Free IMA CMA Part 2 (Strategic Financial Management) Capital Investment Decisions Practice Questions
Investment Decisions on CMA Part 2 covers capital budgeting techniques (NPV, IRR, payback, discounted payback, profitability index), cash flow analysis (incremental cash flows, after-tax cash flows, MACRS depreciation), and risk analysis in capital budgeting (sensitivity, scenario, simulation). NPV and IRR computational problems dominate.
Sample Questions
Question 1
Easy
Which of the following is generally the LAST step in the capital budgeting process?
Solution
A is correct. The capital budgeting process typically proceeds from (1) identifying candidate projects, to (2) estimating cash flows, (3) applying analysis methods such as NPV and IRR, (4) selecting and funding projects, and finally (5) conducting a post-audit that compares actual results to original projections. The post-audit occurs after implementation and is the final stage.
Question 2
Medium
Beacon Industries must choose between two mutually exclusive projects. Project X has an NPV of $45,000 and an IRR of 18%. Project Y has an NPV of $38,000 and an IRR of 22%. The firm's cost of capital is 10%. Which project should Beacon accept?
Solution
B is correct. When NPV and IRR conflict for mutually exclusive projects, NPV is the preferred decision criterion because it measures the absolute dollar value added to the firm and assumes reinvestment of intermediate cash flows at the cost of capital, which is more realistic than IRR's reinvestment-at-IRR assumption. Project X adds $45,000 to firm value versus Project Y's $38,000, so Beacon should accept Project X.
Question 3
Hard
Ridgemont Foods is evaluating a 4-year project requiring $240,000 of equipment depreciated straight-line to zero salvage value. The project will increase annual revenues by $180,000 and cash operating costs by $90,000. The tax rate is 25% and the required rate of return is 10%. The 4-year, 10% present value annuity factor is 3.1699. What is the project's NPV (rounded to the nearest $100)?
Solution
A is correct. Annual depreciation = $240,000 / 4 = $60,000. Annual after-tax operating cash flow = ($180,000 - $90,000)(1 - 0.25) + $60,000(0.25) = $67,500 + $15,000 = $82,500. PV of cash flows = $82,500 × 3.1699 = $261,517. NPV = $261,517 - $240,000 ≈ $21,500.