CFA Institute CFA-LEVEL-1 Online Practice Questions and Exam Preparation

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 91:

  J_Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. The firm's current after-tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate. The firm's preferred stock currently sells for $90 a share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock. Ross expects to retain $15,000 in earnings over the next year. Ross' common stock currently sells for $40 per share, but the firm will net only $34 per share from the sale of new common stock. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. What will be the WACC above the break point?

  A. 11.9%
  B. 8.3%
  C. 12. 5%
  D. 14. 1%
  E. 10.6%
  A. 11.9%

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  Explanation

  Preferred stock return: 10/80 = 12. 5% WACC = 6%(0.40) + 12. 5%(0.10) + 16. 5%(0.50) = 11.90%.

• Question 92:

  Which of the following terms describes what happens when the introduction of a new product causes the sales of existing products to decrease?

  A. Opportunity Cost
  B. Sunk Cost
  C. Externality
  D. Incremental Cash Flow
  E. Cannibalization
  E. Cannibalization

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  Explanation

  When the introduction of a new product causes the sales of existing products to decrease, it is called cannibalization.

• Question 93:

  A firm has a net profit margin of 25%. Its total asset turnover equals 1.3 and equity turnover equals 2. 1. The firm's ROE and financial leverage equal ________.

  A. 28.6%, 1.47
  B. 43. 2%, 1.33
  C. 52. 5%, 1.62
  D. 39.8%, 0.62
  C. 52. 5%, 1.62

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  Explanation

  ROE = net income/equity = (net income/sales)*(sales/equity) = net profit margin * equity turnover = 25%*2. 1 = 52. 5% Financial Leverage = Total assets/equity = (total assets/sales)*(sales/equity) = (1/asset turnover)*(equity turnover) = 2. 1/1.3 = 1.62.

• Question 94:

  Dhana Urbanek is a new CFA Charterholder and is considering multiple job offers. She is most interested in managing a fund for an institutional client with high liquidity needs and a short time horizon that also must manage tax consequences. Which of the following institutional investors is she most likely to select?

  A. Satori University Endowment Fund.
  B. Northern State Bank.
  C. Caliber Life Insurance.
  D. Inka Point Defined Benefit Pension Plan.
  B. Northern State Bank.

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  Explanation

  Urbanek is most likely to select the bank because it meets all her criteria. Banks have high liquidity needs and short time horizons due to the need to maintain a positive spread and the need to payout deposits and fund loans. In addition, banks are subject to taxation at the state and Federal levels. Endowment funds and pension funds do not meet any of her criteria ?they generally have low liquidity needs, long time-horizons, and are usually tax-exempt. The liquidity needs and time horizons of life insurance companies depend on the specific products offered. However, they generally have lower liquidity needs and longer time horizons than banks, and usually only a portion of income is taxable.

• Question 95:

  In a sample of 2,000 persons, 1,600 favored more strict environmental protection measures. What is the estimated population proportion?

  A. 0.82 or 82%
  B. 0.20 or 20%
  C. 0.16 or 16%
  D. None of these answers
  E. 0.80 or 80%
  E. 0.80 or 80%

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  Explanation

  Population proportion is given by 1600/2000 = 0.80

• Question 96:

  If you deposit $10,000 into an account paying 6% per year, compounded semiannually, how much do you have in the account in 8 years?

  A. $15,938.48
  B. $16,047. 06
  C. $12,667. 70
  D. $14,800.00
  E. $25,403. 52
  B. $16,047. 06

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  Explanation

  On the BAII Plus, press 16 N, 6 divide 2 = I/Y, 10000 PV, 0 PMT, CPT FV. On the HP12C, press 16 n, 6 ENTER 2 divide i, 10000 PV, 0 PMT, FV. Note that the answer will be displayed as a negative number. Make sure the BAII Plus has the value of P/Y set to 1.

• Question 97:

  The scotch whiskey distilling industry is most likely in which stage of the industry life cycle? Further, what type of earnings multiple and payout ratio should be expected from firms in this industry?

