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

• Question 1361:

  A project requires an initial outlay of 650. It also needs capital spending of 700 at the end of year 1 and 900 at the end of year 2. It has no revenues for the first 2 years but receives 1,200 in year 3, 1,600 in year 4 and 2,300 in year 5. The project's cost of capital is 10%. The project's NPV equals ________.

  A. $2,043

  B. $1,938

  C. $1,428

  D. $1,393

  Correct Answer: D

  The discounted cash flow at the end of year N is obtained by dividing that year's cash flow by 1.1N, since

  the project's cost of capital is 10%. Using this, the discounted cash flows are:

  -636, -744, +902, +1,093, +1,428.

  The Present value of the cash flows is = -636 - 744 + 902 + 1,093 + 1,428 = $2,043. The net present value

  of the project = $(2,043 - 650) = $1,393.

  Exam N

• Question 1362:

  A project's break-even point is 1,235 units when the average sale price per unit is $35 and the average variable cost equals $17.5 per unit. The fixed costs of the project are closest to ________.

  A. $613

  B. $21,612.5

  C. none of these answers

  D. $43,225

  Correct Answer: B

  The break-even sales revenue equal 1,235*$35 = $43,225. The total variable costs equal $17.5*1,235 = $21,612.5. The fixed costs are therefore equal to $43,225 - $21,612.5 = $21,612.5.

• Question 1363:

  A firm's capital structure consists of 35% debt with an after-tax cost of 5.2%. Common equity makes up 55% of the structure and the rest is made up of preferred equity. The preferred stock has a coupon of 7% and the required rate of return on the common stock is 13.7%. The firm's WACC is ________.

  A. 10.06%

  B. 15.61%

  C. none of these answers

  D. 13.24%

  E. 12.19%

  F. 11.95%

  G. 14.39%

  Correct Answer: C

  To get the WACC in this case, you need to have information on the cost of preferred stock. This is not necessarily equal to the coupon rate on the preferred equity. Rather, it is the discount rate that equates the present value of the perpetual payments on the preferred equity to its current price. Without the price information, you cannot get the cost of preferred equity and hence, WACC cannot be calculated.

• Question 1364:

  The date on which a firm's directors issue a statement declaring a dividend is known as ________.

  A. Ex-Dividend Date

  B. Declaration Date

  C. Payment Date

  D. Dividend Date

  E. Holder-of-Record Date

  Correct Answer: B

  The date on which a statement is issued by a firm's directors declaring a dividend is known as the "Declaration Date."

• Question 1365:

  Which of the following is the correct chronological order in dividend payment procedures?

  A. Declaration date, record date, ex dividend date, dividend payment date.

  B. Declaration date, dividend payment date, record date, ex dividend date.

  C. Declaration date, ex dividend date, record date, dividend payment date.

  D. Declaration date, ex dividend date, dividend payment date, record date.

  Correct Answer: C

  In the U.S., the ex dividend date, i.e. the date after which the stock does not carry with it the right to receive the declared dividend, is 4 business days before the record date. The record date is the last day for registering the ownership of the stock with the firm so that the dividend check is mailed to you and not someone else.

• Question 1366:

  Which of the following statements is most correct?

  A. All of these statements are correct.

  B. Stockholders pay no income tax on dividends reinvested in a dividend reinvestment plan.

  C. Investors receiving stock dividends must pay taxes on the new shares at the time the stock dividends are received.

  D. None of these statements are correct.

  E. "New-stock" dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don't change the total equity of a firm.

  Correct Answer: D

  Stock dividends are dividends paid in the form of additional shares of stock rather than in cash. The total number of shares is increased, so earnings, dividends, and price per share all decline. In a dividend reinvestment plan, the stockholder must pay taxes on the dividend amount, even though stock and not cash has been received.

• Question 1367:

  The Residual Dividend Model is characterized as which of the following?

  A. Dividend paid = EBIT (1 - combined state/federal tax rate) - preferred dividends - interest expense

  B. Dividend paid = EBIT - Interest expense (1 - combined state/federal tax rate)

  C. Dividend paid = EBIT - capital expenditures

  D. None of these answers

  E. Dividend paid = EBITA - proposed capital expenditures - interest expense

  F. Dividend paid = EBIT - Retained earnings which are necessary to maintain the firm's optimal capital budget

  Correct Answer: E

  The Residual Dividend Model is characterized by a firm paying out all earnings to common stockholders beyond that which is necessary to maintain the firm's optimal capital budget. Answer C correctly illustrates the calculation of the dividend paid according to the Residual Dividend Model.

• Question 1368:

  10 months ago, a firm had leased a downtown office for $5,000 per month. The lease runs for the next 2.5 years. The current office space of similar size rents at $4,000 per month. If the firm uses the space exclusively for a project over the next 6 months, the opportunity cost related to this equals ________.

  A. $5,000 per month

  B. insufficient information

  C. $4,000 per month

  D. zero

  Correct Answer: C

  Opportunity cost is based on current market cost. It does not matter what the firm originally paid or agreed to pay for the property in question. Of course, since taxes are based on actual costs, the afte rtax opportunity cost is definitely affected by historical contracts currently in force.

• Question 1369:

  Project A has a higher IRR than project B. Both projects have normal cash flows. If the projects have the same cost of capital which is greater than the crossover rate,

  A. Project A has a higher NPV.

  B. Both projects have the same NPV.

  C. Project B has a higher NPV.

  D. Insufficient information.

  Correct Answer: A

  The crossover rate is the discount rate at which the graphs of NPV versus discount rate for the two projects cross. Since the projects have normal cash flows, they will have a single crossover rate. Further, the project with the higher IRR has a "flatter" NPV profile. Therefore, if the cost of capital is larger than the crossover rate, the project with the flatter profile will have a larger NPV.

• Question 1370:

  Steadybeta currently operates 3 projects, resulting in a beta of 1.27. It is considering a risky expansion project whose cash flow analysis indicates a beta of 2.3. The project requires a capital commitment of $4.8 million and has an NPV of $2 million. The current risk-free rate is 5.6% and the market risk premium is 8.9%. Steadybeta's current market capitalization is $17.2 million. If Steadybeta undertook the project, the required rate of return expected by its shareholders will be:

  A. 14.8%

  B. 13.9%

  C. 19.5%

  D. 16.2%

  Correct Answer: C

  19.5% The firm can be considered a portfolio of 4 projects. The beta of a portfolio equals the weighted average of the betas of the individual components. The weight of a component equals the fraction of the market value it comprises. Since the project has an NPV of $2 million, its market value equals $6.8 million and the market value after the project is undertaken will be $(17.2+6.8) = $24 million. Therefore, the beta of the firm after it undertakes the project equals 17.2/24*1.27 + 6.8/24*2.3 = 1.56. The required rate of return then equals 5.6% + 1.56*8.9% = 19.5%.