. It can show the combination of
risks the organization faces.
Correct
60
Marks: 1 Tenir Corporation considers replacing its old computers with new ones in the middle of the tax year. Information
relating to the old computers on the proposed date of replacement:
The new computers would cost $40,000. Tenir’s applicable tax rate is 30%. The cost of capital for Tenir is 20%.
All taxes are paid at the end of the tax year.
What is the present value of the net investment relating to the replacement in the capital budgeting analysis,
rounded to nearest dollar?
answer.
b. $26,364
c. $25,000
d. $26,500
The feature of this problem that is unique is it is stated that the computers are being replaced in the middle of
the tax year and asks for the present value of the net investment. The capital budgeting analysis will begin in the
middle of the tax year, and the date of the replacement will be considered Year 0 for the capital budgeting
analysis. However, the problem tells us that all taxes are paid at the end of the tax year. That means that any tax
effect of the replacement will be delayed for six months.*
Therefore, the tax effect of the replacement must be discounted for 6 months at 20%. This can be accomplished
by using the factor for 10% for one year. 10% is used instead of 20% because the amount is being discounted
for ½ year instead of for 1 year. The factor for 10% for 1 year is equivalent to the factor for ½ year at 20%,
because 10% is onehalf of 20%.
The present value of the net investment will be as follows:
Incorrect
61
Marks: 1 Tau Co. manufactures accumulators. The management of the company received a proposal from one of the
employees related to changes in the technology of accumulators’ manufacturing. The costs of introducing those
changes are estimated at $45,000, but it will allow reduction of direct material costs per unit by 5%. The
estimated level of output is 45,000 accumulators per year. The selling price is expected to be $50 per
accumulator and it does not depend on the decision relating to technology change. Direct material costs per unit
are currently $22, salary expenses are$500,000 per year, and annual manufacturing overhead is $250,000.
Selling and administrationexpenses are $500,000 annually. Should the proposal be accepted, what would be the
total gain for the company in the first year?
answer.
b. $(4,500)
c. $2,143
d. $(2,143)
The cost savings per unit will be $1.10, which is calculated as $22 × 0.05 = $1.10. The cost savings from
producing 45,000 units in the first year is then 45,000 × $1.10, or = $49,500.$49,500 less the cost of $45,000
to implement the changes = $4,500 gain for the company in the firstyear.
Incorrect
62
Marks: 1 Shock Company produces component #6 for manufacturing of its finished product. The company needs 10,000 of
these components per year. The following per unit data for the component is available:
Technoresurs Co. offers to supply the same component at $43 per unit. Accountants also figured out that if
Shock ceases manufacturing the component, fixed costs would decrease by $55,000 per year. The company
should
Choose one a. Continue producing the component because it would cost less than purchasing by
answer. $100,000
b. Stop producing the component and purchase all 10,000 from Technoresurs as it
would reduce total costs by $100,000
c. Stop producing the component and purchase all 10,000 from Technoresurs as it
would reduce total costs by $5,000
d. Continue producing the component because it would cost less than purchasing by
$5,000
The total cost per unit to manufacture component #6 internally is the $37 in variable costs plus the total of
$55,000 in incremental fixed costs per year (the avoidable fixed costs if component #6 were not being
manufactured) divided by the 10,000 units of component #6 manufactured each year, or $5.50 per unit. Thus
the total relevant cost per unit is $37.00 + $5.50, or
$42.50. Purchasing component #6 would cost Technoresurs Co. $43.00 per unit. Therefore, it will cost the
company $0.50 per unit less to continue producing component #6 inhouse than it would to purchase the
component. For 10,000 units produced per year, this would be a cost savings of 10,000 × $0.50, or$5,000 per
year.
Incorrect
63
Marks: 1
The following information is for Questions 63 and 64
: Plast Corporation has been invited to participate in a bid. The corporation has excess capacity and some idle
workforce. Independent consultants were hired in addition to the internal staff in order to develop the bid
proposal and to estimate the project costs. The consultants produced the following information:
Plast Corporation has enough material X in its inventory to perform the contract. The market price for material X
to be used in the project is $25,000. The company on a regular basis purchases material Y, and its current per
unit market price is $55. Workers are paid fixed amounts in accordance with their annual contract in the amount
of $18,500 each per year. If Plast Corporation wins the bid, each worker will be paid an additional $1,500 for
overtime. The equipment to be used in the project has excess capacity and could be used for performing the
project without disrupting the current manufacturing schedule.
