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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 2541:

  A portfolio manager is attempting to determine the earnings multiple for an index of technology companies, and has gathered the following information:

  D1: $0.20 EPS: $1.44

  k: 28% per year

  g: 26. 5% per year

  Using the information provided, what is the price-to-earnings ratio for this technology index? Further, is this earnings multiple realistic assuming that the demand for technology is great, earnings visibility is clear, and the industry is expected to grow rapidly? To solve for P/E, manipulate the infinite period dividend discount model.

  A. 13. 33, this multiple is unrealistic
  B. 9.26, this multiple is realistic
  C. 9.26, this multiple is unrealistic
  D. 480, this multiple is likely to high
  E. None of these answers is correct
  F. 13. 33, this multiple is realistic
  C. 9.26, this multiple is unrealistic

  ---

  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 = [($0.20 *1.265/ ($1.44*1.265)) / (0.28 - 0.265)] = 9.26

  This is a rather low multiple, appropriate only for slow growth industries or specific situations such as industries with high risk or uncertainty. The fact that the index under examination is a compilation of firms in the high tech business, where demand is expected to be great, does not logically lead to this low of an earnings multiple. The fact that earnings visibility is clear augments this. The reasoning behind this is the fact that firms in the technology sector are expected to grow very rapidly, i.e. they should merit higher earnings multiples. Think of a P/E ratio as a proxy for future earnings growth. In this situation, a multiple of less than 10 seems unrealistic.

• Question 2542:

  A financial analyst with Mally, Feasance and Company is examining shares of a large specialty retailer. Assume the following information:

  EPS: $2. 30

  ROE: 16. 25%

  Growth rate of dividends: 12. 00%

  Discount rate: 13. 33%

  Tax Rate 35%

  Using this information, what is the dividend payout ratio for this specialty retailer? Further, what is the annual dividend?

  A. 73. 85% $1.70
  B. 23. 07%, $0.53
  C. 26. 15%, $0.60
  D. 26. 15%, $1.70
  E. 65. 16%, $1.50
  F. 73. 85%, $0.60
  C. 26. 15%, $0.60

  ---

  Explanation

  To determine the dividend payout ratio, the equation used to determine the growth rate of dividends must be manipulated. This equation is originally structured as follows:

  {g = ROE (1 - Dividend Payout Ratio)}

  In order to determine the Dividend Payout Ratio, the equation must be rearranged to the following: {(1 - Dividend Payout Ratio) = Growth Rate of Dividends / ROE}.

  Imputing the given information into this equation will yield:

  {(1 - Dividend Payout Ratio) = 0.12/0.1625)} = 0.73846

  Finally, subtracting this figure from 1 will yield the answer of 26. 15%. We must subtract the first answer from one because the first answer represents the retention rate, i.e. the percentage of earnings that is retained and reinvested at the

  firm's ROE. The retention rate and the payout ratio will always combine to equal positive one. In order to determine the annual dividend, take the Dividend Payout Ratio, which was found to be 26. 15%, and multiply this figure by the Earnings

  Per Share calculation, which is given as $2. 30. This will yield an annual dividend of $0.60154. As you can see, neither the discount rate nor the tax rate is factored into the equation.

• Question 2543:

  Given that this period's dividend is $3, the required rate of return is 16%, and the dividend growth rate is 4%, what is the current value of the common stock (using the infinite period Dividend Discount Model)?

  A. Not enough information
  B. $18.75
  C. $25. 00
  D. $26. 00
  E. $19.50
  D. $26. 00

  ---

  Explanation

  The infinite period Dividend Discount Model postulates that the current value of a common stock is equal to D1 / (k - g), where D1 is next period's dividend, k is the required rate of return, and g is the growth rate of dividends. Next period's dividend is equal to this period's dividend multiplied by the dividend growth rate. In this question, next period's dividend is 3 x 1.04 = 3. 12. The common stock is worth 3. 12 / (0.16 - 0.04) = $26.

• Question 2544:

  If an independent auditor has not become satisfied by means of other auditing procedures with respect to opening inventories, they should

  A. either disclaim an opinion on the statement of income or qualify the opinion thereon, regardless of the degree of materiality of the amounts involved.
  B. either disclaim an opinion on the statement of income or qualify the opinion thereon, depending on the degree of materiality of the amounts involved.
  C. disclaim an opinion or qualify the opinion on the statements as a whole.
  D. express an adverse opinion on the statements taken as a whole when the amount in question is material.
  B. either disclaim an opinion on the statement of income or qualify the opinion thereon, depending on the degree of materiality of the amounts involved.

  ---

  Explanation

  If the auditor has become satisfied as to current inventory, the auditor may use alternative procedures to become satisfied as to opening inventories. But if they cannot become satisfied regarding inventories, a qualified opinion or a disclaimer of opinion may be expressed, depending on materiality. Because cost of goods sold is dependent on opening inventories, an unqualified opinion on the income statement is not possible.

