Answers to Questions CMA Part 2

Answers to Questions
1 b – This question can be made easier by making an assumption regarding variable costs. Assume the
company has variable costs of $10 per unit. If it marks up the variable cost by 60%, the selling price will be
$16. A markdown of 10% results in a selling price of $14.40 ($16 × 0.90). A selling price of $14.40 minus
variable cost of $10 provides a contribution of $4.40 per unit, which is 0.306 or 30.6% of the selling price
($4.40 ÷ $14.40).
Another way to approach the problem is by using algebra, as follows: The original selling price is 1.60 times
the variable costs (1 + 0.60), or 1.6VC. The marked down price is 10% off the selling price. Therefore, the
marked down price is 90% of the original selling price. Therefore, the marked down selling price = 1.6VC ×
0.9. Combine the terms by multiplying 1.6 by 0.9, and the result is the marked down price = 1.44VC. Now,
the contribution margin can be calculated. If one single product has a variable cost of $1.00, then the marked
down selling price for that product must be 1.44 times $1.00, which is $1.44. The unit selling price = $1.44.
The unit variable cost = $1.00. The unit contribution margin is $1.44 − $1.00, which equals $0.44. The
contribution margin ratio is $0.44 ÷ $1.44 = 0.306 or 30.6%.
2 a – The breakeven point in units is Fixed Cost divided by the Unit Contribution Margin. Cost of Goods Sold
is 75% variable cost, or $15,000,000 variable cost for the budgeted 600,000 units ($20,000,000 × 0.75).
Sales, General and Administrative Expense is 40% variable cost, or $3,000,000 variable cost for 600,000
budgeted units ($7,500,000 × 0.40). Therefore, the contribution margin at a sales level of 600,000 units is
$30,000,000 − $15,000,000 − $3,000,000, or $12,000,000. The Unit Contribution Margin is $12,000,000
divided by 600,000 units, or $20 per unit. Fixed costs equal 25% of COGS, or $20,000,000 × 0.25
($5,000,000), plus 60% of SG&A Expense, or $7,500,000 × 0.60 ($4,500,000), for total fixed cost of
$9,500,000. Therefore, the breakeven point in units is $9,500,000 ÷ $20 = 475,000 units.
3 d – The breakeven point in revenue is Fixed Cost divided by the Contribution Margin Ratio. The Unit
Contribution Margin calculated in the previous answer is $20. The sales price per unit is $50. Therefore, the
Contribution Margin Ratio is $20 ÷ $50, or 40%. Total fixed costs were calculated in the previous answer as
$9,500,000. Therefore, the breakeven point in revenue is $9,500,000 ÷ 0.40, or $23,750,000. The same
answer could also be calculated by multiplying the 475,000 units found in the previous answer as the
breakeven point in units by the price per unit of $50. 475,000 × $50 = $23,750,000.
4 c – The breakeven point in units is Fixed Cost divided by Unit Contribution Margin, so the unit contribution
margin multiplied by the breakeven point in units will equal fixed costs. At a sales volume of 900,000 units,
KJR’s contribution margin is $24,300,000, so the company’s unit contribution margin is $24,300,000 ÷
900,000, or $27. The breakeven point in units is given as 750,000. Fixed cost is therefore the unit
contribution margin multiplied by the breakeven point in units: $27 × 750,000 = $20,250,000.
5 c – Because the sales commission is a percentage of the sales price, it is a variable cost and needs to be
deducted from the sales price along with other variable costs to calculate the contribution margin per unit.
The sales commission is $2 per unit ($40 × 0.05) and deduction of the commission along with the other
variable costs results in a contribution margin per unit of $16 ($40 − $22 − $2). The fixed costs are
$9,331,200 and given a contribution margin of $16 per unit, a total of 583,200 units must be sold to break
even ($9,331,200 ÷ $16).
6 d – At the current loss position of $40,000, 24,000 units are sold ($300,000 of revenue ÷ $12.50 selling
price). Variable costs per unit are $7.50 ($180,000 ÷ 24,000), and the contribution margin is $5 per unit. To
cover the $40,000 loss the company needs to sell 8,000 additional units ($40,000 ÷ $5 contribution per
unit).
7 c – Given that the sales price is $36 and that the variable costs are $16, the contribution per unit is $20.
With fixed costs of $450,000, Delphi must sell 22,500 units to break even ($450,000 ÷ $20 per unit).
8 a – Since only 25,000 units can be sold, the maximum contribution margin will be $500,000 (the
contribution margin per unit of $20 multiplied by 25,000 units). This contribution margin will be reduced by
the fixed costs of $450,000 resulting in a maximum pre-tax profit of $50,000. As taxes are 40%, the
maximum after-tax profit is $50,000 × (1 – 0.40) = $30,000.
9 d – If the management of Delphi has required that this project have an after-tax profit of $75,000, this pre-
tax required income must be included as a fixed cost. The pre-tax income that is required is $125,000
($75,000 ÷ 0.6). Adding this required pre-tax income to the fixed costs of $450,000, the company now needs
to cover $575,000 of costs and pre-tax profit with the sale of the 25,000 units that can be sold. This means
that each unit must provide $23 of contribution ($575,000 ÷ 35,000). The variable costs of $16 per unit plus
the $23 required contribution per unit equal $39 per unit, the required selling price. If the company sells each
of the 25,000 units for $39, it will achieve an after-tax profit of $75,000.
10 a – To find the breakeven point, first determine fixed costs. Based on the information given, fixed costs
must be $50,000 ($500,000 revenue − $300,000 variable costs − $150,000 pretax profit). If the company

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CMA Part 2 Answers to Questions

