Question 11

Which of the following statements is CORRECT?

a. One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's
full life whereas IRR does not.

b. Since cash flows under the IRR and MIRR are both discounted at the same rate (the cost of
capital), these two methods always rank mutually exclusive projects in the same order.

c. One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the
MIRR is based on undiscounted cash flows.

d. One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested
at the cost of capital, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV
assumption is generally more appropriate.

e. One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a
project's full life whereas MIRR does not.

Question 12
A company expects sales to increase during the coming year, and it is using the AFN equation to forecast
the additional capital that it must raise. Which of the following conditions would cause the AFN
to increase?
a. The company increases its dividend payout ratio.

b. The company begins to pay employees monthly rather than weekly.

c. The company previously thought its fixed assets were being operated at full capacity, but now it
learns that it actually has excess capacity.

d. The company's profit margin increases.

e. The company decides to stop taking discounts on purchased materials.

Question 13
Which of the following statements is CORRECT?
a. Forecasted financial statements, as discussed in the text, are used primarily as a part of the
managerial compensation program, where management's historical performance is evaluated.

b. Perhaps the most important step when developing forecasted financial statements is to
determine the breakdown of common equity between common stock and retained earnings.

c. The capital intensity ratio gives us an idea of the physical condition of the firm's fixed assets.
 d. The first, and perhaps the most critical, step in forecasting financial requirements is to forecast
future sales.

e. The AFN equation produces more accurate forecasts than the forecasted financial statement
method, especially if fixed assets are lumpy, economies of scale exist, or if excess capacity exists.

Question 14
Yoga Center Inc. is considering a project that has the following cash flow and cost of capital (r) data.
What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be
rejected. 

r: 14.00%        

Year 0 1 2 3 4

Cash flows $400 $425 $450 $475

−$1,200
a. $41.25

b. $45.84

c. $62.88

d. $50.93

e. $56.59

0 -1200 1 -1200

1 400 0.877193 350.8772

2 425 0.769468 327.0237

3 450 0.674972 303.7372

4 475 0.59208 281.2381

NPV 62.87621

Question 15
Westbrook's Painting Co. plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00%
annual coupon, paid semiannually. The company's marginal tax rate is 25%, but Congress is considering
a change in the corporate tax rate to 15%. By how much would the component cost of debt used to
calculate the WACC change if the new tax rate was adopted?
a. 0.63%
b. 0.70%

c. 0.85%

d. 0.77%

e. 0.57%