  A. Accelerating growth, high multiple and low payout
  B. Mature growth, low multiple and high payout
  C. Mature growth, high multiple and high payout
  D. Sales decline, low multiple and high payout
  E. Development, high multiple and low payout
  F. Decelerating growth, low multiple and high payout
  B. Mature growth, low multiple and high payout

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  Explanation

  The industry life cycle is divided into five distinct stages. Specifically, the industrial life cycle progresses from the development stage to an accelerating growth stage to a mature growth stage to a market maturation and stabilization stage. Finally, the fifth stage of the industrial life cycle is characterized by decelerating growth and sales decline. During the mature growth stage, sales are still growing, albeit slowly. During the last stage of the industrial life cycle, however, is characterizes by a decline in annual sales.

  As an industry or company progresses through the industrial life cycle, sales begin to grow rapidly (accelerating growth) then slow considerably as the product or service begins to reach critical mass (mature growth). During the mature growth stage, the industry or company grows at a slower pace, until eventually growth begins to slow considerably (market maturity and stabilization) as the market for the industry or company's products becomes more completely defined. Finally, the industry will begin to decline, as it advances to the last stage in the industry life cycle.

  The market for scotch whiskey is mature, and very defined. Companies who are in the scotch whiskey distilling industry should be expected to have slow to mediocre annual sales growth, and thus should warrant a lower earnings multiple. In this same light, firms in the scotch whiskey industry are likely to have inferior investment opportunities, holding everything else equal. So said, shareholders of these firms will likely require high dividend payments to compensate for the slow anticipated earnings growth.

• Question 98:

  Which of the following is/are true about turnover ratios?

  I. A high receivables turnover ratio might imply overly lax credit policy.

  II. A low inventory ratio implies that capital might be locked up for a long time in excess inventory.

  III.

  A high payables turnover ratio implies that the firm is lagging behind in its credit payments.

  A. II only
  B. I, II and III
  C. I and II
  D. I and III
  A. II only

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  Explanation

  The receivables turnover is the ratio of net sales to average receivables. If this ratio is high, then it indicates that the receivables are relatively low compared to sales. This could happen if the credit policy is stringent, forcing fewer sales on credit. The inventory turnover is the ratio of net sales to average inventory. A low value for this ratio indicates that the firm is maintaining a high level of inventory to maintain the sales. This might be an indicator (though not necessarily) that capital is being locked up in excess inventory. The payables turnover ratio is the ratio of the cost of goods sold to average trade payables. A high ratio implies that the payables are not very high compared to the COGS. This will happen when the firm is paying off its payables debt at a quick pace.

• Question 99:

  Jacobi Lefebre, CFA, recently accepted a position in the Real Estate Strategy group of a large retail company. The Director of the group walks by Lefebre's cubicle, hands him a report with the following information, and asks Lefebre to

  determine how large a project the firm can undertake without increasing the marginal cost of capital.

  The firm can undertake a project costing up to approximately:

  A. $54 million.
  B. $81 million.
  C. $83 million.
  D. $29 million.
  A. $54 million.

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  Explanation

  This question is asking you to calculate the retained earnings break even point BPRE(in relation to the marginal cost of capital). Once the breakeven point is reached, the firm will have to use external equity to fund projects, thus increasing

  the weighted average cost of capital (WACC).

  The break point on the marginal cost curve is given by:

  BPRE= (Retained Earnings) / (Equity Fraction, we)

  Here, RE = earnings * (1 ?Payout) = $50 million * (1 ?0.35) = $ 32. 5 million,

  And BPRE= $32. 5 million / 0.60 = $54. 17 million, or approximately $54 million.

• Question 100:

  Which of the following best describes the first step in the Top Down Approach to security valuation?

  A. None of these answers
  B. Analysis of the growth potential of specific industries
  C. Identification of geographical growth trends
  D. Analysis of specific companies
  E. Analysis of the Macroeconomic Environment
  E. Analysis of the Macroeconomic Environment

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  Explanation

  The "top down" approach to investment identification begins with an analysis of the macroeconomic environment, then moving on to an analysis of specific regions and countries. The later stages of the top-down approach involve the analysis of specific industries and end with the analysis of specific companies.

  While "identification of geographical growth trends" is an appealing choice, it does not represent the best possible answer. Had the question asked for the first step in the Bottom Up approach, then "analysis of specific companies" would have been the correct choice.