reduces fixed costs by 20%, fixed costs will be $40,000 ($50,000 × 80%). The contribution margin given the
stated changes will be $250,000 [($500,000 × 110%) − $300,000] The contribution margin ratio is 45.45%
($250,000 ÷ $550,000). The formula for breakeven sales revenue is: Fixed Costs ÷ Contribution Margin
Ratio. $40,000 ÷ 0.4545 = $88,000 breakeven sales revenue (differences due to rounding).
11 b – Product XY-7 has a contribution margin of $1 per unit ($4.00 selling price − $2.00 variable
manufacturing cost − $1.00 variable selling cost). Therefore, if the entire $160,000 were spent on advertising
for XY-7, the company would need to sell an additional 160,000 units if XY-7 to “break even” on the
increased advertising ($160,000 ÷ #1).
12 c – Product BD-4 has a contribution margin of $0.50 per unit ($3.00 selling price − $1.50 variable
manufacturing cost − $1.00 variable selling cost). The product’s contribution margin percentage is $0.50 ÷
$3.00, or 0.16666667. The additional fixed cost of $160,000 divided by 0.16666667 equals $960,000, the
increase in revenue for BD-4 that would be required to offset the increased advertising expense.
13 a – The unit contribution margin for plastic frames is $5, and the unit contribution margin for glass frames
is $7. Plastic frames represent 100,000 units of the total production of 400,000 units, or 25%. Glass frames
represent 300,000 units of the total production of 400,000 units, or 75%. To calculate the weighted average
contribution margin, weight each individual product’s contribution margin by its percentage of total production
and sales, as follows: ($5 × 0.25) + ($7 × 0.75) = $6.50. Given fixed overhead of $975,000, MultiFrame
must sell $975,000 ÷ $6.50 = 150,000 total units of both frames to produce and sell to break even.
14 b – The reduction in labor costs increases the contribution for plastic frames from $5 to $6 per unit and
increases the weighted average unit contribution to $6.75 ($6 × 0.25) + ($7 × 0.75) = $6.75. The breakeven
number of units in total will become 144,444.44, or 144,445 units ($975,000 ÷ $6.75).
15 c – With the new weighting of 150,000 units of plastic frames and 300,000 units of glass frames, use of
percentages for the weighting introduces rounding errors because the plastic frames constitute 1/3 of the mix
and glass frames constitute 2/3 of the mix. Therefore, the better approach is to imagine a basket of three
products containing 1 plastic frame and 2 glass frames. The contribution margin for plastic frames is $5 per
unit ($10 selling price − $2 direct materials − $3 direct labor). The contribution margin for glass frames is $7
($15 selling price − $3 direct materials − $5 direct labor). Therefore, the contribution margin per basket
containing 1 plastic frame and 2 glass frames is (1 × $5) + (2 × $7), which equals $19. The fixed costs of
$975,000 divided by the $19 contribution margin per basket equals 51,316 baskets required to break even.
The total number of units needed to break even equals 3 units per basket multiplied by 51,316 baskets, or
153,948 total units.
16 b – Product 158-D accounts for 35% of total sales revenue and its contribution margin ratio is 1 – the
variable cost ratio, or (1 − 0.45), which equals 0.55. Product 074-J accounts for 65% of total sales revenue,
and its contribution margin ratio is (1 − 0.55), or 0.45. Therefore, the weighted average contribution margin
ratio of the product mix is: (0.35 × 0.55) + (0.65 × 0.45) = 0.485. Thus, the breakeven sales revenue for
the two products together is: $250,000 ÷ 0.485 = $515,464.
17 b – This question is a little unusual because the fixed costs have been given separately for each product.
However, nothing special needs to be done. Simply sum the two fixed costs to get the total fixed cost to use
in calculating the breakeven point. First, find the weighted average contribution margin ratio, using the
percentage of sales dollars of each product as the weights: (0.40 × 0.40) + (0.50 × 0.60) = 0.46. Next,
divide the total fixed costs by the weighted average contribution margin ratio to find the breakeven point in
revenue: (240,000 + $700,000) ÷ 0.46 = $2,043,478.
18 c – The break-even point in units is total fixed costs divided by the weighted average unit contribution
margin in dollars. The total fixed costs are given as $675,000. The weighted average unit contribution margin
in dollars is the sum of the products of each product’s weight (percentage) of total sales in units multiplied by
its unit contribution margin in dollars. Each product’s percentage of total sales in units is given in the
question. The selling price of Quinoa Bars is $1.00 and its contribution margin percentage is 25%, so the unit
contribution margin of Quinoa Bars in dollars is $0.25. The selling price of Millet Cookies is $1.00 and its
contribution margin percentage is 50%, so the unit contribution margin of Millet Cookies in dollars is $0.50.
The selling price of Amaranth Pops is $2.00 and its contribution margin percentage is 50%, so the unit
contribution margin of Amaranth Pops is $1.00. Therefore, the weighted average unit contribution margin is
(0.50 × $0.25) + (0.30 × $0.50) + (0.20 × $1.00) = $0.475. The break-even point in units is thus $675,000
÷ $0.475 = 1,421,053 total units.
19 b – The answer to this question can be calculated in several different ways:
Method #1: The simplest way is to calculate the weighted average unit selling price and multiply it by the
breakeven number of units calculated in the answer to the previous question. The weighted average unit
selling price is the sum of each product’s selling price multiplied by its percentage of total sales in units: (0.50
× $1) + (0.30 × $1) + (0.20 × $2) = $1.20. The breakeven point in units is 1,421,053 total units. Therefore,
the breakeven point in total revenue equals 1,421,053 × $1.20, or $1,705,264.

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Answers to Questions CMA Part 2

Method #2: Divide fixed costs by the weighted average contribution margin ratio. Fixed costs are given as
$675,000. The weighted average contribution margin ratio is calculated as follows:
(a) Calculate the weighted average unit selling price. This was calculated in Method #1 above as $1.20.
(b) Calculate each product’s percentage of total revenue by calculating the proportion represented by each
product in the weighted average unit selling price:
Quinoa Bars: 0.50 ÷ $1.20 = 0.41666667
Millet Cookies: 0.30 ÷ $1.20 = 0.25
Amaranth Pops: 0.40 ÷ $1.20 = 0.33333333
(c) Calculate the weighted average contribution margin ratio as the sum of the products of each product’s
proportion of the average unit selling price and its contribution margin ratio: (0.41666667 × 0.25) + (0.25 ×
0.50) + (0.33333333 × 0.50) = 0.395833332.
The next step is to divide fixed costs by the weighted average contribution margin: $675,000 ÷ 0.395833332
= $1,705,263 (difference is rounding).
Method #3: This method is the best way to prove the answer. Calculate the total breakeven number of
units. Then use that to calculate the breakeven number of units for each product and use the breakeven units
for each product to calculate the breakeven revenue for each product by multiplying each breakeven number
of units by its product’s selling price. Then sum the individual products’ breakeven revenues to find the total
breakeven revenue. The breakeven contribution margin for each product can be calculated at the same time
and serve as a proof of the answer, because if the sum of the products’ breakeven contribution margins
equals the fixed cost, the revenue calculated is the breakeven revenue.
(a) The total breakeven number of units was calculated in the answer to the previous question as 1,421,053.
(b) The breakeven number of units for each product is as follows, using the percentage of total units given in
the question for each product:
Quinoa Bars: 1,421,053 × 0.50 = 710,526 units
Millet Cookies: 1,421,053 × 0.30 = 426,316 units
Amaranth Pops: 1,421,053 × 0.20 = 284,211 units
(c) The breakeven revenue for each product is:
Quinoa Bars: 710,526 units × $1 = $710,526
Millet Cookies: 426,316 units × $1 = $426,316
Amaranth Pops: 284,211 units × $2 = $568,422
Total breakeven revenue = $710,526 + $426,316 + $568,422 = $1,705,264
(d) Proof: The breakeven contribution margin for each product is:
Quinoa Bars: $710,526 × 0.25 = $177,631
Millet Cookies: $426,316 × 0.50 = $213,158
Amaranth Pops: $568,422 × 0.50 = $284,211
Total breakeven contribution margin = $177,631 + $213,158 + $284,211 = $675,000
When revenue is $1,705,264, the contribution margin is $675,000, which is equal to total fixed costs, so net
income is zero. Therefore, $1,705,264 is the correct breakeven revenue.
20 b – The expected value is calculated by multiplying the probability of each result by that result. The
resulting products are summed to calculate the expected value, as follows: (200,000 × 0.20) + (250,000 ×
0.50) + (300,000 × 0.20) + (350,000 × 0.10) = 260,000 units as the expected value of the sales volume.
21 b – In the deterministic approach, the single most likely outcome is used in the decision model. The
volume of frozen dessert sales with the greatest probability of occurring is 300,000 units. Since the question
asks for the revenue, multiply 300,000 units by the unit selling price of $1.80. The resulting most probable
revenue using the deterministic approach is $540,000.
22 c – The expected value of the operating profit of frozen desserts is calculated by first determining the
expected value of the sales volume for frozen desserts. The expected value of the sales volume = (250,000 ×
0.30) + (300,000 × 0.40) + (350,000 × 0.20) + (400,000 × 0.10) = 305,000 units. The price of frozen
desserts is $1.80, and with variable costs of $1.15 per unit, the contribution per unit is $0.65. The expected
volume of 305,000 units multiplied by the unit contribution margin of $0.65 equals a total contribution of
$198,250. Subtracting from $198,250 the fixed costs and advertising costs ($78,000 in total) yields an
operating profit from desserts of $120,250.

