Level I — Practice Set

Quantitative Methods: Time Value of Money & Financial Statement Analysis: Ratios

Each topic includes two difficult multiple-choice questions. The answer key is at the bottom.

Time Value of Money

Question 1

Two mutually exclusive projects (A and B) have conventional cash flows. Project A has larger near-term inflows, while Project B’s inflows are back-loaded but larger in total. At the firm’s 10% WACC, NPV(A) > NPV(B). At 18%, NPV(B) > NPV(A). Which statement is most accurate?

  1. The crossover rate is < 10%; MIRR will rank B above A at all rates.
  2. The crossover rate is between 10% and 18%; IRR’s reinvestment assumption helps explain the ranking conflict.
  3. NPV profiles will not intersect because both have conventional cash flows; ranking change is a calculation error.
  4. If cash flows are scaled equally, NPV and IRR must always agree on ranking regardless of timing differences.

Question 2

Consider a growing annuity with first cash flow \(C_1\) at \(t=1\), growth rate \(g\), and discount rate \(r\) where \(r\) is only slightly larger than \(g\) (i.e., \(r \approx g^+\)). Which sensitivity is most important for the present value and why?

  1. Growth sensitivity is minor; PV is mostly driven by \(C_1\) because the horizon is finite.
  2. PV is highly sensitive to the spread \((r - g)\); small changes in either parameter can materially swing PV.
  3. Discount rate dominates; as \(r\) increases slightly, PV rises sharply due to convexity.
  4. Neither \(r\) nor \(g\) matters much; timing dominates when \(r \approx g\).

Financial Statement Analysis — Ratios

Question 3

In a period of rising input prices and stable demand, a company switches from FIFO to weighted-average for inventory. Immediately after the change (all else equal), which combined effect is most likely in the next reporting period?

  1. COGS ↓, Inventory ↓, Current Ratio ↓, Debt/EBITDA ↑
  2. COGS ↑, Inventory ↑, Current Ratio ↑, Debt/EBITDA ↓
  3. COGS ↓, Inventory ↑, Current Ratio ↑, Debt/EBITDA ↑
  4. COGS ↑, Inventory ↓, Current Ratio ↓, Debt/EBITDA ↑

Question 4

A firm begins capitalizing development costs it previously expensed. In the early years following this policy change, which impact on performance metrics is most likely (all else equal)?

  1. ROE ↑; Interest coverage ↑; CFO ↑
  2. ROE ↑; Interest coverage ↓; CFO ↑
  3. ROE ↓; Interest coverage ↑; CFO ↓
  4. ROE ↑; Interest coverage ↑; CFO ↓

Answer Key

Notes:
• Q1: Ranking reversal implies a crossover rate between 10% and 18%. IRR assumes reinvestment at IRR; MIRR fixes reinvestment rate at WACC, often resolving conflicts.
• Q2: When \(r \approx g\), PV is extremely sensitive to the spread \((r-g)\)—small changes in either parameter can swing PV materially.
• Q3: Rising prices → Avg COGS exceeds FIFO COGS (COGS ↑), ending inventory under average is lower than FIFO (Inventory ↓), current ratio tends to fall; EBITDA roughly unchanged so Debt/EBITDA ↑.
• Q4: Capitalizing boosts near-term earnings (ROE ↑), reduces operating expense → interest coverage improves; capitalization moves cash outflows to investing, so CFO decreases (CFFO ↓). Hence D.