Question 63:
What is the minimum acceptable bid price for the corporation to submit?
answer.
b. $83,000
c. $63,000
d. $64,500
The only costs that are relevant are the costs that the company will incur only if they do the project. Any costs
that the company would pay anyway (such as regular fixed labor amounts paid in accordance with the workers’
annual contract) and any sunk costs (costs already paid) are not relevant because they will not be any different
whether Plast gets the work or does not get the work. The costs that are relevant include:
The payment made to the consultants to develop the bid and the internal costs of bid development are sunk
costs and are thus irrelevant. Since administrative expenses are usually fixed expenses and we are not told that
they will change if Plast wins the bid, they are also irrelevant.
Incorrect
64
Marks: 1 Assume the time on the equipment to be used in the project could instead be rented to an outside party for
$19,000 per year. Now what would be the minimum acceptable bid price for the corporation?
answer.
b. $63,000
c. $83,000
d. $82,000
Calculated as follows :
Incorrect
65
Marks: 1 The following information is for Questions 65 and 66:An important part of the process of enterprise risk
management is prioritizing identified risks in order to determine which will be addressed first. Indubitable
Company has identified four risks, the amount of each loss if the risk does occur, and the probability of each risk’s
occurring during a oneyear period, as follows:
Question 65:
Which risk should Indubitable address first?
Choose one a. Risk #1
answer.
b. Risk #2
c. Risk #3
d. Risk #4
Indubitable should address Risk #3 first, because its expected value is greater than the expected values of the
other risks. The expected value is the amount of the potential loss multiplied by the probability of the loss
occurring. Risk #3’s $300,000 loss amount multiplied by its 20% probabilityof occurring equals an expected loss
of $60,000, which is higher than the expected losses of the other three risks, calculated in the same manner.
Correct
66
Marks: 1 What is the probability that Risk #1 will not occur during the oneyear period?
Choose one a. 25%
answer.
b. 55%
c. 5%
d. 95%
The probability that Risk #1 will not occur is 100% minus the probability that it will occur, which is 5%.
Therefore, the probability that Risk #1 will not occur is 95%.
Incorrect
67
Marks: 1 Pomegranate, Inc., has estimated that a proposed project's 10year annual net cash benefit, received each year
end, will be $2,500 with an additional terminal benefit of $5,000 at the end of the tenth year. Assuming that
these cash inflows satisfy exactly Pomegranate's required rate of return of 8 percent, calculate the initial cash
outlay.
Click here to Open Present Value Table
answer.
b. $19,090
c. $25,000
d. $30,000
If the present value of the cash inflows exactly satisfies Pomegranate’s required rate of return of 8%, that means
that the NPV of the project is zero. If the NPV of the project is zero, the net cash inflows throughout the life of
the project, when discounted back to Year 0 at 8%, must be exactly equal to the initial cash outlay. The present
value of the cash inflows is ($2,500 × 6.710) + ($5,000 ×0.463) = $16,775 + $2,315 = $19,090. So that is the
amount of the initial cash outlay.
Incorrect
68
Marks: 1 A company has the following current assets and current liabilities (in thousands ofdollars):
How would you interpret this company’s current ratio and quick ratio?
Choose one a. The company’s current and quick ratios are too low, so it may be having liquidity
answer. problems.
b. The company’s current ratio is good, but its quick ratio is too high.
c. The company’s quick ratio is good, so even though the current ratio is below the
norm, this company is quite liquid.
d. The balance of accounts receivable is too high, so the current and quick ratios are too
high.
The quick ratio, which includes only cash, marketable securities, and accounts receivable in the numerator, is a
more conservative form of liquidity analysis than the current ratio because it excludes inventory. If the quick ratio
is greater than 1:1, it means the company has enough in “quick” assets (i.e., assets close to cash) to satisfy its
shortterm liabilities. This company has a quick ratio of 1.02:1 ([80 + 350] ÷ 420), so there are no liquidity
concerns. Assuming the company is operating profitably, one of the keys to its profitability is that it does not
keep a high inventory, and so it does not have cash tied up in inventory where it earns no return. So even though
this company’s current ratio, at 1.5:1 ([80 + 350 + 200] ÷ 420) is below the norm of 2:1, the company is not in
a liquidity crisis and in fact, appears to be wellmanaged.
