Chartered Institute of Management Accountants (CGMA) · Advanced Management Accounting
CIMA P2 Capital investment decision making: practice questions with answers
6 free exam-style questions on Capital investment decision making for CIMA P2 Advanced Management Accounting. Try each one, then open the answer to read the explanation. Fincora has 84 original questions on this syllabus area.
Question 1
Which of the following is a benefit of carrying out post-completion audits of capital projects?
- A It allows the original investment decision to be reversed without cost once the audit is complete
- B It replaces the need to monitor the project's costs and progress while it is being implemented
- C It encourages managers to make realistic forecasts and helps improve the appraisal of future projects
- D It ensures that every project, however small, is reviewed in full detail regardless of the cost of the audit
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Answer: C. A post-completion audit (PCA) compares a project's actual costs, benefits and outcomes with the forecasts made when it was approved. Its benefits include:
- discouraging over-optimistic forecasts, because managers know they will be checked
- improving future forecasting and appraisal through lessons learned
- identifying projects that should be changed or abandoned
Its drawbacks include cost, the difficulty of isolating a project's cash flows, and the risk of a blame culture that discourages sensible risk-taking. Because of the cost, PCAs are usually applied selectively.
Question 2
Which of the following statements about the use of Monte Carlo simulation in capital investment appraisal is correct?
- A It produces a probability distribution of possible NPVs by repeatedly sampling values of the uncertain variables
- B It changes one variable at a time to find how far that variable can move before the NPV becomes zero
- C It removes the need to estimate probability distributions for the key variables in the project
- D It identifies a single correct decision, so management judgement is no longer needed
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Answer: A. Monte Carlo simulation assigns a probability distribution to each uncertain variable (for example sales volume, price, costs), uses random numbers to select a value for each, computes the NPV, and repeats this many times. The result is a distribution of NPVs from which managers can read the expected NPV, the spread and the probability of a negative NPV.
It can model many variables changing together and their interdependencies, unlike sensitivity analysis, but it is only as good as the estimated distributions, and it still needs management judgement about acceptable risk.
Question 3
Which of the following is an advantage of the discounted payback method over the simple (non-discounted) payback method?
- A It takes into account all cash flows arising after the payback period
- B It always gives a shorter payback period, which reduces the risk of the project
- C It shows the absolute increase in shareholder wealth from the project
- D It allows for the time value of money when measuring how quickly the investment is recovered
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Answer: D. Discounted payback is the time taken for the cumulative present value of cash inflows to equal the initial investment.
- Advantage over simple payback: it reflects the time value of money (and so the cost of capital)
- Limitation shared with simple payback: it ignores cash flows after the payback point, so it does not measure total value created
Because discounted inflows are smaller, discounted payback is always at least as long as simple payback.
Question 4
Which of the following statements about sensitivity analysis in investment appraisal is correct?
- A It shows the effect on NPV of changes in several variables at the same time
- B It shows how far a single variable can change before the NPV falls to zero, but not how likely that change is
- C It produces a probability distribution of the project's possible NPVs
- D It removes risk from the project by identifying the critical variables
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Answer: B. Sensitivity analysis measures the percentage change in each key variable (e.g. sales volume, price, cost) that would reduce the NPV to zero. Variables with a small margin of safety are critical.
Limitations:
- only one variable is changed at a time, but in practice variables are often related
- it gives no indication of probability
- it does not provide a decision rule; management must judge whether the margins are acceptable
Question 5
Which of the following shows the stages of the capital investment process in the correct order?
- A Screening, origination of proposals, implementation, detailed appraisal and approval, post-completion audit
- B Origination of proposals, detailed appraisal and approval, post-completion audit, screening, implementation
- C Detailed appraisal and approval, origination of proposals, screening, implementation, post-completion audit
- D Origination of proposals, screening, detailed appraisal and approval, implementation, post-completion audit
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Answer: D. A typical capital investment process:
1. Origination of proposals: identifying investment opportunities
2. Screening: initial review for strategic fit and feasibility
3. Detailed appraisal and approval: financial (e.g. NPV) and non-financial analysis, then authorisation
4. Implementation: monitoring and controlling the project as it proceeds
5. Post-completion audit: comparing actual results with forecasts to learn lessons for the future
Question 6
Bramcote Hotels carries out post-completion audits (PCAs) on its major refurbishment projects. Which of the following is a genuine limitation of post-completion audits?
- A It can be hard to separate one project's cash flows from the rest of the business, so actual results may not be measured reliably
- B They provide no useful information, because all of a project's costs are sunk once it has been completed and paid for
- C They make detailed appraisal before approval unnecessary, which weakens the control over capital spending
- D They can only be carried out after the end of a project's whole life, so their findings always come too late to act on
Show the answer
Answer: A. A post-completion audit compares a project's actual costs and benefits with those forecast when it was approved.
Benefits: it improves the realism of future forecasts (managers know they will be checked), helps learn lessons for future appraisals, can identify corrective action or abandonment, and improves control.
Limitations:
- difficulty in isolating the cash flows that result from one project when it interacts with others;
- it can be costly and time-consuming, so it is usually applied selectively to large or risky projects;
- many uncontrollable factors affect outcomes, so differences may not be the managers' fault;
- it may make managers over-cautious, rejecting risky but worthwhile projects;
- it can be seen as a blame exercise, reducing co-operation.
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