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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1061:

  Which of the following Companies has the highest degree of financial leverage? Firm A EBIT: $1,500,000 Interest Paid: $130,000 Total Operating Expenses: $600,000 Fixed Operating Expenses: $350,000 Firm B EBIT: $400,000 Interest Paid: $55,000 Total Operating Expenses: $1,300,000 Fixed Operating Expenses: $1,000,000 Firm C EBIT: $500,000 Interest Paid: $45,000 Total Operating Expenses: $6,000,000 Fixed Operating Expenses: $4,750,000 Firm D EBIT: $995,000

  Interest Paid: $105,000 Total Operating Expenses: $5,000,000 Fixed Operating Expenses: $3,000,000 Firm E EBIT: $995,000 Interest Paid: $120,000 Total Operating Expenses: $5,900,000 Fixed Operating Expenses: $2,000,000

  A. Firm D
  B. Firm A
  C. Firm B
  D. Firm C
  E. Firm E
  C. Firm B

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  Explanation

  The Degree of Financial Leverage (DFL) measures the percentage change in EPS that results from a given percentage change in EBIT. Financial Leverage is the second component of total leverage, along with Operating Leverage. The equation used to calculate the Degree of Financial Leverage is as follows: {DFL = [EBIT/(EBIT - Interest Paid)]}. In this example, Firm B has the highest DFL, with a figure of 1.15942. Remember that the Degree of Financial Leverage can never be less than one, and can never be negative In a situation where thecompany under examination has zero interest expense, the DFL would be equal to one, i.e. the EBIT is equal to the EBIT minus the interest expense. Another important note to remember is that in calculating the Degree of Financial Leverage, dividend payments to preferred stockholders should be included in the interest expense figure. Operating expenses are not factored into the DFL calculation, rather are used in the determination of Operating Leverage.

• Question 1062:

  Which of the following statements is most incorrect?

  A. All of these answers are correct.
  B. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure.
  C. The optimal capital structure minimizes the WACC.
  D. None of these answers are correct.
  E. Increasing the amount of debt in a firm's capital structure is likely to increase the cost of both debt and equity financing.
  B. If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure.

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  Explanation

  This statement is not always true.

• Question 1063:

  Karen Callaway is an investor in the 35% tax bracket. She is evaluating a tax-exempt municipal security with a tax-exempt yield of 4. 5%. What is the taxable equivalent yield (TEY) of the municipal security?

  A. 2. 9%.
  B. 6. 9%.
  C. 12. 9%.
  C. 12. 9%.

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  Explanation

• Question 1064:

  Freelancers.com, a publishing agency, has an issue of preferred stock outstanding. The preferred stock of Freelancers pays a semiannual dividend of $0.40, and this dividend is not expected to grow in the foreseeable future. Similar investments are currently warranting a 12. 5% per year required rate of return.

  What is the value of Freelancers' preferred stock? Further, is this preferred stock valued as a perpetuity or as a finite series of cash flows?

  A. $6. 40; finite series of cash flows
  B. $3. 20; perpetuity
  C. None of these answers is completely correct.
  D. $6. 40; perpetuity
  E. The answer cannot completely be calculated from the information provided.
  F. $3. 20; finite series of cash flows
  D. $6. 40; perpetuity

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  Explanation

  Preferred stock is commonly valued as a perpetuity using the following equation: {P0 = [d1 / k]}

  Where: P0 = the price of the preferred stock at time 0, d1 = the annual dividend at t1, and k = the required rate of return.

  In this example, the dividend is provided as a semiannual figure, which must be doubled to show the annual dividend. After this adjustment has been made, the value of the preferred stock can be found as follows:

  {P0 = [$0.80 / 0.125] = $6. 40}

  Preferred stock is commonly valued as a perpetuity because there is no finite conclusion to the projected series of cash flows for a preferred stock. Unlike a bond, whose cash flows are characterized by a finite lifespan (i.e. the cash flows of a

  bond cease at maturity), the cash flows (dividends) produced by a preferred stock could theoretically last forever.

• Question 1065:

  Consider the following annual growth forecasts for a common stock:

  Growth in years 1-3 = 25%

  Growth after year 3 = 15%

  Assuming that the last dividend was $2. 25 per share, and the required rate of return is 20% per year, what is the value of this common stock?

  A. $63. 78
  B. $58.23
  C. $71.92
  D. $65. 82
  E. None of these answers is correct.
  F. $72. 10
  D. $65. 82

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  Explanation

  To determine the value of a common stock experiencing temporary supernormal growth, use the following equation:

  {V = {[d0 * (1 + gs)^1] / k} + {[d1 * (1 + gs)^2} + ... {dn * (1 + gs)^n} + {[dn * (1 + gs)^n * (1 + gn] / (k - g)}/ (1 + k)^n}}

  Where: V = the value of common stock at t0, d0 = the dividend at t0, d1 = the dividend at t1, dn = the dividend at tn, gs = the supernormal rate of growth, gn = the normal rate of growth, n = the time period "n", and k = the required rate of

  return.

