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

• Question 1451:

  Photon Corporation has a target capital structure of 60 percent equity and 40 percent debt. The firm can raise an unlimited amount of debt at a before-tax cost of 9 percent. The company expects to retain earnings of $300,000 in the coming year and to face a tax rate of 35 percent. The last dividend was $2 per share and the growth rate of the company is constant at 6 percent. If the company needs to issue new equity, then the flotation cost will be $5 per share. The current stock price is $30. Photon has the following investment opportunities: Project Cost IRR 1 $100,000 10.5% 2 $200,000 13.0 3 $100,000 12.0 4 $150,000 14.0 5 $75,000 9.0

  A. $150,000

  B. $450,000

  C. $350,000

  D. $550,000

  E. $625,000

  Correct Answer: B

  Calculate the retained earnings break point (BPRE) as $300,000/0.6 = $500,000. Calculate ks as D1/P0 + g = $2(1.06)/$30 + 6% = 13.07%. Calculate ke as D1/(P0 - F) + g = $2(1.06)/($30 - $5) + 6% = 14.48%. Find WACC below BPRE as: WACC = 0.6(13.07%)+ 0.4(9%)(1 - 0.35) = 10.18%. Thus, up to $500,000 can be financed at 10.18%. Find WACC above BPRE as: WACC = 0.6(14.48%) + 0.4 (9%) (1 - 0.35) = 11.03%. Thus, financing in excess of $500,000 costs 11.03%. Projects 2, 3, and 4 all have IRRs exceeding either WACC and should be accepted. These projects require $450,000 in financing. Project 1 is the next most profitable project. Given its cost of $100,000, half or $50,000 can be financed at 10.18% and the other half must be financed at 11.03%. The relevant cost of capital for Project 1 is then 0.5(10.18%) + 0.5(11.03%) = 10.61%. Since Project 1's IRR is less than the cost of capital, it should not be accepted. The firm's optimal capital budget is $450,000.

• Question 1452:

  Monte Carlo simulation

  A. All of the answers are correct.

  B. Is capable of using probability distributions for variables as input data instead of a single numerical estimate for each variable.

  C. Produces both an expected NPV (or IRR) and a measure of the riskiness of the NPV or IRR.

  D. None of the answers are correct.

  E. Can be useful for estimating a project's stand-alone risk.

  Correct Answer: A

  These are all true.

• Question 1453:

  Proponents of which of the following theories would claim that companies seek to balance the tax shelter benefits of debt financing with the increased interest rates and risk of bankruptcy that come with increased debt levels?

  A. Modigliani and Miller's "with-taxes" Theory of Capital Structure

  B. Bird-in-the-Hand Theory

  C. Modigliani and Miller's Theory of Capital Structure

  D. Tax Preference Theory

  E. Signaling Theory

  F. Trade-off Theory of Leverage

  Correct Answer: F

  Trade-off Theory of Leverage The Trade-off Theory of Leverage claims that firms will seek to balance the tax-shelter benefits of debt financing with the increased interest costs and risk of bankruptcy that come with increased debt levels. The Trade-off Theory of Leverage came about largely from criticisms raised against the Modigliani andMiller Theory of Capital Structure under the "with-taxes" assumption. MandM claimed that, under a restrictive set of assumptions, the value of firms would be maximized only when their capital structure is comprised of 100% debt. The Trade-off Theory of Leverage proposed a more realistic and moderate answer to the Capital Structure debate, and remains an important milestone in the field of Pure Finance.

• Question 1454:

  Despite relative congruence in their ranking methods, NPV and MIRR will sometimes produce conflicting answers. Which of the following correctly illustrates an example in which the two methods would likely produce conflicting rankings?

  I. When examining projects with non-normal cash flows

  II. When examining projects that differ substantially in scale

  III. When examining independent projects

  IV.

  When examining projects that differ substantially in their lifespan

  A.

  I and III

  B.

  I and II

  C.

  II and IV

  D.

  II and IV

  Correct Answer: C

  While the MIRR method is designed to tackle many of the problems associated with the traditional IRR calculation, there exist situations in which the MIRR will produce rankings which conflict with those produced by the NPV method. Specifically, when mutually-exclusive projects whose lifespans or scale differ substantially are being examined. In these situations, the NPV calculation should be relied on, as this method is considered to produce the correct results.

• Question 1455:

  If a new option contract is listed on an option exchange and only one trader buys one contract in the first day, the open interest after that day is:

  A. two contract.

  B. zero contract.

  C. cannot be determined with this information.

  D. one contract.

  Correct Answer: D

• Question 1456:

  A property has a potential gross rental income (PGRI) of $740,000. Operating expenses, excluding insurance and property taxes, amount to 30 percent of gross rents. Insurance and property taxes total $16,800. If the market capitalization rate is 22 percent, what is the value of this property?

  A. $1,726,667.

  B. $2,410,667.

  C. $2,430,909.

  D. $2,278,182.

  Correct Answer: D

  

• Question 1457:

  You need to estimate the market value of an income producing property located in your town. Through research you have found that the property should have net operating income of $956,000, taxes of $143,400, a capitalization rate of 16 percent, and an inflation rate of 3 percent. What is the estimated property value?

  A. $5,078,750.

  B. $5,975,000.

  C. $7,353,846.

  D. $8,456,923.

  Correct Answer: B

  

• Question 1458:

  Based on the following information, what is the net asset value (NAV) per share. There are currently no expenses and no load. Cap Stock Sold $109,000 Price per share $10

  

  A. $13.26.

  B. $27.03.

  C. $15.96.

  D. $27.03.

  Correct Answer: C

  

• Question 1459:

  You are going to invest in a closed-end mutual fund and are told that the net asset value of the fund is $20.40, and the share price is $18.20. What is the discount you would receive or the premium that you would pay?

  A. 0.1209.

  B. -0.1209.

  C. -0.1078.

  D. 0.1078.

  Correct Answer: C

  

• Question 1460:

  A fund to be purchased had a net asset value (NAV) of $72.40 and a load of 5 percent. What is the offering price per share?

  A. $76.211.

  B. $3.811.

  C. $76.020.

  D. $72.400.

  Correct Answer: A