Incorrect
69
Marks: 1 A company considers a project that would involve a new product and a new market. Although the project has a
positive NPV, the company decides not to invest in the new project at this time, because the market is just
developing. The company is not sure enough about the adequacy of the cash flows, due to the riskiness of the
market. This is an example of
Choose one a. a timing real option.
answer.
b. the real option to wait and learn more before investing.
c. the real option to make followon investments.
d. a flexibility in production real option.
This is an example of an option to wait and learn more before investing.
Correct
70
Marks: 1 Maryann Johnson, controller of Teenware, Inc., a closelyheld, private corporation, was standing in a long
checkout line at her local Walmart when she received an urgent call on her cell phone from Michael Cole, CEO of
Teenware. Cole was attending a weekend retreat with the members of the company’s board of directors, and the
directors had some questions about the financial statements that Cole needed answers to right away. In an effort
to accommodate Cole’s needs without losing her place in line, Johnson attempted to answer his questions as best
she could. This was a violation of which standard in the IMA’s Statement of Ethical Professional Practice?
Choose one a. Competence.
answer.
b. Confidentiality.
c. Integrity.
d. Credibility.
Financial information about a closelyheld, private corporation is confidential. Johnson should have left the line so
she would be able to speak without being overheard.
Correct
71
Marks: 1 During the year ended June 30, 20X5, Dixon’s Dog Supplies earned gross profit of$25,000, which represented a
markup of 50%. Opening inventory was $3,000 and closing inventory was $5,000. The inventory turnover ratio
was:
Choose one a. 6.25 times
answer.
b. 2.78 times
c. 5.00 times
d. 12.50 times.
The inventory turnover ratio is annual cost of goods sold divided by average inventory for the period. Since
neither of those values is given, they must be calculated from the information that is given. We know that the
markup was 50% and gross profit was $25,000. Letting X equal cost of goods sold, the formula to calculate cost
of goods sold is:
Incorrect
72
Marks: 1 Josie James, a customer of Mac’s Jewelry, a publiclytraded company, placed an online order for some highvalue
jewelry. Mac’s shipped the jewelry. However, over a period of several subsequent months, periodically Mac’s also
shipped to James several other highvalue pieces of jewelry that she had not ordered or paid for. The billing
address on the packing slip for the shipments was always different, but the shipping address was always James’s
address. James returned several shipments, refused several other shipments, and contacted Mac’s customer
service department about it multiple times, to no avail. The customer service personnel would not allow her to
speak to a supervisor, and the unordered and unpaidfor jewelry kept coming. What should James do about the
situation?
Choose one a. Keep all the jewelry and sell it on eBay, because legally it is her right to do so.
answer.
b. Continue returning and/or refusing the shipments.
c. Register a complaint on Mac’s hotline, available via the Internet.
d. Contact Mac’s external auditors and alert them to investigate.
This is an internal control and a systems control problem. It is not a situation of fraud or embezzlement. But
clearly, there is a need to make the problem known to someone in the organization with higher authority than
that of a customer service employee, so it can be addressed. The external auditors are outside the organization
and their audit is done only once a year, so that is not a practical or timely solution. Since Mac’s is a publicly
traded company, it is required to provide a hotline. Section 301 of the SarbanesOxley Act mandated, and the
Securities Exchange Act of 1934 has been amended to require, that audit committees of public companies
establish a system for receiving, retaining, and treating complaints regarding accounting, internal controls, or
auditing matters. The hotline is intended primarily for complaints from employees, but vendors and customers
may also make use of it. Reporting the problem to Mac’s hotline will initiate a highlevel investigation that should
lead to correction of the operational problem that allowed the problem to arise, so that it does not occur again,
possibly with a customer who may take advantage of it.
Incorrect
73
Marks: 1 Bill Jones dba International Enterprises is a sole proprietorship. The company was unprofitable during the past
year. However, it had more cash at the end of the year than it had at the eginning. Which of the following could
account for this?
Choose one a. Mr. Jones took more out in drawings this year than last year.
answer.
b. The company sold some fixed assets during the year.
c. The number of days’ sales in receivables was higher this year than it was last year.
d. Deposits and prepaids were higher at the end of this year than at the end of last
year.
The only answer choice that could account for higher cash despite a business loss is the sale of fixed assets. Even
if the fixed assets were sold at a loss, the cash generated from their sale will increase cash.
Incorrect
74
Marks: 1 The accounting and recordkeeping provisions of the Foreign Corrupt Practices Act (FCPA)apply to
Choose one a. companies that are regulated by the SEC.
answer.
b. publiclyheld companies only.
c. privatelyowned businesses.
d. all businesses.
