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

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Shantay

27 days 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!

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Lonna

18 days ago

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

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Broderick

1 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.

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Crista

2 days ago

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

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Dexter

8 days ago

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

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Belen

1 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.

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Alyce

2 days ago

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

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Otis

9 days ago

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

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Dottie

2 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.

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Maybelle

27 days ago

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

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Vallie

1 months ago

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

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Ming

2 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.

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