CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers

• Question 1151:

  Marcus Corporation currently sells 150,000 units a year at a price of $4.00 a unit. Its variable costs are approximately 30 percent of sales, and its fixed costs amount to 50 percent of revenues at its current output level. Although fixed costs are based on revenues at the current output level, the cost level is fixed. What is Marcus's degree of operating leverage in sales dollars?

  A. 2.2

  B. 3.5

  C. 1.0

  D. 5.0

  E. 4.0

  Correct Answer: B

  Use the information provided and the formula for DOL in sales dollars: DOL(s) = [($150,000 x $4.00)180,000]/[($150,000 x $4.00)-180,000-300,000] = 3.5

• Question 1152:

  Regarding the net present value of a replacement decision, which of the following statements is false?

  A. The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow.

  B. The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow.

  C. An increase in net working capital is treated as an outflow when the project begins and as an inflow when the project ends.

  D. Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t =

  0.

  E. The after-tax market value of the old equipment is treated as an inflow at t = 0.

  Correct Answer: D

  Since the old equipment is sold at a loss which reduces taxable income, a tax savings is realized and is deducted from the investment outlay.

• Question 1153:

  Which of the following statements is most correct?

  A. The component cost of preferred stock is expressed as k(ps) (1 - T), because preferred stock dividends are treated as fixed charges, similar to the treatment of debt interest.

  B. Due to the way the Marginal Cost of Capital (MCC) schedule is constructed, the first breakpoint in the MCC schedule must be associated with using up all available retained earnings and having to issue common stock.

  C. The cost of equity obtained by using retained earnings is generally regarded as being the rate of return stockholders require on the firm's outstanding common stock.

  D. The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost.

  E. The bond-yield-plus-risk-premium approach to estimating a firm's cost of common equity involves adding a subjectively determined risk-premium to the market risk-free bond rate.

  Correct Answer: C

  Preferred stock dividends are not tax deductible; therefore, the component cost of preferred stock is only k (ps). The risk premium in the bond-yield-plus-risk premium approach would be added to the firm's cost of debt, not the risk-free rate. The first break point does not have to be associated with retained earnings. It could be from other sources of funds such as debt. The choice between preferred stock or common equity financing depends on a number of factors, including required return, flotation costs, management's desired capital structure, etc.

• Question 1154:

  Braun Industries is considering an investment project, which has the following cash flows: tProject Cash Flows 0-$1,000 1 400 2 300 3 500 4 400 The company's WACC is 10 percent. What is the project's payback, internal rate of return and net present value?

  A. Payback = 2.6, IRR = 24.12%, NPV = $300.

  B. Payback = 2.6, IRR = 21.22%, NPV = $260.

  C. Payback = 2.4, IRR = 21.22%, NPV = $260.

  D. Payback = 2.6, IRR = 21.22%, NPV = $300.

  E. Payback = 2.4, IRR = 10.00%, NPV = $600.

  Correct Answer: B

  Payback = 2 + 300/500 = 2.6 years.

  IRR: -1000 + 400/(1+Irr)^1 + 300/(1+Irr)^2 + 500/(1+Irr)^3 + 400/(1+Irr)^4 = 0: IRR = 21.22%.

  NPV = -1000 + 400/(1+.10)^1 + 300/(1+.10)^2 + 500/(1+.10)^3 + 400/(1+.10)^4 = $260.46.

• Question 1155:

  The date on which if you are listed by the company as an owner, you will receive a dividend is known as the:

  A. Holder-of-Record Date

  B. Declaration Date

  C. Beneficiary Date

  D. Payment Date

  E. Ex-Dividend Date

  Correct Answer: A

  The "Holder-of-Record Date" is the date on which if you are listed by the company as an owner, you will receive the dividend.

• Question 1156:

  Which of the following statements is most correct?

  A. The MIRR method will always arrive at the same conclusion as the NPV method.

  B. All of the statements are correct.

  C. The MIRR method can overcome the multiple IRR problem, while the NPV method cannot.

  D. None of the statements are correct.

  E. The MIRR method uses a more reasonable assumption about reinvestment rates than the IRR method.

  Correct Answer: E

  MIRR and NPV can conflict for mutually exclusive projects if the projects differ in size. NPV does not suffer from the multiple IRR problem.

• Question 1157:

  A project has the following cash flows over the next 5 years: $1,000, $600, $300, $1,200 and $1,400.

  Assume all cash flows occur at the end of a year. The project requires an initial cash outlay of $2,900. The

  project's cost of capital is 8%.

  The MIRR of the project equals ________.

  A. 11.54%

  B. 12.22%

  C. 9.92%

  D. 14.19%

  Correct Answer: B

  The MIRR is defined as that rate which discounts the terminal value of the cash inflows to equate to the present value of a project's costs (using the project's cost of capital). The present value of the costs = 2,900. The terminal value (future value at the end of year 5) of the project equals 1,000*1.084 + 600*1.083

  + 300*1.082 + 1,200*1.08 + 1,400 = 5,162. Note that this is calculated using the project's cost of capital. Then, MIRR satisfies 2,900 = 5,162/(1+MIrr)5. Solving gives MIRR = 12.22%.

• Question 1158:

  Which of the following statements is most correct?

  A. All else being equal, an increase in a firm's fixed costs will decrease its degree of operating leverage.

  B. All of these statements are correct.

  C. Firms that have large fixed costs and low variable costs have a higher degree of financial leverage than do firms with low fixed costs and high variable costs.

  D. If a firm's net income rises 10 percent every time its EBIT rises 10 percent, this implies the firm has no debt outstanding.

  E. None of these statements are correct.

  Correct Answer: D

  If no debt were used, there will be no interest charges, which is included in net income but not EBIT.

• Question 1159:

  Grateway Inc. has a weighted average cost of capital of 11.5 percent. Its target capital structure is 55 percent equity and 45 percent debt. The company has sufficient retained earnings to fund the equity portion of its capital budget. The before-tax cost of debt is 9 percent, and the company's tax rate is 30 percent. If the expected dividend next period and current stock price are $5 and $45, respectively, what is the company's growth rate?

  A. 3.44%

  B. 8.16%

  C. 2.68%

  D. 4.64%

  E. 6.75%

  Correct Answer: D

  Solve for k(s) (component cost of retained earnings or internal equity):

  WACC (Weighted Average Cost of Capital) = 11.5% = w(s)k(s) + w(d)k(d)(1 - T)

  11.5% = 0.55k(s) + 0.45(0.09)(0.70)

  k(s) = 15.75%.

  Solve for g: k(s) = 15.75% = D1/P0 + g

  15.75% = $5/$45 + g

  g = 4.64%.

• Question 1160:

  A project has the following cash flows over the next 5 years: $1,000, $600, $300, $1,200 and $1,400.

  Assume all cash flows occur at the end of a year. The project requires an initial cash outlay of $2,900. The

  project's cost of capital is 8%.

  The discounted payback period for the project equals ________.

  A. 4.11 years

  B. 3.84 years

  C. 4.81 years

  D. 4.36 years

  Correct Answer: D

  The discounted payback period is defined as the expected number of years that would be required to recover the original investment using discounted cash flows. The discounted cash flow at the end of year N is obtained by dividing that year's cash flow by 1.08^N, since the project's cost of capital is 8%. Using this, the discounted cash flows are: $926, $514, $238, $882 and $953. Recovery occurs in the 5th year. At the beginning of the 5th year, the outstanding balance equals 2,900-926-514-238-882 = $340. Therefore, the discounted payback period = 4 + 340/953 = 4.36 years.