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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 3351:

  Projects A and B both have normal (conventional) cash flows. A's IRR is 7% and B's IRR is 8%. If projects A and B are mutually exclusive, you should select:

  A. Project B.
  B. Neither A not B.
  C. Insufficient information.
  D. Project A.
  C. Insufficient information.

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  Explanation

  If you were to use the IRR rule, you would select project B if the project's cost of capital were greater than 8%. However, you should always use the NPV criterion for selecting projects. Even though B has a higher IRR, it could have a lower NPV at the project's cost of capital. Since this information is missing, you cannot say for sure whether project A is preferable or project B. Indeed, you don't even know if either of the projects has a positive NPV!

• Question 3352:

  A project that is intended to increase income is known as ________.

  A. Externality
  B. Replacement Project
  C. Cannibalization
  D. Opportunity Cost
  E. Expansion Project
  F. Low Cost Provider
  E. Expansion Project

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  Explanation

  An expansion project is defined as a project that is intended to increase income.

• Question 3353:

  Kruskal Meriwether is a senior research analyst with Bellwether Advisors. He has been following Crystals and Candles a publicly traded firm which makes high-quality diamond jewelry. Kruskal, after extensive interviews with senior management at Crystals, has inferred that the firm is about to take over a diamond- mining firm in South Africa at a rock-bottom price. The Crystal management has refused to explicitly confirm or deny this but Kruskal firmly believes that such a deal is in the works. He has not used any inside information; just pieced together information from various avenues to come to this conclusion. In his reports, he states, "All my research seems to indicate that Crystal and Candles is likely to buy a South African diamond producer at a bargain price. Clearly, now is the time to buy Crystal and Candles' stock." 2 weeks after his report is released, Crystal's management announces that it has no intentions of making any acquisitions in the near future. This leads to a 7% decline in Crystal's stock, causing a large decline in the accounts of Kruskal's clients. Kruskal has

  A. violated Standard IV (A.1) - Reasonable Basis and Representation.
  B. not violated any AIMR code in this incident.
  C. violated Standard IV (B.2) - Portfolio Investment Recommendations and Actions.
  D. violated Standard IV (B.1) - Fiduciary Duties.
  B. not violated any AIMR code in this incident.

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  Explanation

  Kruskal's recommendations were not based on whim, unsubstantiated rumors or inside information. It is clear that he put in much research behind his recommendation. The fact that his recommendation turned out to an incorrect choice ex post does not mean he was negligent. An investment advisor cannot be expected to be correct 100% of the time. What is expected of them is professional competence and diligence (Code of Ethics). Nothing in this incident indicates that Kruskal lacked either of these.

• Question 3354:

  The following information was obtained from the financial statements of Firm A:

  Current assets = $4,500 Current liabilities = $3,000

  Long-range assets = $150,000 Long-term liabilities = $42,000 Contributed capital = $31,000

  Then, the retained earnings of the firm equal ________.

  A. $39,000
  B. $31,000
  C. $78,500
  D. $123,500
  C. $78,500

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  Explanation

  Total assets = Total liabilities + Total Equity

  Total Equity = Retained earnings + contributed capital.

  Total assets = $4,500+$150,000 = $154,500.

  Total liabilities = $42,000+$3,000 = $45,000, hence,

  Total equity = $154,500-$45,000 = $109,500

  Retained earnings = $109,500-$31,000 = $78,500

• Question 3355:

  The Prudent Man Rule, as it was originally written, was clearly oriented towards ________.

  A. charitable organizations
  B. public pension plans
  C. individual clients
  D. personal trust accounts
  E. endowments
  D. personal trust accounts

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  Explanation

  As enunciated, the concept behind the Prudent Man Rule was clearly oriented towards personal trust accounts. Under this rule, trustees must be impartial between income beneficiaries and remainder men and must achieve an equitable balance between current income and the preservation of principal in real terms.

• Question 3356:

  Which of the following statements is most correct?

  A. Generally, we do not need to adjust project cash flows to take into account the effects of inflation, since inflation is not accounted for in the cost of capital.
  B. All of these statements are correct.
  C. For comparing mutually exclusive projects with unequal lives, replacement chain analysis leads to the same decision as obtained by calculating the equivalent annual annuity (EAA).
  D. In comparing mutually exclusive projects with unequal lives, you should always choose the project which has the highest NPV.
  E. The rate of depreciation affects accounting statements, but has no effect on the firm's capital budgeting decisions.
  C. For comparing mutually exclusive projects with unequal lives, replacement chain analysis leads to the same decision as obtained by calculating the equivalent annual annuity (EAA).

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  Explanation

  The replacement chain analysis and the equivalent annual annuity methods lead to the same decision. Depreciation affects a firm's cash flow, which affects its capital budgeting decisions. The project with the highest extended NPV should be chosen. The cost of capital reflects inflation; therefore, project cash flows must be adjusted for inflation.

• Question 3357:

  Wiotech, LLC, a private company, is in the process of developing a revolutionary drug to fight Alzheimer's disease. The drug is in stage 2 development. The management team consists of several experienced clinical doctors. A reputable Wall Street firm has provided venture capital financing. The company would like to go public in the next few years. Which of the following is least likely to be a unique risk of this investment compared to other types of investment?

  A. Inexperienced entrepreneurs.
  B. Uncertain time to success.
  C. Limited information.
  C. Limited information.

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  Explanation

• Question 3358:

  If decision makers fail to anticipate the inflationary effects of demand stimulus policies, in the short run the stimulus will

  A. increase both inflation and the nominal interest rate but exert little impact on real output and employment.
  B. increase the real interest rate.
  C. reduce the real interest rate.
  D. lead primarily to larger output and high employment.
  E. both lead primarily to larger output and high employment and reduce the real interest rate.
  E. both lead primarily to larger output and high employment and reduce the real interest rate.

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  Explanation

  Unanticipated inflation, as the result of demand stimulus policies, increases output and employment since the real wage is eroded and the cost of labor declines.

• Question 3359:

  The GAAP require inventory to be valued using ________.

  A. Lower of market or cost
  B. LIFO or FIFO
  C. LIFO
  D. FIFO
  A. Lower of market or cost

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  Explanation

  Inventory valuation is a balance sheet consideration and is distinct from the calculation of COGS, which is an income statement item. US GAAP requires that inventory valuation be carried out using the lower of cost or market. The "cost" is determined by the inventory costing method chosen, like LIFO or FIFO. If the market value of the inventory falls below that obtained under the inventory costing method, then the firm must take a charge against the current income and "write the inventory down." Under this scenario, the basic inventory equation, Ending inventory = Beginning inventory + Purchases - COGS no longer holds. If the market price rises in the subsequent period, the firm can only write-up to the original cost of the inventory under the costing method chosen. In all periods in which there is no write-up or write-down, the basic inventory equation holds true.

• Question 3360:

  Consider the following information:

  30-day treasury rate (Risk Free rate) 7. 2%

  Company XYZ Bond yield 10.2%

  Beta 0.8

  Risk Premium 4. 0%

  Credit Rating B-

  Calculate Company XYZ's cost of retained earnings using the Bond-Yield-plus-Risk-Premium approach.

  A. 15. 2%
  B. 12. 2%
  C. 11.36%
  D. 17. 4%
  E. 5. 2%
  F. 14. 2%
  F. 14. 2%

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  Explanation

  To estimate a firm's cost of retained earnings using the Bond-Yield-plus-Risk-Premium approach, simply take the company's bond yield and add the risk premium. In this case the cost of retained earnings = 10.2% + 4. 0% = 14. 2%.