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CMA Part 2 Answers to Questions

23 b – For breakfast rolls the contribution margin per unit is $0.45 ($1.20 − $0.75). The production tooling
and advertising total $45,000. Therefore, to cover the production tooling and advertising costs, Gleason must
sell 100,000 breakfast rolls ($45,000 ÷ $0.45).
24 b – Investment B should be recommended because it will result in the highest operating income of the
three potential investments. Since all of the projects are assumed to operate for the same number of years,
the expected annual operating incomes can be used to find the most profitable product. Calculate the
contribution margin for each product by multiplying the (price per unit − variable cost per unit) × volume and
subtract the product’s fixed costs to find each product’s expected operating income.
The expected operating income for each product is:
A B C
Contribution margin $60,000 $60.000 $30,000
Less: Fixed costs 25,000 22,000 15,000
Operating income $35,000 $38,000 $15,000
Product B has the highest expected operating income.
25 b – The two compensation plans are set equal to each other in this formula, where S is equal to the level
of sales:
0.05 S = $45,000
S = $900,000
If the expected level of sales is $900,000, it does not matter who Carter hires. If sales are expected to be
more than $900,000, Carter is better off hiring the sales person who wants a fixed salary. At an expected
sales level of less than $900,000, the commissioned sales person would be preferable.
26 a – To solve this problem, create the two profit functions and set the left sides equal to one another, then
create the two revenue functions and set the left sides equal to one another. Then solve for the one unknown
that remains after plugging the second formula into the first to eliminate one of the unknowns.
The two formulas are:
Profit function: 35.2M − 369,600 = 27.2T − 316,800
Revenue function: $88M = $80T
Solving the revenue equation for M in order to express T in terms of M produces:
M = 80 / 88T or M = 0.90909T
Substitute 0.90909T as the value for M in the profit function. The result is the following formula:
(35.2 × 0.90909T) – 369,600 = 27.2T – 316,800
Perform the multiplication within the parentheses on the left side of the equation:
32T – 369,600 = 27.2T – 316,800
Subtract 27.2T from both sides and add 369,600 to both sides of the equation:
4.8T = 52,800
Divide both sides of the equation by 4.8 to solve for T:
T = 11,000
Using 11,000 as the value for T, calculate the revenue: 11,000 units × $80/unit = $880,000.
Solving for T first produces the same answer.
27 d – In order to solve this problem, calculate the profit from each of the products if sales are 12,000 units.
Using the profit formulas from the answer to the previous question, calculate the expected profits at 12,000
units of either model as follows:
Mountaineering Skis: ($35.20 × 12,000) – $369,600 = $52,800
Touring Skis: ($27.20 × 12,000) – $316,800 = $9,600
Clearly, the profit from selling 12,000 mountaineering skis is greater, so the company should sell mountain-
eering skis.
28 d – Because the factory is automated, the limitation on production will be machine hours. Therefore, with
demand exceeding production, the company needs to make certain that it maximizes the contribution per unit
of the limited resource, or machine hours.
29 d – Since fixed manufacturing cost is applied at the rate of $1.00 per machine hour, use that to calculate
the number of machine hours required to manufacture one unit of each product. Thus, XY-7 requires 0.75

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Answers to Questions CMA Part 2

machine hours per unit to produce, whereas BD-4 requires only 0.20 machine hours per unit to produce. The
unit contribution margins for XY-7 and BD-4 are $1.00 and $0.50, respectively. Therefore, the contribution
per machine hour for XY-7 is $1.00 ÷ 0.75, or $1.33. The contribution margin per machine hour for BD-4 is
$0.50 ÷ 0.20, or $2.50. Since the contribution margin per machine hour for BD-4 is higher, BD-4 should be
produced. The total contribution margin from BD-4 is the 100,000 available machine hours × $2.50
contribution per machine hour, or $250,000. Note that the increased advertising expense is part of fixed
selling, general and administrative expense, so it does not impact the contribution margin.
30 b – The total cost of the zippers for one year is $36,000 (60,000 × $0.60). The company has a choice: It
can purchase all of the zippers needed for a year at the beginning of the year, or it can purchase them as it
needs them, which is 5,000 per month.
If American Coat Company purchases 5,000 zippers monthly, it will pay $3,000 per month for them (5,000 ×
$0.60).
If American Coat Company decides to purchase its full year’s supply of zippers at the beginning of the year,
then the total extra cash outlay for the company in January over and above what they would pay to purchase
only enough for the month of January will be $33,000 [$36,000 − (5,000 zippers needed the first month ×
$0.60)]
The money not needed for zipper purchases could be invested at 3%. The amount of money not needed for
zipper purchases and thus invested would start the year at $33,000 and decline each month by $5,000 until
by the end of the year, the invested money would be zero. Therefore, the average balance of the investable
funds would be the beginning balance plus the ending balance divided by 2 ([$33,000 + $0] ÷ 2), which is
$16,500. An average balance of $16,500 invested at 3% per annum for one year equals income of $495 over
the one-year period. That is the investment income given up by purchasing all of the zippers at the beginning
of the year, and that is the opportunity cost.
31 d – A sunk cost is any cost that has already been spent and is unable to be changed. In this question, the
book value of the old machine is a sunk cost. The book value represents the price paid for the old machine
(minus depreciation) and it cannot be changed, no matter what decision is currently made.
32 b – To answer this question, calculate what the current cost is if Leland continues to produce the part, and
calculate what the costs would be if Leland purchases the part from Scott. The costs if Leland purchases the
part from Scott will include the purchase price as well as any costs that will continue to be incurred by Leland
even if the product is not produced. The current cost of production is $21,200. If Leland were to purchase the
part, the purchase price would be $15,000. However, the Materials Handling charge would still need to be
made since this is an overhead allocation. This cost is 20% of the purchase price, or $3,000. Also, because
the overhead is 2/3 fixed, then 2/3 of the $12,000 of overhead would also continue to be incurred even if the
unit is purchased from Scott. The fixed overhead that would continue is $8,000 and brings the total “cost” of
purchasing the unit to $26,000, which is an increase of $4,800 over the cost if the unit were produced
internally.
33 a – The $4,800 greater cost per unit for purchasing the units as calculated in the answer to the previous
question multiplied by 10 units used per month equals an increase in cost of $48,000 per month for the KJ37.
The increased cost is partially offset by the rental income of $25,000. With the rental income, Leland’s net
increase in cost to purchase the KJ37 instead of manufacturing it is $23,000 per month.
34 c – The maximum the company could pay a supplier is equal to all of the costs that would be avoided if
the company were to not produce the item internally. The variable costs that would be avoided completely are
the variable costs of manufacturing ($2.00 + $2.40 + $1.60 = $6.00). In addition, the variable costs of
marketing would be reduced by 30%, or $0.75. In total, the company would reduce its costs by $6.75 by not
producing the item, so that is the maximum amount the company should pay to an outside supplier for the
item.
35 a – When making a bid for business, the company needs to make certain that the bid covers at least the
variable costs of production. If the company is operating at capacity, it also needs to cover the contribution of
the item that will no longer be produced. In this question, though, the company is operating at less than
capacity so it does not need to worry about this missing contribution. The variable costs of production (or
more accurately, the costs that would be incurred only if the company decides to produce the item) are direct
materials ($200,000), direct labor ($150,000), the supervisor’s salary ($20,000) and the fringe benefits on
the direct labor ($15,000). The rent and depreciation would continue to be incurred and would need to be
absorbed by other products. The total avoidable costs per unit are $385,000 and this is the minimum unit
price that the company should bid for the project.
36 c – The minimum price that will be charged in a situation of excess capacity is the variable costs that will
be incurred by the production and processing of the order. The variable costs are $90 for direct materials, $25
for direct labor, $18 variable manufacturing overhead, and $4 variable selling costs, or $137, so this is the
minimum price to be charged.

