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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 1871:

  A finance major works evenings as an intern at Churn Brothers Brokerage. As a test of her abilities, this intern has been asked to calculate the earnings multiplier of a software index. The firms that comprise this index are all high-technology

  names for whose products there exists great demand. Further, this demand is expected to be explosive in the future and the earnings visibility of these software firms is clear, reliable, and concise.

  In her research of the software index, the intern has gathered the following information:

  EPS: 0.39

  k: 62% per year

  g: 60% per year D1: 0.02

  Using this information, what is the earnings multiplier of this software index? Further, is this earnings multiplier realistic given the demand for the firms' products and the visibility of future earnings?

  A. 19.5, multiple is unrealistic
  B. The answer cannot be calculated from the information provided.
  C. None of these answers is correct.
  D. 1, multiple is unrealistic
  E. 2. 56, multiple is unrealistic
  F. 2. 56, multiple is realistic
  E. 2. 56, multiple is unrealistic

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  Explanation

  To determine the earnings multiplier, or "P/E ratio," of a stock market series, use the following equation: P/E = [(D1 / E1) / (k-g)

  Where: D1 = the annual per-share dividend at t1, E1 = the EPS figure at t1, k = the required rate of return on common stock, and g = the expected growth rate of dividends.

  In this example, all of the necessary information has been provided, and putting it into the equation above will yield the following:

  P/E of a stock market series = [($0.02*1.6 / ($0.39*1.6)) / (0.62 - 0.60)] = 2. 56

  This is an extremely low multiple, appropriate for virtually no-growth industries. The fact that the index under examination is a compilation of firms in high-tech software business, for whose products there exists great demand and promise of future growth, this low multiple seems very unrealistic. Consider the fact that the P/E ratio is a proxy for future growth. Firms in the automobile, basic materials, or other mature industries, which are expected to grow slowly, are characterized by lower earnings multiples and higher dividend payout ratios. Firms in the software, networking, biotechnology, and other high-growth industries, are typically characterized by high earnings multiples and low dividend payout ratios. What is happening here is that investors are giving up current income (i.e. dividends) in the hopes of rapid earnings growth (i.e. greatly increased EPS in the future).

• Question 1872:

  Recent data reveal that the ratio of inventories to sales has risen sharply, suggesting that businesses are experiencing an unplanned build-up in inventories. According to the Keynesian model, these findings indicate that

  A. the economy is operating at full-employment equilibrium, which will probably be sustained in the foreseeable future.
  B. aggregate expenditures exceed output and, as a result, inflation is likely to accelerate.
  C. aggregate expenditures exceed output and, as a result, national income will rise.
  D. aggregate expenditures are less than output and, as a result, national income will decline.
  D. aggregate expenditures are less than output and, as a result, national income will decline.

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  Explanation

  Actual inventories exceed planned inventories only when actual expenditures fall short of expected expenditures. Thus, producers anticipated a certain level of expenditure and produced output accordingly. Thus, output exceeded expenditure and national output (i.e., income) will decline.

• Question 1873:

  In examining the beta for its machine tools division, the management of Clay Industries has regressed the division's ROA against that of the SandP 500. Which of the following best characterize this method of calculating project beta?

  A. None of these answers
  B. Project Beta Method
  C. Monte Carlo Regression
  D. Pure Play Method
  E. Regression of the Poisson Distribution
  F. Accounting Beta Method
  F. Accounting Beta Method

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  Explanation

  In this example, the management of Clay Industries has determined the Beta coefficient for its machine tools division using the Accounting Beta Method. In using the Accounting Beta Method, the monthly (or quarterly) ROE or ROA of a specific division/project is compared to that of a large group of firms. This "large group of firms" is frequently characterized by a major market index, such as the SandP 500 or the Wilshire 5000. The Accounting Beta Method is used more frequently than the Pure Play Method, primarily because it is often difficult to find "pure-play" firms.

• Question 1874:

  Stock A is highly volatile while stock B has low volatility. The difference between the arithmetic and geometric rates of return will be:

  A. same for both stocks, since the difference is not dependent on volatility.
  B. larger for stock A or stock B, depending on their riskiness.
  C. larger for stock A.
  D. larger for stock B.
  C. larger for stock A.