The accounting and recordkeeping provisions of the FCPA apply to companies thatare regulated by the SEC.
Companies that are regulated by the SEC include all publiclyheld corporations and certain privatelyheld
companies that have elected to report to the SEC.
Incorrect
75
Marks: 1 The following information is for Questions 75 and 76:
UsedUp is considering accepting a special order from a foreign firm for BeGone, the main product it produces.
This would be a onetime order, would not impact existing sales, and sufficient capacity exists to manufacture the
goods. Existing cost information is as follows:
The fixed manufacturing costs will remain unchanged whether or not the order is accepted. The foreign purchaser
is willing to pay $22 for each unit and would like to purchase 5,000 units. Because the sales would not go
through regular distribution channels, the variable marketing costs would not be incurred. However, a packing
and shipping cost of $1.00 per unit would be incurred to get the units ready for oversees shipping.
Question 75: What is the relevant cost per unit that UsedUp should use when considering whether or not to
accept the special order?
Choose one a. $17.75
answer.
b. $20.00
c. $23.25
d. $24.50
The relevant cost per unit is the costs that are avoidable if UsedUp does not accept the order, plus the
incremental $1 per unit packing cost that will be incurred only if the company does accept the order. That is
calculated as follows:
Incorrect
76
Marks: 1 What is the potential profit or loss that UsedUp will make on the special order if it accepts it?
Choose one a. $6,250 loss
answer.
b. $12,500 loss
c. $16,250 income
d. $21,250 income
The profit per unit will be $22.00 ? $17.75 = $4.25. The total potential profit for a quantity of 5,000 is 5,000 ×
$4.25 = $21,250.
Incorrect
77
Marks: 1 POP produces three products that all use material A in their production. Information regarding the products and
their costs are as follows (all information is per unit):
During the next period, POP will be able to obtain only 5,000 units of material A. Assuming POP can sell all it
produces of all three products, in what order should POP produce the products during the next period to
maximize profit?
Choose one a. 1, 2, 3
answer.
b. 2, 3, 1
c. 3, 1, 2
d. 3, 2, 1
The way to approach this problem is to first calculate the contribution margin per unit for each product, then
calculate the contribution margin per unit of the scarce resource used, material A, for each unit of each product.
Incorrect
78
Marks: 1 RevIt currently makes a component that it uses called Ver. An outside firm has offered to sell RevIt the needed
quantity of Ver for $20 per unit. Existing cost information on producing the15,000 units of Ver is as follows:
All variable costs as well as fixed manufacturing costs totaling $45,000 can be eliminated if the product is
purchased. The remaining costs will not change even if Ver is purchased. There is no other use for the space
thatVer currently occupies. What is the net advantage or disadvantage to the firm if Ver is purchased from the
outside vendor?
Choose one a. $18,750 advantage
answer.
b. $26,250 advantage
c. $3,750 disadvantage
d. $48,750 disadvantage
If RevIt stops producing the Ver internally, it will save the following costs:
Incorrect
79
Marks: 1 ACB Inc. produces a product called Zite. The following cost information is available with respect to Zite on a per
unit basis: direct materials, $5; direct labor, $4; variable manufacturing overhead, $2; variable marketing, $2;
fixed manufacturing, $4; fixed marketing $2. If ACB wants to earn a 55% markup on the variable cost, what is
the amount of the markup?
Choose one a. $5.50
answer.
b. $7.15
c. $8.25
d. $9.35
Total variable product cost:
Incorrect
80
Marks: 1 Firm A has the following information with regard to the production and sales of product XIT. Selling price per unit
is $15, total variable cost per unit is $9, and total fixed costs are $30,000. What is the breakeven revenue for
XIT?
answer.
b. $5,000
c. $50,000
d. $75,000
The breakeven point in revenue is Total Fixed Costs ÷ Contribution Margin Ratio (Percentage). The Contribution
Margin Ratio is the contribution margin divided by the sales price. The contribution margin is $15 ? $9, or $6.
The Contribution Margin Ratio is $6 ÷ $15, or 0.40. Breakeven Revenue = $30,000 total fixed costs ÷ 0.40 =
$75,000.
Incorrect
81
Marks: 1 Bruce Inc. has the following information about Rut, the only product it sells. The selling price for each unit is $20,
the total variable cost per unit is $8, and total fixed cost for the firm is$60,000. The firm's current tax rate is
25%. If Bruce wants to earn $60,000 in profits after taxes, howmany units must it sell?