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CMA Part 2 Answers to Questions

37 b – When the company is operating at 100% capacity, the amount charged must cover the variable costs
of the item to be produced as well as the contribution that is lost by not producing something else. Since the
company would lose $15,000 in contribution by producing these 500 backstops, it needs to charge an
additional $30 per backstop to recover this lost contribution ($15,000 ÷ 500 units). This $30 added to the
$137 of variable costs calculated in the answer to the previous question results in a minimum selling price of
$167.
38 d – The expected value of the selling price “as is” is ($280,000 × 0.1) + ($320,000 × 0.6) + ($350,000 ×
0.3), or $325,000. The cost of $360,000 is a sunk cost and cannot be changed, so it is not relevant to the
decision. The difference between the expected sale price “as is” of $325,000 and the price after further work
($410,000) is $85,000. $85,000 minus the cost of the additional work ($70,000) is $15,000. Therefore,
Preston should redesign the home because the firm would be $15,000 better off.
This question could also be solved by calculating the loss on both scenarios and then finding the difference
between the two amounts, using the expected value as calculated above for the revenue from selling “as is.”
Sell “As Is” Upgrade and Sell
Revenue $325,000 $410,000
Less: Cost 360,000 430,000 ($360,000 + $70,000)
Loss $(35,000) $(20,000)
The builder will have a loss under both scenarios, but the loss resulting from upgrading before selling is
$15,000 less than the loss from selling “as is.”
However, the sunk cost of $360,000 is not needed to solve this problem because it is the same for both
options. An incremental analysis as demonstrated in the first solution requires less time to perform, so the
first solution is preferable in order to save time on the exam.
39 b – To be compensated for the costs of the plant, Hermo will charge Quigley for the variable costs of
production plus depreciation. At 60% capacity the total costs are $1,800,000. Of these total costs 80%, or
$1,440,000, are fixed costs. Therefore, variable costs are $360,000. In order to increase production from
60% to 90% of capacity, Hermo will incur additional variable costs of $180,000 ([$360,000 ÷ 0.60 × 0.90] −
$360,000 = $180,000). In addition to this is the depreciation, which is currently $1,050,000 per year
($21,000,000 ÷ 20 years). However, because of this increase in capacity, the useful life will be decreased to
14 years, so depreciation will be increased to $1,500,000 per year ($21,000,000 ÷ 14 years). The increase in
the annual depreciation expense is $450,000 and Hermo will pass that cost on to Quigley. Therefore, the
minimum annual amount that Hermo will charge (that will just cover its additional costs and provide no profit)
is $630,000 ($180,000 in variable costs plus $450,000 in increased depreciation costs).
40 c – The maximum annual amount that Quigley will pay Hermo is $1,200,000 because that is what Quigley
is currently paying to MP Electric for its power.
41 a – This question and the following two questions ask for the result of a decision compared to the status
quo, in other words, what would be the amount of change if the decision were implemented. This question
asks how much total operating income would change if the Suburban Store were closed. If this happened, all
of the contribution of the Suburban Store would be lost, a $36,000 decrease in total income. Also, the Urban
Store would lose 10% of its sales and thus 10% of its contribution of $48,000, or $4,800. If the Suburban
Store were closed, 25% of its $40,000 in direct fixed costs would continue, so 75% of $40,000 in fixed costs,
or $30,000, would be saved. $36,000 + $4,800 − $30,000 = $(10,800), the monthly decrease in operating
income if the Suburban Store were to be closed.
42 b – If the Suburban Store’s sales were increased by 10%, this would increase its contribution by $3,600
per month (10% of $36,000). However, Korbin would need to spend $5,000 per month for the promotional
campaign to achieve the increased sales. The promotional campaign would actually lead to a decrease in
operating income of $1,400 per month ($3,600 − $5,000).
43 b – One-half of Suburban Store’s revenue is from items sold at variable cost. The elimination of those
items would not impact the contribution margin of the store since the sale of those items adds nothing to the
store’s contribution margin. However, the corresponding decrease of 20% in other sales would eliminate 20%
of the contribution margin, or $7,200. This lost contribution would be offset by lower fixed costs, which would
be reduced by 15%, or $6,000. Thus Korbin’s operating income would decrease by $1,200 monthly as a
result of this move.
44 a – If Western Unit’s projected loss was less than the amount of home office cost allocated to it, Western
Unit’s operating earnings were covering its own costs and a portion of the home office cost. In closing the
Western Unit, Teen Co. lost this contribution toward its home office cost and its consolidated profit would
have decreased as a result of the closure.
45 b – Marginal product is an increase in the total output resulting from a one-unit increase in an input.

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Answers to Questions CMA Part 2

46 c – Marginal product, or marginal physical product, is the increase in the total output resulting from a 1-
unit increase in an input. In this case the increase of 1 worker from 10 to 11 causes an increase in the total
output equal to 5 units (25 – 20 = 5).
47 c – Marginal revenue product is the change in total revenue from using one more unit of a resource. In
this question, not only the marginal product is declining, but the average selling price is also declining.
Therefore, both factors will affect marginal revenue product. From 11 workers to 12 workers, the average
selling price decreases from $49.00 to $47.50. This is not the incremental selling price but the average selling
price. To calculate the change in total revenue requires multiplying the total number of product units by the
average selling price (for both levels) and then calculating the difference. Therefore, total revenue changes
from 25 units × $49 = $1,225 to 28 units × $47.50 = $1,330. Thus, the marginal revenue product is $1,330
– $1,225 = $105.
48 a – Adding one more worker to a team of 11 results in a change in total revenue from $1,225 (25 units ×
$49) to $1,330 (28 units × $47.50). Thus, the marginal revenue is $1,330 – $1,225 = $105. Adding one
more worker to a team of 11 results in an increase in total product of 3 units (28 – 25), so the marginal
revenue per unit added from adding one more worker is $35 ($105 ÷ 3).
49 a – Market comparables are prices charged by competitors for products that can serve as substitutes for a
company’s product. When a company determines its prices according to the prices competitors are charging
for virtually the same product, it is using market comparable pricing.
50 a – If the demand for a product is elastic, a price decrease will result in an increase in total revenue
because the increase in the quantity demanded and sold will more than compensate for the lower price
received for each unit sold.
51 c – If the price elasticity of demand is greater than 1, then the demand is considered relatively elastic.
52 b – Price elasticity of demand is the percentage change in quantity divided by the percentage change in
price. The percentage of change in the price, using the midpoint method, is $0.30 ÷ $2.15, which equals
0.1395 or 13.95%. If the elasticity of demand is 1.9 and the percentage change in the price is 13.95%, the
percentage change in the quantity is 1.9 × 0.1395, which equals 0.265 or 26.5%.
53 d – If demand for a product is elastic, a decrease in the price would bring a greater proportional increase
in the quantity demanded than the decrease in the price. Thus total revenue will increase.
54 c – If the price elasticity of demand for a normal good were 2.5, a 10% reduction in the price would bring
a 25% increase in the demand (2.5 × 10% = 25%).
55 b – A monopoly will produce as many units as it can until its marginal cost of production exceeds the
marginal revenue it can earn from selling one more unit. Monopoly quantity is determined at the point where
the monopolist’s marginal revenue equals its marginal cost.
56 c – The cost per unit is $90. The formula to determine what selling price will result in a 30% gross profit
is: P – 90 = 0.3P. Solving for P: 0.7P = 90; P = $128.57, or $129.
57 a – Target pricing takes into consideration a product’s entire lifecycle. Target pricing is a type of market-
based pricing, but target pricing is the better answer to this question because target pricing specifically
involves determining a target price that over the long run will cover the target cost per unit and the target
operating income per unit.
58 c – Target pricing involves first determining what the target price should be based on the market price,
then calculating what the target cost must be in order to earn an adequate operating profit at the target
price. If the actual calculated cost does not provide an adequate operating profit at the target price, then
value engineering is one way to reduce the cost to the target cost.
59 c – Companies operating in competitive markets, such as oil and gas, use the market-based approach to
price setting. In a competitive market, one company’s products or services are very similar to another
company’s products or services.
60 d – This scenario describes a short-run pricing decision, made to meet competitive pressure. Since the
market in which the company operates includes companies offering similar products, the price should be the
market price, which has decreased to $60 per unit. At $60 per unit, the company should be able to maintain
quarterly sales of 50,000 units, whereas at any price above $60, sales volume and profits will fall. At a price
of $60 per unit and a volume of 50,000 units, the company will cover its variable costs and its fixed costs and
will earn operating income of $350,000, calculated as [($60 − $13) × 50,000] − $2,000,000 = $350,000. For
the long-term, if management wants to maintain a 30% markup on cost, it needs to find ways to cut the
company’s total manufacturing cost (fixed and variable) to $46.15 per unit, because $46.15 + (0.30 ×
$46.15) = $60.00. Note: $46.15 is calculated as follows:
X + 0.3X = 60
Solving for X:

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CMA Part 2 Answers to Questions

