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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 2971:

  The primary purpose of the statement of cash flows is to

  A. provide information about a company's cash receipts and cash payments during the accounting period
  B. measure the change in the company's assets
  C. state the company's financial position at period-end
  D. analyze net income during the accounting period
  A. provide information about a company's cash receipts and cash payments during the accounting period

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  Explanation

  Other financial statements are used to analyze revenues, expenses, assets, liabilities, and stockholders' equity. The statement of cash flows summarizes transactions affecting cash; it is the balance sheet that states the company's financial position at a point in time.

• Question 2972:

  Which of the following is/are true under accrual accounting?

  I. Expenses are recognized as services are used.

  II. Revenues are recognized when service is performed.

  III. Revenues are recognized in proportion to expenditures incurred.

  IV.

  Revenues are matched with the associated costs.

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

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  Explanation

  Accrual accounting follows the Matching Principle, which requires that revenues and gains be recognized when earned and expenses and losses be recognized when incurred. Under this, (I), (II) and (IV) are correct. However, (III) is not necessarily true.

• Question 2973:

  Assume the following information about a textile manufacturing company. Dividend retention rate = 0.20

  Total assets / common equity = 2. 01 Net income / sales = 0.09 Sales / total assets = 0.67

  What is the expected annual growth rate of this firm's dividends?

  A. None of these answers is correct.
  B. 8.22%
  C. 12. 12%
  D. 5. 40%
  E. The answer cannot be determined from the information provided.
  F. 9.70%
  A. None of these answers is correct.

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  Explanation

  The correct value for the growth rate of dividends for this textile-manufacturing firm is an abysmally low 2. 42%. Thus, none of the answers is correct.

  A popular model for determining the growth rate of dividends is the following: g = RR * ROE

  Where: g = the expected growth rate of dividends, RR = the retention rate (this is equal to 1 - dividend payout ratio), and ROE = the return on equity. Although it may at first appear otherwise, all of the necessary information has been

  provided. Remember the Du Pont decomposition process for ROE, which breaks down the ROE figure into the following:

  ROE = (Net Income / Sales) * (Sales / Total Assets) * (Total Assets * Common Equity)

  Mathematically, this will break down into (Net Income / Common Equity), the ROE figure. The calculation of the return on equity for this company is as follows:

  ROE = [0.09 * 0.67 * 2. 01] = 0.121203, or 12. 12%.

  Now that the ROE figure has been determined, the calculation of the growth rate of dividends is as follows:

  g = [(0.20) * 0.1212] = 0.02424, or 2. 42%

• Question 2974:

  Chris South owns $25,000 face value of Bradco bonds, which have a 7% coupon, pay interest semiannually, and have six years remaining until maturity. The bonds are callable at par. The bonds were rated A when Chris bought them at par two years ago, and they are currently worth $26,225, with a rating of AA. Which of the following statements most accurately describes the change in the risk of the Bradco bonds?

  A. Call risk has decreased.
  B. Liquidity risk has increased.
  C. Credit risk has decreased.
  C. Credit risk has decreased.

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  Explanation

• Question 2975:

  Gulf Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 10 percent so long as it finances at its target capital structure, which calls for 55 percent debt and 45 percent common equity. Its last dividend was $2. 20; its expected constant growth rate is 6 percent; its stock sells on the NYSE at a price of $35; and new stock would net the company $30 per share after flotation costs. GEC's tax rate is 40 percent, and it expects to have $100 million of retained earnings this year. GEC has two projects available: Project A has a cost of $200 million and a rate of return of 13 percent, while Project B has a cost of $125 million and a rate of return of 10 percent. All of the company's potential projects are equally risky. Assume now that GEC needs to raise $300 million in new capital. What is GEC's marginal cost of capital for evaluating the $300 million in capital projects and any others that might arise during the year?

  A. 12. 66%
  B. 6. 00%
  C. 9.50%
  D. 13. 77%
  E. 9.00%
  C. 9.50%

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  Explanation

  k(d) (interest rate on the firm's new debt) = 10%;

  k(d)(1 - T) (after-tax component cost of debt) = 10%(0.6) = 6%.

  D/A = 55%

  D(0) = $2. 20

  g = 6%

  P(0) = $35

  P(N) = $35

  T (The firm's marginal tax rate) = 40%

  Retained earnings = $100M; BP(RE) = $100M/ .45 = $222. 22M

  k(s) (component cost of retained earnings) = $2. 33/$35 + 6% = 12. 66%

  k(e) (component cost of external equity) = $2. 33/$30 + 6% = 13. 77%.

