CIMA BA2 Decision making: practice questions with answers

Question 1

Which of the following is a limitation of using expected values to choose between alternative projects?

1. A Expected values can be calculated only when there are exactly two possible outcomes
2. B Expected values cannot be used when the probabilities have been estimated from past data
3. C The expected value gives the greatest weight to the outcomes that are least likely to occur
4. D The expected value ignores the spread of possible outcomes, so it does not reflect the decision maker's attitude to risk

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Answer: D. Limitations of expected values:

- The EV is a long-run average; it is most useful for decisions that are repeated many times, and less useful for one-off decisions.
- The EV may not correspond to any possible actual outcome.
- It ignores risk: it says nothing about the spread of outcomes or the decision maker's attitude to risk.
- The probabilities used are often subjective estimates.

Question 2

A company draws a profit-volume (P/V) chart with sales revenue on the horizontal axis and profit or loss on the vertical axis. Which of the following statements about the chart is correct?

1. A The profit line cuts the vertical axis at a loss equal to total fixed costs
2. B The slope of the profit line is equal to the variable cost per $ of sales
3. C The profit line cuts the horizontal axis at the margin of safety
4. D The profit line starts at the origin, because no profit is made at zero sales

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Answer: A. On a P/V chart:

- At zero activity the line starts at a loss equal to fixed costs on the vertical axis.
- The line rises with a slope equal to the C/S ratio (if the horizontal axis shows revenue) or the contribution per unit (if it shows units).
- The line crosses the horizontal axis at the breakeven point.
- The margin of safety is the horizontal distance between budgeted sales and breakeven sales.

Question 3

Which of the following statements about the normal distribution is correct?

1. A About 68% of all values lie within two standard deviations of the mean
2. B Half of all values lie within one standard deviation of the mean
3. C All normal distributions with the same mean have the same spread
4. D It is symmetrical about the mean, so its mean, median and mode are equal

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Answer: D. Key properties of the normal distribution:

- Bell-shaped and symmetrical about the mean, so mean = median = mode.
- The total area under the curve is 1, with 0.5 on each side of the mean.
- It is fully described by its mean (position) and standard deviation (spread).
- About 68% of values lie within ±1 standard deviation, about 95% within ±1.96 (roughly 2) and about 99% within ±2.58 and about 99.7% within ±3.

Question 4

Ardmore Ltd is preparing a net present value (NPV) appraisal of a new five-year production project. Which of the following should be included as a cash flow in the appraisal?

1. A Depreciation of $16,000 a year on the new machinery, charged on a straight-line basis over the project's life
2. B Market research costing $8,000, carried out and paid for last year, which identified the demand for the product
3. C A $9,000 a year share of existing head office costs, which will not change, apportioned to the project
4. D Rent of $12,000 a year that Ardmore will no longer receive, because the project will use a warehouse currently let to a tenant

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Answer: D. An NPV appraisal includes only relevant cash flows: future, incremental cash flows that arise as a result of the decision.

- Include opportunity costs, such as rent or other income forgone because a resource is used on the project.
- Exclude depreciation and other non-cash items (the capital cost is included as a cash outflow when paid).
- Exclude sunk costs that have already been incurred, such as past market research.
- Exclude apportioned fixed overheads that will be incurred whether or not the project goes ahead.

Question 5

Strathmore Ltd sells a single product for $50 per unit. The variable cost is $30 per unit and fixed costs are $360,000 a year, giving a breakeven point of 18,000 units. If the selling price is increased by 10% and the variable cost per unit and fixed costs are unchanged, what will the new breakeven point be?

1. A 16,200 units
2. B 14,400 units
3. C 16,364 units
4. D 6,545 units

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Answer: B. - New selling price = 50 × 1.10 = $55
- New contribution per unit = 55 − 30 = $25 (up from $20, a 25% increase)
- New breakeven point = fixed costs / contribution per unit = 360,000 / 25 = 14,400 units

Question 6

Arnside Ltd borrows $60,000 at an interest rate of 8% a year. The loan is to be repaid in 6 equal annual instalments, each paid at the end of the year and covering both interest and capital. The annuity factor is (1 − (1 + r)^−n) / r. What is the annual instalment (to the nearest $)?

1. A $10,000
2. B $14,800
3. C $15,869
4. D $12,979

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Answer: D. The present value of the instalments at 8% must equal the amount borrowed:

Instalment × annuity factor = loan

- Annuity factor (6 years, 8%) = (1 − 1.08^−6) / 0.08 = (1 − 0.6302) / 0.08 = 4.6229
- Annual instalment = 60,000 / 4.6229 = $12,979