1.3X = 60
X = 46.15
61 b – During the growth phase of the product’s lifecycle, sales increase rapidly and competition increases.
Prices are usually decreased to remain competitive because the marketing objective at this stage is to
maximize market share.
62 c – When a company wants to penetrate a market quickly and maximize its market share with a new
product, it may set a low initial price with the expectation that high sales volume will result. The resulting
high sales volume is expected to lead to lower unit costs and higher long-term profit. The goal is to win
market share, stimulate market growth, and discourage competition.
63 c – Last year the contribution margin was 70% ($5.25 contribution ÷ $7.50 selling price). The variable
cost for the coming year will increase by one-third from $2.25 per unit to $3.00 per unit (1/3 of $2.25 equals
$0.75). If the variable costs will increase to $3 this period, the selling price needs to be $10 in order to have
a 70% contribution margin, calculated as follows:
Let X equal the selling price.
X − 3 = 0.7X
0.3X = 3
X = 10.
64 b – In the coming year the selling price will be $9.00 and the variable selling costs will be $3.00. The
contribution margin at this selling price and variable cost is $6.00 per unit. The fixed costs will be 10% more
than last year, but last year’s fixed costs are not given and must be calculated. Last year the contribution per
unit was $5.25 and the company needed to sell 20,000 units to break even. Therefore, fixed costs last year
must have been $105,000 ($5.25 × 20,000). To increase $105,000 by 10%, multiply $105,000 by 1.10, and
the resulting fixed costs for the coming year are $115,500. Now the breakeven point can be calculated for
next year as Fixed Cost divided by the Unit Contribution Margin: $115,500 ÷ $6 = 19,250 units.
65 a – Last year the sales were enough to break even (20,000 units) plus provide an after-tax profit of
$5,040. With a after-tax profit of $5,040 and a 40% tax rate, the pre-tax profit was $8,400 ($5,040 ÷ [1 −
0.40]). In order to have a pre-tax profit of $8,400, the company must have sold 1,600 units more than its
breakeven volume ($8,400 ÷ $5.25 unit contribution margin = 1,600 units). Since the breakeven point was
20,000 units and the company sold 1,600 units above that, last year’s volume was 21,600 units. Since sales
for the coming year are expected to exceed the previous year’s sales by 1,000 units, sales for the coming
year are projected at 22,600 units (21,600 + 1,000).
66 d – Legal risk includes the legal system in which the company operates and the risks of losses from legal
cases.
67 c – Operational risks result from inadequate or failed internal processes, people, or systems. Failure to
perform bank reconciliations for six months is an example of a failed internal process.
68 a – Riverfront was not in compliance with laws and regulations. The owner has created compliance risk,
which is an operational risk. Compliance risk is the current or future risk to profits or the company’s assets as
a result of violations of, or nonconformance with, laws, rules, regulations, required practices, internal policies
and procedures, or ethical standards. While it is true that the remaining inspections could determine that the
building is uninhabitable, the risk created is compliance risk that is due to nonconformance with laws
requiring satisfactory inspections and a certificate of occupancy before allowing tenants to move in.
69 d – Value at risk measures the potential loss in value of a risky asset resulting from a specific risk event
over a defined period of time for a given confidence interval.
70 a – Benchmarking, cash-flow at risk, and scenario analysis can all be used to assess risk quantitatively. A
self-assessment questionnaire is a qualitative measure. Self-assessment questionnaires are used, for
example, to assess a company’s internal controls.
71 d – By moving the risk away from itself to another party, Buckeye Conferencing is transferring the risk of
loss to another party, though insurance is not involved. This is a noninsurance risk transfer.
72 a – When the amount at risk is high and the likelihood of loss is high, the best course of action is probably
to avoid the risk. Avoiding the risk might include selling a business unit or in some other way eliminating the
risk-generating activity from the company.
73 b – Corporate governance is concerned with the achievement of the corporation’s objectives. Enterprise
risk management assists the organization in the achievement of its objectives because it identifies the
organizations’ objectives that are at risk. Therefore, enterprise risk management is aligned with corporate
governance.

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74 a – Supply chain disruption is a common risk, and it entails both inherent and residual risk. Suppliers do
have problems and can sometimes be unable to supply a product, perhaps because of production difficulties
or because of problems getting product from their own suppliers. The risk is inherent because occasional
difficulty in obtaining a product is just a natural part of the process of ordering. As a response to the risk of
supply chain disruption, a company should make sure it has more than one supplier at all times for every
item it uses. However, even if the company has several suppliers, some residual risk still remains. For
example, if only one manufacturer is producing an item and that manufacturer has production problems, all of
the company’s suppliers will be unable to obtain that item and thus none of them may be able to fulfill a given
order.
75 a – The proper order for the four risk management activities given (from the Strategy & Objective-Setting
and the Performance components of COSO ERM, 2017) is objective setting, risk identification, risk
assessment, and risk response.
76 a – Defining the organization’s risk appetite, evaluating alternative strategies and each one’s potential
impact on the organization’s risk, and considering the potential effects of the organization’s business context
on its risk profile are all part of the strategy and objective setting component of ERM. Identifying, assessing,
and prioritizing risks are part of the performance component of ERM.
77 c – Enterprise risk management is the culture, capabilities, and practices that organizations integrate with
strategy-setting and apply when they carry out that strategy, with a purpose of managing risk in
creating, preserving, and realizing value.
78 b – Sales representatives are in constant contact with customers, so they would be in the best position to
recognize a problem related to customer product design. The other people named do not have contact with
customers.
79 a – The net present value of the equipment that is being replaced is not information that is relevant to a
capital budgeting decision. The salvage, or sales value of the asset that is being replaced is relevant
information, as is the depreciation rate that will be used for tax purposes on the new asset and the amount of
additional accounts receivable that will be generated from increased production and sales.
80 a – This question is asking for the annual depreciation tax shield. Even though it asks for incremental cash
flow and the new server is replacing an old server, no information is given regarding the cash flow related to
the old server to be replaced. Therefore, treat this as a purchase that is not replacing an old piece of
equipment. The initial investment is $150,000 and the useful life of the asset is 4 years. Since the problem
states that the company uses straight-line depreciation, the annual depreciation expensed will be $150,000 ÷
4, or $37,500. Since the company’s tax rate is 40%, the annual depreciation tax shield (tax savings) will be
$37,500 × 0.40, or $15,000.
81 b – This question gives a lot of information that is not relevant to the question that is asked, which is
simply what the cash flows in the final year of this project will be. There will be $11,000 of cash inflows that
are a result of operating profits ($40,000 − $29,000). In addition, the equipment will be sold for $9,000.
There is also a total of $12,000 of working capital invested in the project that will be released in Year 10. In
addition to these items, take into account taxes and the fact that taxes will need to be paid on the taxable
income. The equipment is fully depreciated, so the full $9,000 proceeds from the sale will be taxable gain.
Income tax will be paid on that $9,000 gain and on the operating income of $11,000, for a taxable income of
$20,000. Freeing up working capital is not a taxable event. Therefore, taxes will be $8,000 ($20,000 × 40%).
The net Year 10 cash flow is $24,000 ($11,000 pre-tax operating income + $9,000 received from the sale of
the equipment + $12,000 working capital released − $8,000 income tax on the operating income and the
gain).
82 c – This question is asking for the cash flows related to ending the project. The cash flows are: (1)
$10,000 cash received from the salvage value of the project, (2) $40,000 spent on removing the equipment,
and (3) the tax savings, or cash inflow, related to the capital loss from the disposal of the equipment. The
capital loss from the disposal of the equipment is calculated as the $10,000 cash received from the sale of the
equipment minus the $75,000 tax basis (“tax basis” is book value for tax purposes) minus the $40,000
disposal cost. This $105,000 capital loss leads to a tax savings, or cash inflow, of $42,000 ($105,000 ×
40%). Thus, the net cash flows related to the end of the project are $10,000 − $40,000 + $42,000 =
$12,000.
83 c – The payback period is calculated by determining how many years it will take for the net after-tax cash
inflows to equal the initial investment. The yearly cash flow includes the $80,000 in cost reductions, which is
an operating cash inflow. The operating cash inflows will be reduced by the payment of taxes on the increased
income. When reduced by the tax rate of 40%, the net after-tax operating cash inflow is $48,000.
Depreciation is $50,000 per year, so the depreciation tax shield, or the amount of tax savings due to the
depreciation expense, is $50,000 × 0.40, or $20,000 per year. The total after-tax cash flows are $48,000 +

