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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1781:

  Under GAAP, which of the following costs can be capitalized?

  A. drilling costs for oil wells
  B. public relations expense to develop goodwill
  C. research and development
  D. none of these answers
  A. drilling costs for oil wells

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  Explanation

  Drilling costs can be either expensed under Successful Efforts method or capitalized under the Full Cost method. RandD costs cannot be capitalized unless the costs are incurred on assets that have alternative uses. Similarly, internally developed Goodwill cannot be capitalized in the form of an asset. Only if it is purchased during an acquisition can it appear on the balance sheet in a capitalized form.

• Question 1782:

  If the correlation coefficient between two variables equals zero, what can be said of the variables X and Y?

  A. Highly correlated
  B. Not correlated
  C. Dependent on each other
  D. None of these answers are correct
  E. All of these answers are correct
  B. Not correlated

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  Explanation

  r ranges from -1 to +1. The closer it is to -1 or +1, the stronger the relationship. Closer it is to zero, the weaker.

• Question 1783:

  An investor should purchase a stock if

  A. its estimated value is greater than its market value.
  B. the company that issued it is expected to be the industry leader.
  C. its estimated value is greater than its book value.
  D. the company that issued it is one of the best performing firms in one of the best performing industries in the economy.
  A. its estimated value is greater than its market value.

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  Explanation

  Book value has little relevance to purchasing decisions. A company that is expected to perform well may have a stock that is overvalued because of the very positive attention surrounding it. Instead, an investor should purchase a stock if its estimated value is greater than its market value. This implies that the market is undervaluing the stock, the investor can buy it for less than it is worth, and receive excess returns as the market eventually realizes its mistake.

• Question 1784:

  The Price Company will produce 55,000 widgets next year. Variable costs will equal 40 percent of sales, while fixed costs will total $110,000. At what price must each widget be sold for the company to achieve an EBIT of $95,000?

  A. $5. 37
  B. $5. 00
  C. $4. 45
  D. $2. 00
  E. $6. 21
  E. $6. 21

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  Explanation

  EBIT = PQ - VQ - FC $95,000 = P(55,000) - (0.4)P(55,000) - $110,000 $205,000 = (0.6)(55,000)P $205,000 = 33,000P P = $6. 21.

• Question 1785:

  Quick Launch Rocket Company, a satellite launching firm, expects its sales to increase by 50 percent in the coming year as a result of NASA's recent problems with the space shuttle. The firm's current EPS is $3. 25. Its degree of operating leverage is 1.6, while its degree of financial leverage is 2. 1. What is the firm's projected EPS for the coming year using the DTL approach?

  A. $3. 25
  B. $5. 46
  C. $19.63
  D. $10.92
  E. $8.71
  E. $8.71

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  Explanation

  EPS(1) = EPS(0) + EPS(0) [DTL x (percent change in sales)]

  = $3. 25 [1 + (1.6)(2. 1)(0.5)] = $3. 25 [2. 68]

  EPS(1) = $8.71.

• Question 1786:

  Project A has an IRR of 10% and project B has an IRR of 12%. The crossover rate for these projects is 7. 4%. You use the NPV rule for making project selections. If both the projects have a cost of capital of 6. 9%, and are mutually exclusive with normal cash flows, you should:

  A. insufficient information.
  B. select project A.
  C. select neither A nor B.
  D. select project B.
  B. select project A.

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  Explanation

  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 smaller than the crossover rate, the project with the flatter profile will have a smaller NPV. Therefore, project A has a higher NPV at the cost of capital of 6. 9% and should be selected over project B.

• Question 1787:

  Assume the following information about a stock market series:

  Retention rate at t1 = 63%

  Expected growth rate of dividends at t1 = 10%

  Expected growth rate of earnings at t1 = 12%

  Required rate of return = 13%

  EPS at t1 = $3. 65

  Given this information, what is the appropriate earnings multiplier for this stock market series? Further, what is the value of this series?

