IMANET Exam CMA Topic 6 Question 82 Discussion

Actual exam question for IMANET's CMA exam

Question #: 82
Topic #: 6

[All CMA Questions]

The net present value method of capital budgeting assumes that cash flows are reinvested at

AThe risk-free rate.

BThe cost of debt.

CThe rate of return of the project.

DThe discount rate used in the analysis.

Show Suggested Answer

Suggested Answer: B

The estimated incremental after-tax operating cash flows for each year of a capital project consist of two components: the after-tax cash inflows from operations and the depreciation tax shield arising from me purchase of new equipment. The first of these for Pelican can be calculated as follows:

Pelican's total incremental after-tax operating cash flows for each year of the project's

life is thus $106,000 ($90,000 + $16,000).

by Fausto at Mar 04, 2024, 08:30 AM

Limited Time Offer

25%

Off

Get Premium CMA Questions as Interactive Web-Based Practice Test or PDF

Contribute your Thoughts:

Submit Cancel

Shantay

2 months ago

Reinvesting at the risk-free rate? That's about as exciting as watching paint dry. And the cost of debt? Might as well just throw your money into a burning dumpster. Gotta go with the discount rate, folks!

upvoted 0 times

Vicki

1 months ago

The rate of return of the project seems like the best option to me.

upvoted 0 times

...

Helene

1 months ago

I think the discount rate is the most logical choice for reinvestment.

upvoted 0 times

...

Lonna

2 months ago

I agree, reinvesting at the risk-free rate is not very enticing.

upvoted 0 times

...

Broderick

3 months ago

Wait, what? The net present value method assumes cash flows are reinvested at the discount rate? That's wild. I would have guessed the project's rate of return. Time to brush up on my capital budgeting knowledge.

upvoted 0 times

Sena

1 months ago

I always thought it would be the project's rate of return too. Capital budgeting can be tricky.

upvoted 0 times

...

Crista

2 months ago

Yeah, it's kind of counterintuitive. But that's how the NPV method works.

upvoted 0 times

...

Dexter

2 months ago

I know, right? It's actually assumed to be reinvested at the discount rate.

upvoted 0 times

...

Belen

3 months ago

Haha, the answer is clearly D. Who in their right mind would reinvest at the cost of debt? That's like paying twice as much interest! This question is a no-brainer.

upvoted 0 times

Nida

26 days ago

No way, C doesn't make sense. It's definitely D, the discount rate used in the analysis.

upvoted 0 times

...

Goldie

1 months ago

I think it's C actually. Reinvesting at the rate of return of the project seems logical to me.

upvoted 0 times

...

Alyce

2 months ago

Yeah, the risk-free rate would be too conservative. The discount rate is the way to go.

upvoted 0 times

...

Otis

2 months ago

I agree, it's definitely D. Reinvesting at the discount rate makes the most sense.

upvoted 0 times

...

Dottie

3 months ago

I was sure it was C, the rate of return of the project. Reinvesting at the project's rate of return seems logical. Oh well, time to review my notes again.

upvoted 0 times

Maybelle

2 months ago

I agree, the discount rate is used to calculate the present value of future cash flows.

upvoted 0 times

...

Vallie

3 months ago

I think it's D, the discount rate used in the analysis.

upvoted 0 times

...

Ming

3 months ago

Hmm, the correct answer must be D. The discount rate used in the analysis. Why would we reinvest at the risk-free rate or the cost of debt? That just doesn't make sense.

upvoted 0 times

...