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CMA Part 2 Answers to Questions

$20,000, or $68,000. Given a $250,000 initial investment and a net cash inflow of $68,000 per year, the
payback period is 3.68 years ($250,000 ÷ $68,000).
84 c – When the expected cash inflows for an investment are the same each year for the life of the project,
the payback period is the initial investment divided by the annual cash inflow. In this question, not enough
information is given to calculate after-tax operating cash flow or the tax shield related to the depreciation, so
the only thing to do is subtract cash costs (excluding the depreciation) from revenues to determine annual net
operating cash flow. Total annual costs are $90,000, including $22,500 of depreciation (a non-cash expense),
so cash costs excluding the depreciation are $67,500. Thus annual net cash flow is $150,000 minus $67,500,
or $82,500 per year. The initial investment of $270,000 divided by $82,500 equals 3.27, or 3.3 years to pay
back the initial investment.
85 c – The payback period will always be longer under the discounted payback method than it is under the
undiscounted payback method. So if the discounted payback period is 5 years, the undiscounted payback
period must be less than 5 years. That is the only thing that can be known for sure from the information
given.
86 c – Because the discounted payback period is being calculated, it is necessary to discount each annual
cash flow individually, even though the annual operating cash flows are the same. The discounted cumulative
cash flows until the initial investment is recovered are as follows:
Annual Cash Flow × Discounted Cumulative Dis-
Year Discount Factor @ 20% Cash Flow counted Cash Flow
0 $(95,000) × 1.000 $(95,000) $(95,000)
1 $40,000 × 0.833 33,320 (61,680)
2 $40,000 × 0.694 27,760 (33,920)
3 $40,000 × 0.579 23,160 (10,760)
4 $40,000 × 0.482 19,280 8,520
There is no need to carry the calculations beyond Year 4, because the project’s cumulative cash flow becomes
positive at some point during Year 4. Thus the correct answer is “between 3 and 4 years.”
87 a – To calculate the NPV of the investment, multiply each year’s cash inflow by the given present value of
$1 factor for the appropriate time period, add these numbers together, and then subtract the cash investment
of $200,000 from the total. The calculations are as follows:
Cash Inflow Factor PV of $1
Year 1 $120,000 × 0.91 = $ 109,200
Year 2 60,000 × 0.76 = 45,600
Year 3 40,000 × 0.63 = 25,200
Year 4 40,000 × 0.53 = 21,200
Year 5 40,000 × 0.44 = 17,600
PV of Cash Inflows $ 218,800
Less: Initial Investment 200,000
Net Present Value $ 18,800
88 b – The cash flows are as follows:
Year 0 Year 1 Year 2 Year 3
Initial Investment (160,000)
(85,000 ×0.60) (85,000 ×0.60) (85,000 ×0.60)
After-tax operating cash flows (C.F.× 0.60) 51,000 51,000 51,000
(48,000×0.40) (64,000×0.40) (48,000×0.40)
Depreciation Tax Shield (Depr. × 0.40) 19,200 25,600 19,200
After-tax cash from disposition ($10,000 × 0.60) _______ ______ ______ 6,000
Net after-tax cash flow (160,000) 70,200 76,600 76,200
Present Value of $1 factor @ 16% 1.000 0.862 0.743 0.641
Present Value of Cash Flow (160,000) 60,512 56,914 48,844
The net present value is $(160,000) + $60,512 + $56,914 + $48,844 = $6,270.
89 b – If an investment project has a negative net present value, its IRR must be lower than the company’s
weighted average cost of capital, assuming the WACC is used as the required rate of return. A negative NPV
would result from expected returns lower than the required rate of return. An IRR that is lower than the
required rate of return would also result if expected returns were lower than the required rate of return.

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Answers to Questions CMA Part 2

90 c – Of the items listed, only the increased levels of accounts payable and inventory are relevant cash
flows for a capital budgeting analysis because they affect the working capital need. The book value of
warehouse space currently used by another division is not relevant because it does not affect any cash flows
from this project, even if that warehouse space is being contemplated for use in the project. Interest
payments on debt to finance the equipment are not relevant cash flows because the cost of financing is never
a part of a capital budgeting analysis. When discounted cash flow methods such as NPV are used to analyze
the capital project, the cost of the financing is captured in the hurdle rate used to discount the future cash
flows. R&D spent in prior years is a sunk cost and is not relevant for a decision about a project for the future.
91 a – The NPV of the project is the annual cash flow of the project multiplied by the Present Value of an
Annuity factor for 14% for 12 years minus the initial investment.
$6,000,000 × 5.660 $ 33,960,000
Less: Initial investment 40,000,000
NPV $ ( 6,040,000)
The IRR of the project is the discount rate that produces an NPV of zero. The equation is
6,000,000X = 40,000,000
Where X = the Present Value of an Annuity factor for 12 years that equates the left and right sides of the
equation.
X = 40,000,000 ÷ $6,000,000
X = 6.667
The factor on the 12-year line of a Present Value of an Annuity table closest to 6.667 is 6.814, which appears
under the 10% heading in the table. Thus the IRR is approximately 10%.
92 c – In contrast to the usual way of referring to the date of the initial cash outflow, this problem gives the
initial cash outflow as occurring on January 1, Year 1. January 1, Year 1 is essentially the same as December
31, Year 0. Therefore, the cash flows should be discounted for 5 years. To calculate the NPV of Project A,
calculate the present value of the cash inflow at the end of the fifth year and subtract the initial cash outflow.
The cash inflow is $7,400,000 and given an 18% cost of capital, the present value of $1 factor for 5 years is
0.4371. $7,400,000 × 0.4371 = $3,234,540. Given an initial investment of $3,500,000 this project has a
negative NPV of $(265,460).
93 d – The IRR is the discount rate at which the NPV is equal to $0. Since in this problem there is only one
annual cash flow, determine the factor for a 5-year period that makes the following equation true:
9,950,000X = 4,000,000
Where X is the factor.
Solving for X:
X = 4,000,000 ÷ 9,950,000
X = 0.402.
Then, look for a factor in the PV of $1 table that is on the five-year line and is close to 0.402. The factor
0.4019 appears under the rate of 20%. Thus, the IRR is closest to 20%.
94 c – When NPV is used, the assumption is made that the cash inflows from the project will be reinvested at
the discount rate used to calculate the net present value of the project, which is usually the firm’s cost of
capital. The assumption when IRR is used is that the cash inflows from the project will be reinvested at the
internal rate of return.
95 d – A project’s IRR is the discount rate at which the NPV of the project is zero. The net present value of a
project is the present value of the cash inflows minus the initial investment. In order for the net present value
of the project to be zero, the initial investment must be equal to the present value of the net cash inflows.
Therefore, the initial investment in the project is equal to the sum of the present values of the annual future
net cash inflows of the project, discounted at the 14% IRR, as follows:
Net Cash PV of $1 Present
Inflow Factor @ 14% Value
Year 1 $10,000 0.877 $ 8,770
Year 2 20,000 0.769 15,380
Year 3 40,000 0.675 27,000
Year 4 40,000 0.592 23,680
Present value of net cash inflows $74,830
The initial investment in the project was $74,830 because the present value of the net cash inflows
($74,830) minus the initial investment ($74,830) equals zero.
96 a – The NPV of a project is equal to the sum of the present values of the future net cash inflows minus the
initial investment. A project’s IRR is the discount rate at which the NPV of the project is zero. If the IRR is