  WACC (Weighted Average Cost of Capital) (1) = 0.55(6%) + 0.45(12. 66%) = 9.0% WACC(2) = 0.55(6%) + 0.45(13. 77%) = 9.5%

• Question 2976:

  The management of Clay Industries have adhered to the following capital structure: 50% debt, 45% common equity, and 5% perpetual preferred equity. The following information applies to the firm: Before-tax cost of debt = 7. 5% Combined state/federal tax rate = 35% Expected return on the market = 14. 5% Annual risk-free rate of return = 5. 25% Historical Beta coefficient of Clay Industries Common Stock = 1.15 Annual preferred dividend = $1.35 Preferred stock net offering price = $17. 70 Expected annual common dividend = $0.45 Common stock price = $30.90 Expected growth rate = 11.75% Subjective risk premium = 3. 8% Given this information, and using the Capital Asset Pricing Model to calculate the component cost of common equity, what is the Weighted Average Cost of Capital for Clay Industries?

  A. 15. 31%
  B. 11.30%
  C. 9.92%
  D. 9.968%
  E. The WACC for Clay Industries cannot be calculated from the information.
  F. 10.05%
  D. 9.968%

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  Explanation

  The calculation of the Weighted Average Cost of Capital is as follows: {fraction of debt * [yield to maturity on outstanding long-term debt][1-combined state/federal income tax rate]} + {fraction of preferred stock * [annual dividend/net offering price]} + {fraction of common stock * cost of equity}. The cost of common equity can be calculated using three methods, the Capital Asset Pricing Model (CAPM), the Dividend-Yield-plus-Growth-Rate (or Discounted Cash Flow) approach, and the Bond- Yield-plus-Risk-Premium approach. In this example, you are asked to calculate the cost of common equity using the Capital Asset Pricing Model (CAPM). This approach involves the following equation: {risk-free rate +beta[expected return on the market - risk-free rate]}. Specifically, the calculation of the component cost of common equity using the CAPM is as follows: {[5. 25% + 1.15(14. 5%-5. 25%]} = 15. 888%. The after-tax cost of debt can be found by multiplying the yield to maturity on the firm's outstanding long-term debt (7. 5%) by (1-tax rate). Using this method, the after-tax cost of debt is found as 4. 875%. The calculation of the cost of perpetual preferred stock is relatively straightforward, simply divide the annual preferred dividend by the net offering price. Using this method, the cost of preferred stock is found as 7. 627%. Incorporating these figures into the WACC equation gives the answer of 9.968%.

• Question 2977:

  A mortgage holding company has found that 2% of its mortgage holders default on their mortgage and lose the property. Furthermore, 90% of those who default are late on at least two monthly payments over the life of their mortgage as compared to 45% of those who do not default. What is the probability that a mortgagee with two or more late monthly payments will default on the mortgage and lose the property?

  A. 0.018
  B. None of these answers
  C. 0.441
  D. 0.039
  E. 0.459
  D. 0.039

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  Explanation

  We have P(def) = 0.02. P(not def) = 0.98. P(two late payments/def) = 0.90. P(two late payments/not def) = 0.45. Using Bayes formula: p(def/two late payments) = (0.02*0.9)/(0.02*0.9 + 0.98*0.45) = 0.039.

• Question 2978:

  A client tells you that he currently earns $100,000 per year and is comfortable with his lifestyle at that income level. He says he is planning on retiring in 5 years. If inflation averages 8% over the next 5 years, approximately what income level will this client require to maintain his current lifestyle?

  A. $147,000
  B. Not enough information
  C. $169,000
  D. $122,000
  E. $140,000
  B. Not enough information

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  Explanation

  The calculation is as follows: (1.08)^(5)*100000=$146,933

• Question 2979:

  With respect to depreciation methods, which of the following is true?

  I. Accelerated depreciation methods lead to higher depreciation expense over time.

  II. The Straight-line method causes higher taxes in later years.

  III.

  Accelerated methods are preferred for tax reasons.

  A. III only
  B. II and III
  C. I and III
  D. II only
  A. III only

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  Explanation

  Accelerated methods cause depreciation expense to decrease over time. In later years, the straight- line method leads to higher depreciation compared to accelerated methods and hence, leads to lower taxes.

• Question 2980:

  Darlenc Villanueva provides analytical support for portfolio managers at a small investment management firm, Villanueva's latest report highlights two companies, Company X and Company Y. Company X has consistently earned a higher rate of return on assets than their cost of capital, but the stock price is substantially greater than the fair value. Company Y's earnings have been pulled down by the recent economic slowdown, but its stock price has remained stable despite the negative returns on the overall market. Which of the following statements correctly categorizes the two companies?

  A. Stock X is a value stock and Company Y is a defensive company.
  B. Stock X is a growth stock and Company Y is a cyclical company.
  C. Company X is a growth company and Stock Y is a defensive stock.
  C. Company X is a growth company and Stock Y is a defensive stock.

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  Explanation