  A. 63; $229.95
  B. 21; $76. 65
  C. 12. 33; $45
  D. 37; $135. 05
  E. None of these answers is correct.
  F. The answer cannot be determined from the information provided.
  C. 12. 33; $45

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  Explanation

  The earnings multiplier is found as 12. 33 for this series, and the value of the series is computed as $45.

  Estimating the earnings multiplier for a stock market series requires the estimation of each of the following components:

  1. The dividend payout ratio.

  2. The required rate of return on common stock in the country/region/industry/sector being analyzed.

  3. The expected growth rate of dividends for the stocks in the country/region/industry/sector being analyzed.

  Once values for each of these components have been determined, they are imputed into the following formula: {P/E = [D/E / (k - g)]}. Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1, k = the

  required rate of return, and g = the anticipated growth rate of dividends.

  In this example, all of the necessary information has been provided. However, before the earnings multiplier can be determined, the dividend payout ratio must be found by manipulating the retention rate. Remember that the retention rate is

  equal to (1 - the dividend payout ratio), just as the dividend payout ratio is found as (1 - the retention rate). By this logic, the dividend payout ratio and the retention rate must always add up to one. The dividend payout ratio for this series is

  found as (1 - 0.63) = 0.37.

  Now that the dividend payout ratio has been determined, the calculation of the earnings multiplier is shown below: {P/E = [0.37 / (0.13 - 0.10)] = 12. 33}. Notice that it is the anticipated growth rate of dividends that is used in this equation, not

  the anticipated growth rate in earnings.

  Once the earnings multiplier has been determined, the value of this stock market series can be found by multiplying the EPS figure by the earnings multiplier. This will lead to a value of $45 for this stock market series, or 12. 33 x 3. 65 =

  $45. 02.

• Question 1788:

  Which of the following statements is true?

  A. Allocation of plant asset costs, through depreciation, if consistently applied, does not lend itself to serious distortion.
  B. None of these answers.
  C. All of these answers.
  D. Determination of the useful life of an asset, if consistently applied, does not lend itself to serious distortion.
  E. Historical cost valuation of plant assets, if consistently applied, does not lend itself to serious distortion.
  E. Historical cost valuation of plant assets, if consistently applied, does not lend itself to serious distortion.

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  Explanation

  Determining the useful life of an asset is central to the allocation of its cost and its period-to-period valuation; the same is true with depreciation schedules that are selected. These pose problems in determining the fair value of plant and equipment.

• Question 1789:

  John buys a house that costs $275,000 and agrees to pay for it with a 15 year mortgage at 6% per year, compounded monthly. What is John's monthly payment on the loan?

  A. $2,250.06
  B. $2,320.61
  C. $1,552. 12
  D. $1,972. 22
  E. $2,218.50
  B. $2,320.61

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  Explanation

  On the BAII Plus, press 180 N, 6 divide 12 = I/Y, 275000 PV, 0 FV, CPT PMT. On the HP12C, press 180 n, 6 ENTER 12 divide i, 275000 PV, 0 FV, PMT. Make sure the BAII Plus has the P/Y value set to 1.

• Question 1790:

  Sun State Mining Inc., an all-equity firm, is considering the formation of a new division, which will increase the assets of the firm by 50 percent. Sun State currently has a required rate of return of 18 percent, U.S. Treasury bonds yield 7 percent, and the market risk premium is 5 percent. If Sun State wants to reduce its required rate of return to 16 percent, what is the maximum beta coefficient the new division could have?

  A. 2. 0
  B. 1.0
  C. 2. 2
  D. 1.6
  E. 1.8
  B. 1.0

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  Explanation

  Old assets = 1.0.New assets = 0.5. Total assets = 1.5.

  Old required rate:New required rate:

  18% = 7% + (5%)b16% = 7% + (5%)b

  beta = 2. 2. beta = 1.8.

  New b must not be greater than 1.8, therefore

  0.3333(b) = 0.3333

  b = 1.0.

  Therefore, beta of the new division cannot exceed 1.0.