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  Explanation

  The mean and the geometric mean are equal when volatility in the rate of return is zero. For a non- zero volatility, the mean exceeds the geometric mean and the difference is larger the higher the volatility.

• Question 1875:

  When financing a budget deficit, the government might borrow money from ________.

  A. a central bank
  B. individuals
  C. all of these answers
  D. businesses
  E. foreigners
  C. all of these answers

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  Explanation

  The government can borrow money from the central bank, from private businesses, private citizens and foreigners.

• Question 1876:

  Which of the following is/are not extraordinary items?

  I. Write-downs of inventory

  II. Expropriation by a foreign government

  III. Losses due to hurricanes

  IV.

  Gains from disposal of a business segment

  A. I and III
  B. I and IV
  C. II, III and IV
  D. I and II
  B. I and IV

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  Explanation

  Gains from disposal of a business segment are part of "Discontinued Operations," not extraordinary items. They appear segregated from the income from continuing operations as well as extraordinary items and are reported net of tax effects. Inventory write-downs and other such asset revaluations are considered unusual but not extraordinary items. These appear as part of income from continuing operations.

• Question 1877:

  Genuine Products Inc. requires a new machine. Two companies have submitted bids, and you have been assigned the task of choosing one of the machines. Cash flow analysis indicates the following: Year Machine AMachine B 0-$2,000-$2,000 1 0 832 2 0 832 3 0 832 4 3,877 832 What is the internal rate of return for each machine?

  A. IRR(A) = 16%; IRR(B) = 20%
  B. IRR(A) = 24%; IRR(B) = 20%
  C. IRR(A) = 18%; IRR(B) = 24%
  D. IRR(A) = 18%; IRR(B) = 16%
  E. IRR(A) = 24%; IRR(B) = 26%
  C. IRR(A) = 18%; IRR(B) = 24%

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  Explanation

  Solve for numerical PVIF and PVIFA then obtain corresponding interest rate from table Machine A $2,000 = $3,877(PVIF(IrrA,4))

  0.51586 = PVIFA(IrrA,4)

  IRR(A) = 18%.

  Machine B $2,000 = $832(PVIFA(IrrB,4))

  2. 40385 = PVIFA(IrrB,4)

  IRR(B) = 24%.

• Question 1878:

  A common-size balance sheet consists of which of the following?

  A. Expressing all items on the balance sheet as a percentage of total capital.
  B. Expressing all items on the balance sheet as a percentage of total sales.
  C. Expressing all items on the balance sheet as a percentage of total assets.
  D. None of these answers.
  E. Expressing all items on the balance sheet as a percentage of total liabilities.
  C. Expressing all items on the balance sheet as a percentage of total assets.

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  Explanation

  Expressing all items on the balance sheet as a percentage of total assets allows the analyst to review several years of balance sheets at a glance and to determine the relative changes that have taken place within balance sheet accounts.

• Question 1879:

  Which of the following best describes a firm's book value of its common stock?

  A. The amount of retained earnings of a firm minus any authorized but unissued preferred stock.
  B. None of these answers.
  C. All of these answers.
  D. The total number of common shares of a firm that are outstanding multiplied by the present price that the firm's stock is selling for.
  E. The total assets of a firm less liabilities and any claims senior to common stock that is reported on a firm's balance sheet.
  E. The total assets of a firm less liabilities and any claims senior to common stock that is reported on a firm's balance sheet.

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  Explanation

  The book value of a firm's common stock is represented by the common shareholders ownership interest in the firm. This consists of the value that the firm's assets are reported on the firm's balance sheet minus the liabilities of the firm and any "equity" claims that are senior to the common stockholders, such as preferred stock.

• Question 1880:

  Depreciation expense for fixed assets is recorded:

  A. for each period the asset is in use
  B. when the asset is sold
  C. as a liability until the asset is sold
  D. at the end of each fiscal period during the asset's useful life
  D. at the end of each fiscal period during the asset's useful life

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  Explanation

  Depreciation is the periodic allocation of the cost of a tangible, long-term asset over its estimated useful life, and therefore a period expense. This expense is recorded at the end of each fiscal period until the asset is fully depreciated or disposed of.