• Question 2545:

  Using the information below, value the stock of Meerkat Publishing, Inc. using the free cash flow from equity (FCFE) valuation method.

  

  Which of the following choices is closest to the correct answer? The per share value of Meerkat Publishing is:

  A. $31.52.
  B. $45. 39.
  C. $32. 86.
  D. $24. 06.
  C. $32. 86.

  ---

  Explanation

  The FCFE is calculated as follows (all amounts in million of $ except per share price): Step 1: Calculate Present Value of Each Year's FCFE Step 2: Calculate Present Value of final cash flow times FCFE multiple Step 3: Calculate per share value Add up PV of FCFE and end value and divide by number of shares outstanding = (10.67 + 11.85 + 15. 45 + 339.93) / 11.5 =32. 86

• Question 2546:

  Normal projects C and D are mutually exclusive. Project C has a higher net present value if the WACC is less than 12 percent, whereas Project D has a higher net present value if the WACC exceeds 12 percent. Which of the following statements is most correct?

  A. All of the statements are incorrect.
  B. Project D has a higher internal rate of return.
  C. All of the statements are correct.
  D. Project D is probably larger in scale than Project C.
  E. Project C probably has a faster payback.
  B. Project D has a higher internal rate of return.

  ---

  Explanation

  From the information given, D has the higher IRR. The project's scale cannot be determined from the information given. As C's NPV declines more rapidly with an increase in rates, this implies that more of the cash flows are coming later on. So C would have a slower payback than D.

• Question 2547:

  If a company receives an unqualified audit opinion, it means the auditors

  A. are providing assurance that the company's financial statements are free from misstatement, fraudulent accounting and fairly indicate future performance.
  B. are providing assurance that the company will remain financially viable for at least the next year.
  C. are providing assurance that the company's financial statements fairly present company's financial performance and position.
  D. did not complete a full audit and therefore do not feel qualified to give and opinion on financial statements.
  C. are providing assurance that the company's financial statements fairly present company's financial performance and position.

  ---

  Explanation

• Question 2548:

  The balance sheet of firm A shows the following:

  Cash and Cash equivalents 386 Receivables 119 Inventories 204 Marketable securities 143 Short-term loans 649 Current portion of long-term debt 312

  The cash ratio of the firm equals ________.

  A. 0.55
  B. 0.82
  C. 1.82
  D. 0.63
  A. 0.55

  ---

  Explanation

  The cash ratio is the most conservative liquidity ratio calculated using only cash and marketable securities relative to current liabilities. Thus, Cash ratio = (cash + marketable securities)/current liabilities In this case, Cash ratio = (386+143)/ (649+312) = 0.55

• Question 2549:

  New Gestalt, Inc., a software firm had a net income of 1.7 million last year. It has 200,000 common shares and 300,000 convertible bonds with face value of 100 outstanding. The convertible bonds carry a coupon of 4% and can be converted one-for-one. The average stock price last year was 39 and the maximum price was 57. The effective interest rate on the convertible debt is 8%. New Gestalt issued 100,000 preferred shares with face value 100 and a coupon of 5% on March 31st of last year. Assume the convertible bonds are dilutive and that New Gestalt faces a 30% tax rate. Given the above, New Gestalt's Basic EPS equals ________.

  A. 8.5
  B. none of these answers
  C. 6. 62
  D. 10.4
  C. 6. 62

  ---

  Explanation

  The preferred dividends = 100,000*5%*100*9/12 = 375,000 (they were outstanding for 9 months). Therefore, Basic EPS = (Net Income - Preferred dividends)/weighted # of common shares = (1,700,000 - 375,000)/200,000 = 6. 62

• Question 2550:

  The stock of Constagrow pays dividends that are expected to grow at a steady rate of 3. 2% per year. Investors expect a rate of return of 11.5% from Constagrow stock. If the spread between this required rate of return and the dividend growth rate were to increase by 50 basis points, the percentage change in the stock price would be:

  A. -4. 73%
  B. +3. 94%
  C. -5. 68%
  D. +4. 22%
  C. -5. 68%

  ---

  Explanation

  In the usual notation, the Dividend Discount Model gives Po = D1/(k-g). When k - g = 11.5% - 3. 2% = 8.3%, the price is given by Po = D1/0.083. When the spread increases by 50 basis points and all else stays constant, the price becomes P1 = D1/(0.083 + 0.005) = D1/0.088. The percentage change in the price equals (P1 - Po)/Po = (1/0.088 - 1/0.083)*0.083 = 8.3/8.8 - 1 = -5. 68%. Thus, the stock price falls by 5. 68% when the spread between k and g increases by 50 basis points, all else equal.