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CMA Part 2 Answers to Questions

equal to the discount rate used to calculate the NPV, and if that discount rate is assumed to be the company’s
cost of capital, then the NPV of the project must be zero.
97 a – When NPV is being used to evaluate a project, it is not necessary to use the same discount rate for
every year of the project’s life. If the required rate of return is expected to fluctuate throughout the life of the
project, each year’s cash flow can be discounted in multiple steps, with each step utilizing one of the discount
rates in effect and the number of years it will be in effect before the receipt of that cash flow. Net Present
Value is the only capital budgeting method that can incorporate a fluctuating required rate of return.
98 d – The net cash outflow, or net investment, includes not only the cost of the machine itself, but also the
costs of shipping and installation. The purchase price of the machine is $90,000 and it will cost $6,000 to
transport to Moore's plant and $9,000 to install, for a total of $105,000.
99 a – In the third year the machine will produce 2,000 units (as it does in each year). The before-tax
operating cash flow from these units will be $100,000 ($50 profit per unit), so the after-tax operating cash
flow will be $60,000 given a tax rate of 40%. In addition, there will be depreciation of $21,000 per year for
the first 5 years, resulting in a depreciation tax shield of $8,400 in Year 3 ($21,000 × 0.40). The net cash
flow for the third year will thus be $60,000 + $8,400, or $68,400.
100 d – In the tenth year the before-tax operating cash flow will again be $100,000 and the after-tax
operating cash flow will be $60,000, as calculated in the answer to the previous question. There will be no
depreciation and no depreciation tax shield. Cash of $5,000 will be received from the sale of the equipment,
and there will be $5,000 taxable gain on the sale, so the net proceeds from the sale of the equipment will be
$3,000 ($5,000 – [$5,000 × [0.40)], which equals $3,000). The net cash flow for Year 10 will be $60,000 +
$3,000, or $63,000.
101 c – This question is asking for an average annual after-tax cash flow amount that will result in a net
present value of zero for the project, because that will be the average annual cash flow at which Yipann will
be indifferent to the investment. Even though the expected net after-tax cash flows vary from year to year,
the expected annual cash flows given in the problem are irrelevant to calculating the answer to this question
because an average annual cash flow amount is needed. Thus this is a present value of an annuity problem.
After Year 0, all the annual cash flow amounts used must be the same average amount.
Since the initial investment is $105,000 and the project’s life is 5 years, find the annuity amount that will
produce a present value of $105,000 when discounted at 24% for 5 years. The present value of an annuity is
the annuity amount multiplied by the PV of an annuity factor. The PV of an annuity factor for 24% for 5 years
is given in the question: 2.74. The present value needed is the amount of the initial investment, which is
$105,000. Use the present value and the present value factor to calculate the annuity amount. The annuity
amount is $105,000 ÷ 2.74, which is equal to $38,321.
Therefore, if the 5 annual after-tax cash flows are all the same and they are each $38,321, the NPV of the
investment will be zero and Yipann will be indifferent to whether or not it makes the investment. If it makes
the investment, the investment will provide no additional value to the shareholders and the shareholders will
gain nothing. If Yipann does not make the investment, the shareholders will lose nothing.
102 b – The accounting rate of return is the average annual after-tax net income attributable to the project
divided by the net initial investment. The average of the five annual net income amounts given is $19,000
([$15,000 + $17,000 + $19,000 + $21,000 + $23,000] ÷ 5 = $19,000). $19,000 ÷ $105,000 = 0.18095 or
18.1%. (Note: sometimes the average of the initial investment over the life of the project is used to calculate
the accounting rate of return. The average of the initial investment over the life of the project is calculated as
the initial investment divided by 2. However, this question specifies to use the initial value of the investment,
not the average investment.)
103 c – The cash flow analysis is as follows:
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial Investment in Equipment (105,000)
After-Tax Cash Flow ________ 50,000 45,000 40,000 35,000 30,000
Total After-Tax Cash Flows (105,000) 50,000 45,000 40,000 35,000 30,000
Cumulative After-Tax Cash Flow (105,000) (55,000) (10,000) 30,000 65,000 95,000
The cumulative cash flow from the project becomes positive during Year 3. Assuming that the cash flows
occur evenly throughout the year, the payback period is 2.25 years, calculated as follows:
Number of the project year in the final year when cash flow is negative = 2, plus a fraction as follows:
 Numerator = the positive value of the negative cumulative inflow amount from the final negative year,
which is 10,000
 Denominator = cash flow for the following year, which is 40,000
or: 2 + (10,000 ÷ 40,000) = 2.25 years

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Answers to Questions CMA Part 2

Note that the present value factors given are irrelevant to answering this question, because the payback
method is not a discounted cash flow technique.
104 b – To calculate the NPV, multiply each annual after tax cash flow amount by the appropriate present
value of $1 factor, sum them, and subtract the initial investment. All of these amounts are given, which
means that the work is simply mathematical.
Cash Inflow PV of $1 factor
Year 1 $50,000 × 0.81 = $ 40,500
Year 2 45,000 × 0.65 = 29,250
Year 3 40,000 × 0.52 = 20,800
Year 4 35,000 × 0.42 = 14,700
Year 5 30,000 × 0.34 = 10,200
PV of Cash Inflows = $115,450
The NPV is $115,450 minus the initial investment of $105,000, or $10,450.
105 c – If there are no budget restrictions, Capital should invest in every project that has a positive NPV.
This is Projects 2, 3, and 4.
106 c – The MACRS depreciation in the fourth year will be 7% of the initial cost, or $84,000 ($1,200,000 ×
0.07). This depreciation will lead to a tax deduction that will reduce the amount of taxes payable by 40% of
the $84,000, or $33,600. This tax savings in Year 4 must now be discounted back to the beginning of the first
year (or Year 0), using the present value of $1 factor of 0.64 as given in the question. The discounted cash
flow from the MACRS depreciation is $21,504 ($33,600 × 0.64).
107 b – The existing asset will be sold for $180,000, which will result in a taxable gain of $30,000 ($180,000
− $150,000). The tax on this gain will be $12,000 (40% of $30,000), but the taxes will not be paid until the
end of the year, so this tax payment must be discounted for 12 months, using the present value of $1 factor
of 0.89. This gives us a discounted value for the taxes of $10,680 ($12,000 × 0.89). Subtracting this $10,680
in taxes due from the $180,000 received produces a discounted cash effect of the disposal of the existing
asset of $169,320 ($180,000 − $10,680).
Note: It is not usual for payment of income tax to be delayed to the end of the year because businesses pay
estimated taxes each quarter. Since this question states that the tax payment is delayed, however, the
payment needs to be discounted. Ordinarily, though, income tax payments related to a cash flow are
assumed to take place at the same time as the cash flow occurs.
108 d – To answer this question correctly, remember that “contribution margin” equals sales minus variable
costs. The increase in fixed costs is not included in this calculation. The additional sales will be $600,000 per
year (30,000 units @ $20/unit), and variable costs will increase by $360,000 (30,000 units @ $12/unit). The
additional pre-tax contribution will be $600,000 minus $360,000, or $240,000 per year, from which taxes
must be subtracted. Taxes are 40%, so the after-tax contribution margin is $144,000 ($240,000 × [1 -
0.40]). Multiply this $144,000 by the present value of an annuity factor for 4 years, which is given as 3.04.
The present value of the annuity is $437,760 ($144,000 × 3.04).
109 b – The working capital investment is an outflow investment of $50,000 at the beginning and an inflow
of the same amount at the end. The outflow is not discounted because it occurs at Year 0. The PV of the
inflow is $32,000 ($50,000 × 0.64 PV of $1 factor for 4 years). These netted together gives a net discounted
cash outflow of $18,000 related to the required working capital investment.
110 a – Project A’s cash flows are all received in the first three years of the project, whereas Project Z’s cash
flows are received in Years 2 through 5, with its largest cash flow not received until Year 5. The Payback
Period for Project A is 2 years ($7,000 + $8,000 = $15,000, the amount of the investment). The Payback
Period for Project Z is 4 years ($0 + $5,000 + $5,000 + 5,000 = $15,000). Therefore, according to the
Payback Period, Project A is the better project to invest in because its payback period is shorter.
The NPVs of both projects are as follows:
Project A: ($7,000 × 0.926) + ($8,000 × 0.857) + ($9,000 × 0.794) − $15,000 = $5,484
Project Z: ($5,000 × 0.857) + ($5,000 × 0.794) + ($5,000 × 0.735) + ($25,000 × 0.681) − $15,000 =
$13,955.
Since the NPV of Project Z is higher than the NPV of Project A, Project A is less profitable than Project Z.
Therefore, the use of the Payback Method would result in an initial recommendation of the less profitable
project as the better choice.
(Note: The problem does not give the company’s tax rate. Therefore, it is not possible to calculate the
depreciation tax shields for these projects. However, because the initial investments and the lengths of the
two projects are the same, the depreciation and thus the depreciation tax shield will be the same for both
projects and so it is not relevant to a comparison of which NPV is higher.)