Choose one a. 15,000
answer.
b. 17,500
c. 10,000
d. 11,667
The first step in this problem is to convert the aftertax net income desired to before tax net income by dividing
the desired aftertax net income by (1 ? the tax rate): $60,000 ÷ (1 ? 0.25)= $80,000. Then, add the $80,000
beforetax net income desired to the fixed costs and divide by the contribution margin per unit:
($60,000 fixed cost + $80,000 beforetax net income desired) ÷ ($20 ? $8) = $140,000 ÷ $12 =$11,667.
Correct
82
Marks: 1 Bruce Inc. has the following information about Rut, the only product it sells. The selling price for each unit is $20,
the total variable cost per unit is $8, and total fixed cost for the firm is$60,000. Bruce has budgeted sales of
$130,000 for the next period. What is the margin of safety indollars for Bruce?
answer.
b. $70,000
c. $100,000
d. $130,000
The margin of safety is the excess amount of budgeted sales revenue over the breakeven sales level. We first
determine the breakeven revenue by dividing fixed costs by the contribution margin ratio: $60,000 ÷ [($20 ?
$8) ÷ $20] = $100,000. The difference between thebudgeted sales of $130,000 and the breakeven level of sales
of $100,000 is the margin of safety, or$30,000.
Incorrect
83
Marks: 1 As fixed costs for a firm rise, all other things held constant, the breakeven point will
Choose one a. Be unchanged
answer.
b. Not be impacted by fixed costs
c. Increase
d. Decrease
As fixed costs increase, the breakeven point in sales will increase because more units will need to be sold,
generating a higher total contribution margin, in order to cover the fixed costs. We could also look at this
algebraically: Since the breakeven point in sales units is Total Fixed Costs ÷ Contribution Margin Per Unit, if the
numerator (Total Fixed Costs) increases while the denominator (Contribution Margin Per Unit) remains the same,
the quotient will increase.
Correct
84
Marks: 1 A relevant revenue is a revenue that is a
Choose one a. Past revenue
answer.
b. Future revenue
c. Inhand revenue
d. Earned revenue
Relevant revenues and costs are revenues and costs that are both future and thatdiffer among alternatives.
Correct
85
Marks: 1 TRIIT is looking at replacing a current machine with a newer model. The followinginformation has been collected
by the managers.
Which of the costs are relevant in the decision as to whether the new machine should be acquired?
Choose one a. Direct materials only
answer.
b. Direct materials and variable overhead
c. Direct materials, variable overhead, and direct labor
d. Direct materials, variable overhead, direct labor, and supervisor's salary
Relevant revenues and costs are revenues and costs that are both future and that differ among alternatives. The
only costs that differ are Direct Materials and Variable Overhead, so those are the relevant costs.
Incorrect
86
Marks: 1 The U.S. federal act that requires corporate management to maintain books, records and accounts that accurately
and fairly reflect transactions and to develop and maintain a system of internal accounting control is the
Choose one a. Securities Act of 1933.
answer.
b. Securities Exchange Act of 1934.
c. Foreign Corrupt Practices Act of 1977.
d. SarbanesOxley Act of 2002.
The Foreign Corrupt Practices Act of 1977 (substantially revised in 1988 and amended in 1998) requires publicly
owned U.S. corporations to maintain systems of internal control that meet certain minimum standards.
Incorrect
87
Marks: 1 The quality of being truthful and free from deceit or fraud is the definition of
Choose one a. impartiality.
answer.
b. objectivity.
c. honesty.
d. credibility.
Honesty is one of the overarching ethical principles according to the IMA’s Statement of Ethical Professional
Practice. It means being upright, having integrity, truthfulness, sincerity, frankness, and freedom from deceit or
fraud. The other overarching ethical principles in the Statement are impartiality, objectivity, and credibility.
Impartiality means being without bias, which is a preference that inhibits impartial judgment. It means being
without prejudice. Objectivity means basing a judgment on an established set of criteria, making decisions on the
facts alone. Credibility is the quality of being believable and trustworthy.
