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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 3621:

  Your assistant has just completed an analysis of two mutually exclusive projects. You must now take her report to a board of directors meeting and present the alternatives for the board's consideration. To help you with your presentation, your assistant also constructed a graph with NPV profiles for the two projects. However, she forgot to label the profiles, so you do not know which line applies to which project. Of the following statements regarding the profiles, which one is most reasonable?

  A. If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistant must have made a mistake.
  B. If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision).
  C. If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted. Both would be accepted if they were not mutually exclusive.
  D. Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows. However, if they have identical cash flow patterns, then the one with the steeper profile probably has the lower initial cost.
  E. If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist.
  B. If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision).

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  Explanation

  A conflict will exist if the cost of capital is less than the crossover rate. In this case the cost of capital must be greater than minus 10 percent and, therefore, there will probably not be a NPV versus IRR conflict.

• Question 3622:

  Mr. Taylor states in his will that his $50,000 portfolio of bank CD's will go to his only son. Upon Mr. Taylor's death, the son sells the CD's and invests the proceeds in a stock mutual fund. How does this immediately impact M2 and the effective amount money available for transactions?

  A. both decrease
  B. decrease, increase
  C. no change, decrease
  D. both increase
  E. no change for either
  F. decrease, no change
  G. increase, decrease
  F. decrease, no change

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  Explanation

  Prior to Mr. Taylor's death, the CD's were counted as part of M2. In addition, this money was not used for current consumption. After the sale of the CD's, the money is still not being used for current consumption, but it is now not counted as part of M2. The real level of money in circulation has not changed here, but the measure of the money supply has decreased. This is an example of a distortion of money supply measures.

• Question 3623:

  A useful tool in financial statement analysis is the common-size financial statement. What does this tool enable the financial analyst to do?

  A. Determine which companies in the same industry are at approximately the same stage of development.
  B. Evaluate financial statements of companies within a given industry of approximately the same value.
  C. Ascertain the relative potential of companies of similar size in different industries.
  D. Compare the mix of assets, liabilities, capital, revenue, and expenses within a given industry without respect to relative size.
  E. None of these answers.
  D. Compare the mix of assets, liabilities, capital, revenue, and expenses within a given industry without respect to relative size.

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  Explanation

  Common-size financial statements present items in a financial statement as percentages of a common base. Comparison among firms in the same industry is made possible despite differences in size. Comparison of firms in different industries has drawbacks because the optimum mix of assets, liabilities, etc. will vary from industry to industry.

• Question 3624:

  Byron Corporation's present capital structure, which is also its target capital structure, is 40 percent debt and 60 percent common equity. Next year's net income is projected to be $21,000, and Byron's payout ratio is 30 percent. The company's earnings and dividends are growing at a constant rate of 5 percent; the last dividend was $2. 00; and the current equilibrium stock price is $21.88. Byron can raise all the debt financing it needs at 14 percent. If Byron issues new common stock, a 20 percent flotation cost will be incurred. The firm's marginal tax rate is 40 percent. What is the component cost of the equity raised by selling new common stock?

  A. 12. 0%
  B. 16. 4%
  C. 14. 6%
  D. 15. 0%
  E. 17. 0%
  E. 17. 0%

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  Explanation

  k(e) (component cost of external equity) = ($2. 10/$21.88(1-.20)) + 0.05 = 17%.

• Question 3625:

  ________ interest is the cumulative number of shares that have been sold short by investors and not covered.

  A. Minority
  B. Selling
  C. Short
  D. None of these answers
  C. Short

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  Explanation

  The short interest is the cumulative number of shares that have been sold short by investors and not covered. Technicians consider a high short-interest ratio bullish because it indicates potential demand when those who previously sold short must cover their sales.

• Question 3626:

  Given that the required rate of return on a common stock is 17%, the dividend growth rate is 13%, and the P/E ratio is 17, what is the expected dividend payout ratio?

  A. 0.43
  B. Not enough information
  C. 0.46
  D. 0.79
  E. 0.68
  E. 0.68

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  Explanation

  The infinite period Dividend Discount Model claims that the current price of a common stock is equal to D1 / (k - g), where D1 is next period's (most often next year's) dividend, k is the required rate of return, and g is the growth rate of dividends. The earnings multiplier model goes a step further by dividing both sides of the infinite period Dividend Discount Model equation by expected earnings during the next 12 months, yielding P/E = (D1/E) / (k - g). Rearranging this results in D1/E = (P/E) x (k - g). In this question, the expected dividend payout ratio is equal to 17 x (0.17 - 0.13) = 0.68.

