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IMANET Exam CMA Topic 1 Question 63 Discussion

Actual exam question for IMANET's Certified Management Accountant exam
Question #: 63
Topic #: 1
[All Certified Management Accountant Questions]

Book rate of return is an unsatisfactory guide to selecting capital projects because

I . It uses accrual accounting numbers

II . It compares a single project against the average of capital rejects.

III . It uses cash flows to gauge the desirability of the project.

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Suggested Answer: B

A common misstep in regard to capital budgeting is the temptation to gauge the desirability of a project by using accrual accounting numbers instead of cash flows. Net income and book value are affected by the compas choices of accounting methods. A project's true rate of return cannot be dependent on bookkeeping decisions. Another distortion inherent in comparing a single project's book rate of return to the current one for the company as a whole is that the latter is an average of all of a firm's capital projects. Embedded in that average number 'may be a hand Full of good projects melding up for a large number of poor investments.


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