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

• Question 1481:

  Dana Leone, Level 2 candidate in the CFA Program, is a manager in the capital planning division of a large consumer products company. Today, she must decide whether to recommend Project Forrest or Project Trieste to the Division Director. Leone's assistant has determined the following information about the projects (which are of approximately the same size and life):

  

  Note:NPV = Net Present Value MIRR = Modified Internal Rate of Return PBP = Pay Back Period WACC = Weighted Average Cost of Capital Based on the information in the above table, which of the following statements is FALSE? If company management is most concerned with:

  A. increasing the value of the firm, Leone should recommend Project Forrest.

  B. liquidity, Leone should recommend Project Trieste.

  C. return safety margin, Leone should recommend Project Forrest.

  D. shareholder interests, Leone should recommend Project Trieste.

  Correct Answer: A

  Since Leone can recommend either Forrest or Trieste, this question should be answered using the decision rules for mutually exclusive projects. For a company most interested in shareholder wealth and increasing the value of the firm (which are the same concept), Project Trieste is best because it has the higher NPV. NPV is the measure that indicates the direct impact on shareholder wealth. The other statements are true. The PBP measures liquidity, i.e., the shorter the PBP, the higher the liquidity.The IRR method does provide a measure of safety margin (and Project Forrest does have the highest IRR).

• Question 1482:

  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.

  Correct Answer: A

  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 1483:

  Helmut Humm, manager at a large U.S. firm, has just been assigned to the capital budgeting area to replace a person who left suddenly. One of Humm's first tasks is to calculate the company's weighted average cost of capital (WACC) ?and fast! The CEO is scheduled to present to the board in half an hour and needs the WACC ?now! Luckily, Humm finds clear notes on the Target capital component weights in the current workpapers. Unfortunately, all he can find for the cost of capital components is some handwritten notes. He can make out the numbers, but not the corresponding capital component. As time runs out, he has to guess. Here is what Humm deciphered: If Humm guesses correctly, the WACC is:

  A. 10.1%.

  B. 10.4%.

  C. 9.7%.

  D. 11.0%.

  Correct Answer: B

  If Humm remembers to order the capital components from cheapest to most expensive, he can calculate WACC. The order from cheapest to most expensive is: debt, preferred stock (which acts like a hybrid of debt and equity), retained earnings, and common stock. (Remember that internal equity ?retained earnings is cheaper than external equity 璫ommon equity due to floatation costs.) Then, using the formula for WACC

  = (wd)(kd) + (wps)(kps) + (ws)(ks)+ (we)(ke)

  where wd, wps, wsandweare the weights used for debt, preferred stock, retained earnings, and common

  equity.

  WACC = (0.30 * 6.0%) + (0.20 * 8.5%) + (0.15 * 11.00%) + (0.35 * 15.0%) =10.4%.

• Question 1484:

  Based upon the following information, what is the net operating income of the property?

  

  A. $104,000.

  B. $98,600.

  C. $114,600.

  D. $120,000.

  Correct Answer: D

  

• Question 1485:

  What is the net operating income (NOI) of this property?

  A. $113,124.

  B. $108,599.

  C. $92,886.

  D. $97,410.

  Correct Answer: C

  108,660 - 15,714 = 92,886

• Question 1486:

  What are the earnings before interest and taxes (EBIT) of the building?

  A. $79,563.

  B. $52,919.

  C. $95,277.

  D. $59,580.

  Correct Answer: A

  92,886 - 13,322 = 79,564

• Question 1487:

  What are the earnings before taxes (EBT)?

  A. $52,919.

  B. $66,241.

  C. $62,629.

  D. $59,580.

  Correct Answer: A

  79,564 - 26,664 = 52,919

• Question 1488:

  What is the building's net income?

  A. $42,646.

  B. $49,307.

  C. $35,985.

  D. $29,324.

  Correct Answer: C

  52,919 x .68 = 35,985

• Question 1489:

  What is the after tax cash flow of the investment?

  A. $52,919.

  B. $35,985.

  C. $26,275.

  D. $42,646.

  Correct Answer: D

  NI + DEP EXP - PRIN PMT = 35,985 + 13,322 - 6,661 = 42,646

• Question 1490:

  The net asset value (NAV) of this fund would be:

  

  A. $17.30.

  B. $26.00.

  C. $23.12.

  D. $15.80.

  Correct Answer: A

  (Total Market Value/Total Number of Shares)=(432,400/25,000)=17.296=17.30