• Question 3627:

  Which of the following is most correct?

  A. Conflicts between NPV and IRR rules arise in choosing between two mutually exclusive projects (that each have normal cash flows) when the cost of capital exceeds the crossover point (that is, the point at which the NPV profiles cross).
  B. None of the statements are correct.
  C. The discounted payback method overcomes the problems that the payback method has with cash flows occurring after the payback period.
  D. The NPV and IRR rules will always lead to the same decision in choosing between mutually exclusive projects, unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream.
  E. The Modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of capital.
  B. None of the statements are correct.

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  Explanation

  IRR can lead to conflicting decisions with NPV even with normal cash flows if the projects are mutually exclusive. Cash outflows are discounted at the cost of capital with the MIRR method, while cash inflows are compounded at the cost of capital. Conflicts between NPV and IRR arise when the cost of capital is below the crossover point. The discounted payback method does correct the problem of ignoring the time value of money, but it still does not account for cash flows beyond the payback period.

• Question 3628:

  Foundation Systems, a software engineering company, is considering the acceptance of two mutually exclusive projects. Assume the following information: Project A Initial cash outlay ($40,000) t1: $8,000 t2: $14,000 t3: $13,000 t4: $12,000 t5: $11,000 t6: $10,000 cost of capital is 11.5% Project B Initial cash outlay ($20,000) t1: $7,000 t2: $13,000 t3 $12,000 cost of capital is 11.5% Assuming no taxes, a $0.00 salvage value at the end of each project, and the fact that both projects can be replicated identically at the end of their lives, which is the superior project according to the Common Life approach? Additionally, what is the NPV of the superior project over the common life?

  A. Project A, NPV $7,165. 11
  B. Project A, NPV $9,280.90
  C. The Common Life approach cannot be applied to these two projects, due to the fact that the projects share unequal lives.
  D. Project B, NPV $9,280.90
  E. Project B, NPV $5,391.49
  D. Project B, NPV $9,280.90

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  Explanation

  The Common Life, or "Replacement Chain" approach is a method which allows two projects with differing lives to be compared on the basis of NPV or IRR. In analyzing two or more projects using theCommon Life approach, the two projects are multiplied in such a way that each comprises the same amount of time periods. In this example, you are provided with one project that is three periods long, and another which is six periods. By multiplying the three-period project by two, then we are able to formulate a situation in which both projects share a "common life." The calculation of the NPV for Project B assumes the following series of cash flows: t0: ($20,000) t1: $7,000 t2: $13,000 t3: [$12,000 + ($20,000)]= ($8,000) t4: $7,000 t5: $13,000 t6: $12,000 During t3, the project is "replaced," and the $12,000 inflow is offset by the ($20,000) required to implement the project once again. Incorporating this series of cash flows into your calculator will yield a NPV of $9,280.90 for project B, and this is higher than the NPV of $7,165. 11 for project A.

• Question 3629:

  The nominal required rate is determined by the inflation premium, the risk premium, and the:

  A. nominal risk-free rate.
  B. real risk-free rate.
  C. exchange rate impact.
  D. liquidity risk.
  B. real risk-free rate.

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  Explanation

  The equation for the nominal risk free rate is:

  RequiredReturnnominal= [(1 + Risk-FreeRatereal) * (1 + Inflation Premium) * (1 + Risk Premium)] - 1

  The market risk premium is used when determining the security market line (SML) and equals the required market return minus the nominal risk-free rate. Liquidity risk is a part of total risk which is measured by the risk premium. The exchange rate is not a factor in this calculation.

• Question 3630:

  How much would an original deposit of $1,500 grow to be after 8 and a half years, if the deposit earns interest at 6. 5% per year, compounded quarterly?

  A. $870,183. 49
  B. $3,601.34
  C. $2,541.02
  D. $2,594. 84
  E. $1,570.42
  D. $2,594. 84

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  Explanation

  On the BAII Plus, press 1500 PV, 0 PMT, 34 N, 6. 5 divide 4 = I/Y, then press CPT FV. On the HP12C, press 1500 PV, 0 PMT, 34 n, 6. 5 ENTER 4 divide i, then press FV. Note that N = 34 quarters and the answer is displayed as a negative number. Make sure that the BAII Plus has the P/Y value set to 1.