Correct
88
Marks: 1 Clay Co. has considerable excess manufacturing capacity. A special job order's cost sheet includes the following
applied manufacturing overhead costs:
Fixed costs $21,000
Variable costs $33,000
The fixed costs include a normal $3,700 allocation for inhouse design costs, although no inhouse design will be
done. Instead the job will require the use of external designers costing $7,750. What is the total amount that
should be included in the calculation to determine the minimum acceptable price for the job?
answer.
answer. b. $40,750
c. $54,000
d. $58,050
When a company has excess capacity, only variable costs should be included in the calculation to determine the
minimum acceptable price for a job. Here, that consists of the $33,000 in variable costs plus the $7,750 to be
paid to external designers, for a total of $40,750.
Incorrect
89
Marks: 1 The following information is for questions 89 and 90:
Josh McDaniel has just been hired as the finance director of Bronco Widgets, a large manufacturing company. At
his first board meeting he is proposing to increase the number of days customers have to pay their receivable
balance from 30 days to 60 days. He believes that increasing the time customers are allowed to carry their
receivable balances to 60 days will achieve an increase in annual sales of 20%. He also believes that some
improvements in the collection procedures will reduce the level of bad debts. He believes that the value of sales
where there is a default will fall each year from 2% of sales to 1.8% of sales.
Josh believes that in order to increase annual sales and profits, the company should be willing to increase its risk
appetite and accept the risk of higher bad debts.
Question 89: In the event of default, it is estimated that 25% of the debt will be recovered. Given the current
sales level of $10 million, if the board accepts Josh’s proposal, anticipated annual losses would
Choose one a. Increase $16,000
answer.
b. Decrease $16,000
c. Increase $12,000
d. Decrease $12,000
Current sales are $10,000,000 and the expected default rate each year is 2%, so the expected default amount
each year is $200,000. However, 25% of that loss will be recovered, so the net loss currently is $200,000 × 0.75,
or $150,000.
With the change in terms, sales will increase by 20% to $12,000,000. The expected default rate will decrease to
1.8% of sales, which will be $216,000. 25% of that loss will be recovered, so the future net loss will be $216,000
× 0.75, which is $162,000.
The increase in the net loss is $12,000.
Incorrect
90
Marks: 1 Josh is having difficultly understanding and assessing the different risks (i.e., credit risks, liquidity risks, solvency
risks, etc.) facing the company. A method to assist Josh with his understanding and assessment process is to:
Choose one a. Establish quality circles to evaluate and assess the risks.
answer.
b. Implement TQM (Total Quality Management).
c. Prioritize risks and develop a risk map or risk dashboard.
d. Ask the board to indicate their risk appetite.
Prioritizing risks in order to rank them and developing a risk map or risk dashboard is qualitative risk assessment.
Qualitative risk assessment can be used to assess risk when the amount of loss is not calculated as a specific
amount, but the amount at risk can be ranked from the most to the least for the different risk events that are
being evaluated.
Incorrect
91
Marks: 1 Price markups over cost are likely to be higher when
Choose one a. Competition is more intense
answer.
b. Innovation in the industry is high.
c. Demand is less elastic.
d. Brand loyalty among consumers is low.
Price markups over cost are likely to be higher when demand is less elastic. Demand for a product is inelastic (i.e.
less elastic) if the quantity demanded changes by a smaller percentage than the associated change in the
product’s price. So if demand is less elastic, a price increase will not result in a large drop in sales. Sellers can
charge higher prices for a good when the demand for it is less elastic, because they can do it without losing too
many sales.
Correct
92
Marks: 1 The U.S. federal act that requires a company to disclose whether or not it has adopted aCode of Ethics for its
senior financial officers, and if not, why not, is the
Choose one a. AntiBribery Act of 1998.
answer.
b. SarbanesOxley Act of 2002.
c. Foreign Corrupt Practices Act of 1977.
d. Securities Exchange Act of 1934.
The SarbanesOxley Act requires a company to disclose whether or not it has adopted a Code of Ethics for its
senior financial officers, and if not, why not. The International AntiBribery and Fair Competition Act of 1998
amended and expanded the Foreign Corrupt Practices Act. It does not have any provision that requires a
company to disclose whether or not it has adopted a Code of Ethics for its senior financial officers, and if not, why
not. The Foreign Corrupt Practices Act of 1977 (substantially revised in 1988 and amended in 1998) has two
main provisions: 1) antibribery provisions, and 2) accounting provisions. Neither of these two main provisions
requires a company to disclose whether or not it has adopted a Code of Ethics for its senior financial officers, and
if not, why not. The Securities Exchange Act of 1934 was passed to regulate the sale and trading of securities
subsequent to their initial issuance. It does not have any provision that requires a company to disclose whether or
not it has adopted a Code of Ethics for its senior financial officers, and if not, why not.
