Student Forums CMA Part 2 Section E: Investment Decisions E.2. Capital Analysis Analysis Methods Question ID: ICMA 10.P2.289 02 300 (Topic: Net Prevent Value Method)

Question ID: ICMA 10.P2.289 02 300 (Topic: Net Prevent Value Method)

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  • #218004
    Ji Hyun Jin
    Participant

    In the question it asks for the cash flow from year 5, however, I don’t understand why the cash flow from sales of land, building and equipment is included in the cash inflow, since the question does not necessarily mention that those will be sold by the end of the 5 years.
    I’d like some clarity over whether we have to always assume that investments will be sold at the end of the period, or if it depends on the question. Thanks!

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  • #218007
    Lynn Roden
    HOCK international

    Hi Ji Hyun Jin,

    The question says “At the end of the fifth year, the assumed sales values of the land and building are $800,000 and $500,000, respectively. It is further assumed the equipment will be removed at a cost of $50,000 and sold for $300,000.”

    That tells you that the plan is to sell the land and building at the end of the fifth year. Since that is the plan, those cash flows are part of the capital budgeting analysis.

    I don’t think you can always assume anything. You just need to read each question very carefully to get the facts you need to answer the question. And don’t overthink it. You may have read that sentence and said to yourself, “but it doesn’t actually say the land and building will be sold.” When a business makes a decision, it uses the best information it has, and that information will not be perfect because no one knows exactly what will happen in the future. The company makes estimates and uses those estimates to make the best decision it can. Ultimately, the land and building may be sold for more or less than the estimates, or the company may not be able to find a buyer at all. But as of the present, they use the assumptions available to them to make their projections about cash flows. And all the cash used in a net present value analysis is a projection, anyway.

    Lynn

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