  In this example, there is a supernormal growth period of three years, during which the growth rate of this common stock is expected to grow at 25% annually. After this period of supernormal growth, the growth rate is anticipated to settle to a

  "normal" rate of 15%, and this rate is expected to remain stable indefinitely. The calculation of the value of this common stock is illustrated as follows:

  {V = {[$2. 25 * (1.25)^1] / (1.20)} + {[$2. 25 * (1.25)^2] / (1.20)^2} + {[$2. 25 * (1.25)^3] / (1.20)^3}{{[$2. 25 * (1.25)^3 * (1.15)^1]/ (0.20 - 0.15)}/ (1.20)^3}

  which can be deduced to the following:

  {V = [$2. 34375 + $2. 441406 + $2. 543132 + $58.492025] = $65. 82}

• Question 1066:

  Which of the following statements about security market line (SML) is least likely to be true?

  A. The SML must be graphed using the standard deviation of the market portfolio.
  B. The SML measures risk using the standardized covariance of the stock with the market.
  C. Securities plotting above the SML are undervalued.
  A. The SML must be graphed using the standard deviation of the market portfolio.

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  Explanation

• Question 1067:

  What is the standard error of estimate?

  A. Based on squared vertical deviations between Y and Y'
  B. None of these answers
  C. Measure of the accuracy of the prediction
  D. Cannot be negative
  E. All of these answers
  E. All of these answers

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  Explanation

  All the descriptions are correct for the standard error of estimate.

• Question 1068:

  George Black, CFA, is examining the financial performance of Clay Industries, a large industrial firm, and has assimilated the following information from the most recent fiscal year:

  Adjusted operating profit before tax: $13,900,000 Cash operating taxes: $4,350,000 Cost of capital: 15. 60% per year Total capital employed: $56,500,000

  Using this information, what is the Economic Value Added for Clay Industries? Further, should the management of Clay Industries be considered to have created economic value for shareholders?

  A. ($736,000); management has not created economic value
  B. $736,000; management has not created economic value
  C. None of these answers is correct.
  D. ($736,000); management has created economic value
  E. $736,000; management has created economic value
  F. $850,000; management has created economic value
  E. $736,000; management has created economic value

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  Explanation

  Economic Value Added, a value-based measure of economic profit, is a registered trademark of Stern, Stewart and Company. The equation used to calculate EVA is as follows:

  EVA = {Net Operating Profits Less Adjusted Taxes - [Total Capital Employed * (Cost of Capital)]}.

  In this case, the NOPLAT figure must be calculated manually by subtracting the Cash Operating Taxes from the Adjusted Operating Profit before Tax (AOPBT) figure. Doing so will produce an answer of $9,550,000 for the Net Operating Profit

  less Adjusted Taxes figure. Now that the necessary information has been determined, the calculation of EVA is as follows:

  EVA = {$9,550,000 - ($56,500,000 * 0.156)} = $736,000

  A positive EVA calculation indicates that management has provided economic profits to shareholders, as evidenced by the fact that the opportunity cost of capital employed is less than the NOPLAT figure. In this example, the management of

  Intelligent Semiconductor should be considered as having succeeded in providing shareholder value.

  The calculation of Adjusted Operating Profit Before Taxes (AOPBT), and Cash Operating Taxes are important. The calculation of AOPBT is as follows:

  Operating profit (after depreciation and amortization) + Implied interest on operating leases + any increase in the LIFO reserve + goodwill amortization = Adjusted Operating Profit Before Taxes.

  Cash Operating Taxes, another important component of EVA, is calculated as follows:

  Cash Operating Taxes = Income Tax Expense + tax benefit from interest expenses + tax benefit from interest on leases + taxes on non-operating income

  Adjusted Operating Profit Before Taxes minus Cash Operating Taxes = Net Operating Profit Less Adjusted Taxes (NOPLAT). Subtracting the dollar cost of capital from the NOPLAT figure will yield the EVA.

• Question 1069:

  On Jan 1, a firm had 700 stocks outstanding. On May 1, it issued 300 more shares. On October 1, it repurchased 100 shares. If the firm's net income was 12,000 and it paid a preferred dividend of 1,400, its reported EPS is ________.

  A. 12
  B. 10.6
  C. 11.77
  D. 12. 1
  D. 12. 1

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  Explanation

  For a simple capital structure, EPS = (Net Income - Preferred stock dividends)/weighted # of common shares To calculate the weighted # of shares, note that 600 shares remained outstanding for 12 months, 100 shares for 9 months and 300 shares for 8 months. Therefore, weighted shares = 12/12*600 + 9/12*100 + 8/12*300 = 875. EPS = (12,000 - 1,400)/875 = 12. 11.

• Question 1070:

  How long will it take for an initial deposit of $1,500 to grow to be $4,000, if the interest rate is 5% per year, compounded annually?

  A. 16. 93 years
  B. 20.10 years
  C. 17. 72 years
  D. 14. 48 years
  E. 24. 03 years
  B. 20.10 years

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  Explanation

  Either the $1,500 or the $4,000 must be entered as a negative number - it won't matter which. On the BAII Plus, press 5 I/Y, 1500 PV, 0 PMT, 4000 +/- FV, CPT N. On the HP12C, press 5 i, 2500 PV, 0 PMT, 4000 CHS FV, n. Note that the HP12C will indicate 21 years for the answer. Make sure the BAII Plus has the P/Y value set to 1.