Incorrect
93
Marks: 1 The following data relate to two capitalbudgeting projects of equal risk. The two projects are mutually exclusive.
Which of the projects, if any, will be selected using the NPV approach?
Choose one a. A
answer.
b. B
c. Neither
d. Cannot be determined without knowing the required rate of return.
The cash flows for both projects have already been discounted, so calculating the NPV is just mathematical
calculations. Knowing the required rate of return is not necessary, since the cash flows have already been
discounted.
NPV is the total of the present values of the future cash flows minus the initial cash investment. The NPV
of Project A is 4,550 + 4,150 + 3,750 + (10,000) = 2,450. The NPV for Project B is 13,650 + 12,450 +11,250 +
(30,000) = 7,350. The NPV of Project B is higher. Therefore, using the NPV approach, ProjectB will be selected.
Incorrect
94
Marks: 1 Garwood Company has purchased a machine that will be depreciated on a straightline basis over an estimated
useful life of 7 years with no salvage value. The machine is expected to generate net aftertax cash flow of
$80,000 in each of the 7 years. Garwood’s expected rate of return is 12%.
Click here to Open Present Value Table
Assuming a positive net present value of $12,720, what was the cost of the machine?
answer.
b. $253,120
c. $352,400
d. $377,840
The present value of the annual cash flows from an investment minus the initial investment equals the net
present value of the investment. The cash flows from this project are equal for each of the 7 years of the project
at $80,000 after tax. Therefore, the present value as of Year 0 of the$80,000 annual cash flows, discounted at
12%, is $80,000 × 4.564, or $365,120. If the net presentvalue of the project is $12,720, the cost of the machine
must be $365,120 ? $12,720, or $352,400.
Alternatively, we could use algebra to solve this. The formula would be 80,000 × 4.564) – X = 12,720
365,120 – X = 12,720
?X = ?352,400
X = 352,400
Incorrect
95
Marks: 1 Everything else being equal, the internal rate of return of an investment project will be lower if
Choose one a. The investment cost is lower.
answer.
b. Cash inflows are received later in the life of the project.
c. Cash inflows are larger.
d. The project has a shorter payback period.
A project’s IRR is the discount rate that would result in an NPV of zero for a project. When cash inflows are
received later in the project, the present value of the cash inflows will be lower than if the same cash flows had
been received earlier and the same discount rate is used. Thus, the IRR of a project with cash inflows received
later will be lower than the IRR of a project with the same cash inflows received earlier. Answer a is incorrect
because if the investment cost is lowered but the cash inflows remain the same, the IRR will be higher because
the higher the discount rate is, the lower the present value of the cash inflows will be. So lowering the
investment cost will cause the discount rate that equates the present value of the cash inflows to it to increase.
Answer c is incorrect because if cash inflows increase while the investment cost remains the same, the present
value of the cash inflows will increase unless the discount rate used is increased. Since the IRR is the discount
rate at which the present value of the cash inflows is equal to the investment cost, the IRR will increase, not
decrease. Answer d is incorrect because the length of a project’s payback period has nothing to do with its IRR.
Incorrect
96
Marks: 1 A company’s marginal cost of new capital (MCC) is 10% up to $600,000. MCC increases0.5% for the next
$400,000 and 0.5% thereafter. Several proposed projects are under consideration, with projected cost and the
internal rates of return (IRR) as follows:
What should the company’s capital budget be?
Choose one a. $0
answer.
b. $1,050,000
c. $1,500,000
d. $1,600,000
The capital budget will consist of those projects that will be profitable for the company. Profitable projects are
projects with IRRs that exceed their cost of capital. The first step is to prioritize the projects according to their
IRRs, and the next step is to determine the marginal cost of capital for each project in order to know which of the
projects have IRRs exceeding their marginal cost of capital.
