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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Broderick

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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Belen

6 days 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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Dottie

11 days 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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Ming

13 days 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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