Ama Set 19

ADVANCED MANAGEMENT ACCOUNTING (MCQs SET 19)
Q1: Bay City’s Department of public Works (DPW) is considering the replacement of some machinery.
This machinery has zero book value but its current market value is Rs. 960. One possible alternative is
to invest in new machinery, which has a cost of Rs. 46,800. This new machinery would produce
estimated annual operating cash savings of Rs. 15,000. The estimated useful life of new machinery is
four years. The DPW uses straight line depreciation. The new machinery has an estimated salvage
value of Rs. 2400 at the end of four years. The investment in the new machinery would require an
additional investment in working capital of Rs. 3600 which would be recovered after four years. If the
DPW accepts this investment proposal, disposal of the old machinery and investment in the new
equipment will take place in December 31, 20X4. The cash flows from the investment will occur during
the calendar years 20X5 through 20X8. The city has a 10% hurdle rate.
a) Prepare a net-present value analysis of the county DPW’s machinery replacement decision.
b) Should the DPW’s proposed investment in new machinery be accepted?
Answer: “Rs.”
Part a:
Initial Cash flow:
Cost of new machine..............................46,800
Less: Market value of old machine........ (960)
Add: Working capital.............................. 3600
Initial cash flow 49,440.
Annual cash flows:
Cash savings........................................... 15,000.
Terminal cash flow:
Annual cash flows................................... 15,000
Add: Salvage value.................................... 2400
Add: Working capital................................ 3600
Terminal cash flow 21,000
NPV Calculation:
Items Years Cash flows Discount rate Present Value
Initial investment 0 (49,440) 1 (49440)
Annual cash flows 1-3 15,000 3.1699 37,302

Terminal Cash flow 4 21,000 0.683 14,343
Net Present Value 2205
NPV Analysis: From above calculation NPV is found out to be Rs. 2205. (approx..).
Part b:
Since NPV of disposal decision is positive, Hence DPW’s proposed investment in new machinery should
be accepted.
Q2: Which of the following statements is correct?
a) ABM can be operated without ABC. (ABM: activity based management)
b) ABC costs are 100% accurate.
c) Unit-level ABC cost drivers are very different to overhead absorption rate.
d) There is more than one possible cost driver for each activity.
Q3: Which of the following would be used in capital investment decision?
a) Revenues received after the payback period when using the payback method.
b) Discount factor when using ARR.
c) How long the project will last for when using ARR.
d) Sunk costs.
Q4: Fazal Wood Limited (FWL) has the nominal cost of capital at 20% per annum. If the inflation is
recorded at 8%. The real cost of capital would be .
a) 11.11%.
b) 28.00%.
c) 29.60%.
d) 16.00%.
1 + real rate = 1 + nominal/ 1 + inflation
Real rate = 1.20/1.08 – 1
Real rate = 11.11%

Q5: Dr. Zain Shah is the managing partner of Benard health care clinic. Dr. Zain is trying to determine
the feasibility of moving both the patients and other related files out of the store room situated in the
clinic, replacing it with another OPD room. He has estimated the investment of Rs. 3595,200 required
for equipment and other necessities of the room. Based on receipts being generated from other
rooms in the clinic, Dr. Zain also estimated the annual cash inflow from the new room would be Rs.
750,000 per annum. The equipment purchased from the room would have an estimated life of 10
years.
i. Determine the Internal Rate of Return (IRR).
ii. Assuming that Dr. Zain Shah will not purchase the new equipment unless it promises a return of at
least 15%. Compute the amount of annual cash inflows that would provide this return on Rs. 3595200
investment.
Answer:
Part i:
NPV at 14% “ Rs.”
Items Years Cash flows Discount Rate Present Value
Initial Investment 0 (3595200) 1 (3595200)
Annual Cash flows 1 – 10 750,000 5.216 3912086
Net Present Value 316887
Net Present Value (101,248)
IRR Calculation:
IRR= 0.14 + 316889 (0.17 – 0.14)
316889 + 101248
IRR= 16.27%.
Part ii:
Net Present Value 0 .
Since, at 15% discount rate, the NPV becomes zero, making 15% , the internal required rate of return,
for which the annual cash inflows must be approximately Rs. 716,312.

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ADVANCED MANAGEMENT ACCOUNTING (MCQs SET 19)

b) Should the DPW’s proposed investment in new machinery be accepted?

Initial Cash flow:

Cost of new machine..............................46,800

Less: Market value of old machine........ (960)

Add: Working capital.............................. 3600

Initial cash flow 49,440.

Annual cash flows:

Cash savings........................................... 15,000.

Terminal cash flow:

Annual cash flows................................... 15,000

Add: Salvage value.................................... 2400

Add: Working capital................................ 3600

Terminal cash flow 21,000

Items Years Cash flows Discount rate Present Value

Initial investment 0 (49,440) 1 (49440)

Annual cash flows 1-3 15,000 3.1699 37,302

Net Present Value 2205

Q2: Which of the following statements is correct?

a) ABM can be operated without ABC. (ABM: activity based management)

b) ABC costs are 100% accurate.

Q3: Which of the following would be used in capital investment decision?

b) Discount factor when using ARR.

1 + real rate = 1 + nominal/ 1 + inflation

Real rate = 1.20/1.08 – 1

Real rate = 11.11%

i. Determine the Internal Rate of Return (IRR).

NPV at 14% “ Rs.”

Items Years Cash flows Discount Rate Present Value

Initial Investment 0 (3595200) 1 (3595200)

Annual Cash flows 1 – 10 750,000 5.216 3912086

Net Present Value 316887

NPV at 17% “ Rs.”

Items Years Cash flows Discount Rate Present Value

Initial Investment 0 (3595200) 1 (3595200)

Annual Cash flows 1 – 10 750,000 4.659 3493952

Net Present Value (101,248)

IRR= 0.14 + 316889 (0.17 – 0.14)

NPV at 15% “ Rs.”

Items Years Cash flows Discount Rate Present Value

Initial Investment 0 (3595200) 1 (3595200)

Annual Cash flows 1 – 10 716,312 5.019 3595200

Net Present Value 0 .

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