The priority of the projects according to their IRRs is:
#1: B for $300,000, IRR 14.0%
#2: D for $350,000, IRR 13.5%
#3: E for $400,000, IRR 12.0%
#4: C for $450,000, IRR 10.8%
#5: A for $100,000, IRR 10.5%
Correct
97
Marks: 1 A company sells 2 products, X and Y. The sales mix is two units of product X for every 5 units of product Y. Fixed
costs are $49,500. The unit contribution margins for X and Y are $2.50 and$1.20, respectively. If the company
had an operating income of $22,000, the unit sales must have been:
Product X / Product Y
Choose one a. 5,000 / 12,500
answer.
b. 13,000 / 32,500
c. 23,800 / 59,500
d. 28,600 / 71,500
Each “basket” consists of 7 units: 2 units of X and 5 units of Y. The weighted average contribution margin of each
“basket” is (2/7 × $2.50) + (5/7 × $1.20) = $1.57143. The breakeven formula we will use to calculate the total
number of units of both products to be produced will be the breakeven formula where a specific operating income
is desired: ($49,500 + $22,000) / $1.57143, which equals 45,500. X represents 2/7 of that, or (2/7 × 45,500),
which equals 13,000. Y represents 5/7 of that, or (5/7 × 45,500), which equals 32,500.
Correct
98
Marks: 1 Last year, the contribution margin ratio of Lamesa Company was 30%. This year, fixed costs are expected to be
$120,000, the same as last year, and revenues are forecasted at $550,000, a10% increase over last year. For the
company to increase operating income by $15,000 in the comingyear, the contribution margin ratio must be
Choose one a. 20%
answer.
b. 30%
c. 40%
d. 70%
Last year’s revenue was $500,000, calculated as $550,000 ÷ 1.10, since revenue is forecasted at $550,000 for
the coming year and that is a 10% increase over last year. Last year’s contribution margin ratio was 30%, so last
year’s contribution margin was 30% of $500,000, or$150,000. Fixed costs last year were $120,000, so operating
income last year was $150,000 ?$120,000, or $30,000. The company wants to increase operating income by
$15,000 in the coming year, to $45,000 ($30,000 + $15,000). This year’s revenue is projected to be $550,000.
Fixed costs are expected to be the same as last year, or $120,000. If operating income is to be $45,000, then the
contribution margin needs to be $120,000 (the fixed costs) plus $45,000 (the required operating income), which
is $165,000. This $165,000 required contribution margin divided by the projected revenue of $500,000 equals a
contribution margin ratio of 30%.
Incorrect
99
Marks: 1 During the past year, Thor Lab supplied hospitals with a comprehensive diagnostic kit for$120. At a volume of
80,000 kits, Thor had fixed costs of $1 million and an operating income before income taxes of $200,000.
Because of an adverse legal decision, Thor’s current year’s liability insurance increased by $1.2 million over the
previous year. Assuming the volume and other costs are unchanged, what should the current year price be if Thor
is to make the same $200,000 operating income before income taxes? Assume no change in sales volume from
last year.
Choose one a. $120
answer.
b. $135
c. $150
d. $240
In order to generate enough net income before income taxes to match the previous year’s results, Thor Lab will
need to generate an additional $1,200,000 in revenue, the amount of the increase in fixed costs due to the
increased liability premium. Since we are assuming the sales volume will be the same as the previous year, this
will mean a price increase of $1,200,000 ÷ 80,000 units sold, which equals $15 per unit. Last year’s price was
$120, so next year’s price will need to be $120 + $15, or $135.
Correct
100
Marks: 1 What are the two primary areas where management accountants have a responsibility to act as change agents
within their organizations where ethics are concerned?
Choose one a. Internal control and financial reporting
answer.
b. Management accounting and risk management
c. Financial reporting and risk management
d. Internal control and risk management
Internal control and risk management are the primary areas where management accountants have a
responsibility to act as change agents within their organizations where ethics are concerned. Companies need to
have a valuesbased framework of corporate ethical behavior in order to have an effective internal control system.
The absence of a valuesbased ethical environment could result in higher risk for the organization, because an
environment based on rules and compliance will not be able to cover every possible situation to which an
employee might be exposed. The lack of specific guidance in a rulesbased culture creates risk. Without specific
guidance, employees will use their personal values to resolve ethical issues, and their personal values may not be
consistent with the company’s values. An ethics/valuesbased environment, however, provides a framework for
decision making by employees when company policy does not provide a specific answer. This framework should
help lead to answers that are consistent with the company’s overall objectives. Without such a framework, the
organization’s internal control objectives are at risk, and the risk assessment of the organization needs to include
human behavior as a risk.
The “tone at the top” is the basis for internal control within an organization, and the management accountant
must be aware of this environment in any risk or internal control assessment that he/she performs. Does that
tone reflect a genuine commitment to valuesbased behavior? Is there leadership by example in the organization
that helps establish and determine its ethical environment? If not, there is greater risk.
Correct
Finish review
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