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CMA Part 2 Answers to Questions

111 d – The result of simulation using the Monte Carlo technique should be the expected value of whatever
is being simulated.
112 c – Monte Carlo simulation can be used to develop an expected value when the situation is complex and
the values cannot be expected to behave predictably. Monte Carlo simulations uses repeated random
sampling and can develop probabilities of various scenarios coming to pass that then can be used to compute
a result that approximates an expected value.
113 c – A post-completion audit or post-audit of a capital budgeting project involves comparing the actual
costs and benefits of the project with the original estimates. A post-completion audit lets management know
how close the actual results of the project came to its original estimates. The feedback received from a post-
audit helps management to learn where its forecasts may have been off and to understand what important
factors it may have omitted in the capital budgeting analysis. The information gained from a post-audit can
help to improve future capital budgeting analyses.
114 c – Simulation models do not generate optimal solutions to problems. They do permit modeling of “what-
if” types of questions. They do not interfere with real-world systems because they do not change any actual
transactions, and they allow the study of the interactive effect of variables because the inputs to the model
can be changed to see how the result differs.
115 b – Although the most appropriate discount rate for a capital investment project is the company’s cost of
capital adjusted for risk, that is not one of the choices available. The best answer from among the answer
choices given is the yield on investment grade bonds. Of the choices given, U.S. Treasury obligations carry
the least risk and equities (stocks) carry the greatest amount of risk. The risk on investment grade bonds is in
between that of U.S. Treasury obligations and equities, so the yield on investment grade bonds would be the
most appropriate choice for an investment with moderate risk.
116 b – Having a real option to abandon a capital investment project is like owning an American put option,
because a put option gives the owner the right, but not the obligation, to sell the underlying asset at a
specific price until a specific expiration date.
117 b – According to “Resolving Ethical Issues” in the IMA Statement of Ethical Professional Practice, when
an IMA member encounters an unethical issue, the resolution process could include a discussion with the
member’s immediate supervisor. If it appears the supervisor is involved, the issue can be presented to the
next level of management. In this situation, it appears the supervisor may be involved. Thus, Tian should
discuss his concerns with the level of management above the immediate supervisor.
118 d – Postponing planned marketing expenditures until January would not violate the IMA Statement of
Ethical Professional Practice. Marketing expenditures are discretionary expenses that are expensed when
incurred. If an expense is not incurred during the current fiscal year, it is appropriate not to accrue it in the
financial statements for the year. All of the other answer choices would violate the standards of competence
and credibility in the IMA Statement of Ethical Professional Practice because they would involve violating
generally accepted accounting principles. The Competence standard requires IMA members to perform their
professional duties in accordance with relevant laws, regulations, and technical standards, so violating
generally accepted accounting principles violates the Competence standard. The Credibility standard
requires members to provide all relevant information that could reasonably be expected to influence an
intended user’s understanding of the reports, analyses, or recommendations, and violating generally accepted
accounting principles would violate the Credibility standard.
119 b – Payments, or bribes, to officials of foreign governments in order to obtain business are prohibited by
the Foreign Corrupt Practices Act.
120 c – A whistleblowing framework provides (1) the means for tracking issues raised, which can create
opportunities to enhance and improve internal controls, (2) an outlet for employees to confidentially report
potential violations, and (3) a means for collecting, analyzing and summarizing ethical issues, which can
provide insight into the operation of the company’s code of ethics and the degree to which employees are
following it. A whistleblowing framework does not provide a method for defining the organization’s behavioral
values.
121 d – All four provisions are requirements of the FCPA.
122 d – Society at large would be impacted by the company’s environmental policies, by its usage of
resources, by outages (such as service outages), and by its waste disposal practices. All of the other answer
choices list items that would not impact society at large.
123 d – Because there are 4 annuity payments to be made at the end of each of the subsequent years,
calculate the present value of these 4 future payments to determine the present value of the note. The
present value of an ordinary $1 annuity factor at 6% for 4 years is 3.465. The present value of the $1,000
annuity at 6% for 4 years is $1,000 × 3.465 = $3,465.

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Answers to Questions CMA Part 2

124 a – Because the question does not provide a present value of $1 table, use the PV of an annuity table
given in Appendix A to determine the factor for the PV of $1 to use. The present value of $1 factor for 8% for
4 years is 0.735. The present value of $4,000 discounted at 8% for 4 years is $4,000 × 0.735 = $2,940.
125 b – The amount borrowed will be only $450,000 because a 10% down payment ($50,000) will be made.
This $450,000 needs to be divided by the present value of an annuity factor for 25 years at 9% to determine
how much each individual payment will be. The factor is given as 9.8226. $450,000 ÷ 9.8226 = $45,813.
This is the amount of each payment over the life of the loan.
126 d – The $4,000 deposited at the end of each of the next 3 years is a 3-year ordinary annuity. The future
value of an ordinary annuity factor given for 3 years at 8% is 3.25. Multiply the $4,000 that will be deposited
each year by 3.25 to calculate the future value of the $4,000 deposits, which equals $13,000. This $13,000
needs to be added to the future value of the $75,000 that is already in the bank account. The $75,000
already in the bank account will also be there for 3 years. The future value of $1 factor for 3 years at 8% is
1.26. $75,000 × 1.26 = $94,500. $13,000 + $94,500 = $107,500, the future value at the end of 3 years of
all the funds in the account.
127 b – This is a future value of $1 question. The factor in the Future Value of $1 table used to calculate the
future value of earnings per share ($4.41) after 5 years, beginning with an earnings per share of $3.00, will
be found at the intersection of 5 years and the interest rate (rate of growth) in the Future Value of $1 table.
To find the factor, divide the ending value of $4.41 after five years by the beginning value, $3.00. The result
is 1.47. Next, turn to the Future Value of $1 table in this book following the Time Value of Money discussion.
Look across the 5-year line to find a factor that is close to 1.47. The factor 1.469 appears under the rate of
8%. Therefore, 8% is the forecasted compound annual growth rate in earnings per share, rounded to the
nearest percentage point.
To prove this answer, multiply $3.00 by 1.469, the factor for a compound annual growth rate of 8% after 5
years. The result is the $4.41 earnings per share forecasted after 5 years.
128 c – This question requires the use of the future value of $1 and the future value of an ordinary annuity
tables. The future value of today’s cost of $500 million, expected to escalate at 5% a year for 20 years, is
$500,000,000 × 2.653 (the FV of $1 at 5% for 20 years) = $1,326,500,000.
Mega Power currently has a balance of $100 million to put toward this obligation, and those funds are
expected to grow at 7% a year for 20 years. The future value of that amount in 20 years at 7% will be
$100,000,000 × 3.870 (the FV of $1 at 7% for 20 years) = $387,000,000.
Therefore, the net future amount to be funded through annual collections from customers over the next 20
years (which will also grow at 7% annually) is $1,326,500,000 − $387,000,000, or $939,500,000. Those
collections will take place at the end of each year, so this is an ordinary annuity. To calculate the amount of
the annual annuity required, use the future value of an ordinary $1 annuity factor for 7% for 20 years, which
is 40.995, and use $939,500,000 as the future value, as follows:
Let X = the required annuity amount:
40.995X = $939,500,000
Divide both sides of the equation by 40.995 to find the value of X:
X = $22,917,429, or $23,000,000 rounded to the nearest million.

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