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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 3841:

  The following data are available for a firm for a given year:

  Net Sales 21,896 Sales and marketing expenses 4,346 Administrative expenses 2,143 COGS 10,084 Depreciation 967 Interest expense 573 Tax rate 35% Dividends paid 3,445 Preferred Dividends 897 Average total equity 37,432 Average common equity 26,782 Average total liabilities 18,583

  In the above example, the firm's return on common equity equals ________.

  A. 5. 83%
  B. 4. 77%
  C. 6. 12%
  D. 4. 38%
  A. 5. 83%

  ---

  Explanation

  Return on common equity = (Net income - preferred dividends)/average common equity. In the above example, Net Income = Earnings after depreciation, interest expense and taxes = (21,896 - 4,346 - 2,143 - 10,084 - 967 - 573)*(1 - 0.35) = 2,459. Therefore, Return on common equity = (2,459 - 897)/26,782 = 5. 83%.

• Question 3842:

  Firms with higher operating leverage tend to have _______ financial leverage.

  A. lower
  B. same
  C. higher or lower (since the two are not related).
  D. higher
  A. lower

  ---

  Explanation

  Firms with higher operating leverage have a higher fraction of costs in the form of fixed costs and hence, have a higher business risk. This makes them more averse to debt. Consequently, firms with higher operating leverage tend to have lower D/E ratios i.e. lower financial leverage.

• Question 3843:

  Fundamental Responsibilities is dealt with under:

  A. Standard I
  B. Standard III
  C. None of these answers
  D. Standard V
  E. Standard II
  F. Standard IV
  A. Standard I

  ---

  Explanation

  Fundamental Responsibilities is dealt with under Standard I.

• Question 3844:

  When valuing real estate, ________ utilizes selling prices of properties that are similar to the subject property.

  A. the comparative sales approach
  B. the income approach
  C. the cost approach
  D. none of these answers
  A. the comparative sales approach

  ---

  Explanation

• Question 3845:

  Given the following information about a manufacturing firm, determine the optimal capital structure. The optimal capital structure for this firm is:

  A. 10% Debt, 90% Equity.
  B. 25% Debt, 40% Equity.
  C. 40% Debt, 60% Equity.
  D. 50% Debt, 50% Equity.
  C. 40% Debt, 60% Equity.

  ---

  Explanation

  After calculating the missing data points in the table, we can determine that the capital structure of 40% debt and 60% equity minimizes the WACC and maximizes the stock price (see calculations below), and is thus considered optimal.

  To calculate WACC for the missing data points, we will use the formula:

  WACC = (wd)(kd) + (we)(ke), where wd, weare the weights used for debt and common equity.

  To calculate the Stock Price for the missing data points, we will use the formula:P0= D1/ ke

  Here, we need to calculate D1using the EPS and payout information; g is given as 0.0%.

• Question 3846:

  Michelle Garcia, CFA, is analyzing two newly issued corporate debt securities for possible purchase by a client. Bond X is a noncallable 10-year coupon bond currently trading at 102. 50. Bond Y is a noncallable 10-year coupon bond currently trading at 98.25. Garcia wants to ensure that her client is fully aware of any probable changes in the bonds' values as they approach maturity. Holding interest rates constant, which of the following best describes how each bond's price will change as it approaches maturity?

  A. The price of both bonds will decrease.
  B. The price of Bond X will decrease, and the price of Bond Y will increase.
  C. The price of Bond X will increase, and the price of Bond Y will decrease.
  B. The price of Bond X will decrease, and the price of Bond Y will increase.

  ---

  Explanation

• Question 3847:

  ________ establishes the fiduciary principles for U.S. corporate pension plans.

  A. AIMR
  B. PSPC
  C. ERISA
  D. WTO
  E. UMIFA
  F. None of these answers
  G. RELAC
  C. ERISA

  ---

  Explanation

  ERISA establishes the fiduciary principles for U.S. corporate pension plans. ERISA is very specific in its definition of fiduciaries and their responsibilities and investment managers of U.S. corporate pension plans are subject to ERISA's fiduciary provisions.

• Question 3848:

  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. 3%

  Given this information, and using the Bond-Yield-plus-Risk-Premium approach to calculate the component cost of common equity, what is the Weighted Average Cost of Capital for Clay Industries?

  A. 15. 03%
  B. 9.97%
  C. 8.762%
  D. 7. 70%
  E. 7. 30%
  F. The WACC for Clay Industries cannot be calculated from the information.
  D. 7. 70%

  ---

  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 Bond-Yield-plus-Risk-Premium approach. To calculate the cost of equity using this approach, take the yield to maturity on the firm's outstanding debt (7. 5%) and add a subjective risk premium (3. 3%), which gives a cost of common equity of 10.8%. The after-tax cost of debt can be found by multiplying the yield to maturity on the firm's outstanding longterm 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 7. 679%.

• Question 3849:

  Estimates of GNP

  A. are used to estimate aggregate net sales for the firms in a stock market series such as the SandP 400. About 90% of the variance in percentage changes in SandP 400 net profits can be attributed to percentage changes in the GNP. Net sales are more volatile than GNP.
  B. are used to estimate aggregate net profits for the firms in a stock market series such as the SandP 400. About 30% of the variance in percentage changes in SandP 400 net profits can be attributed to percentage changes in the GNP. The GNP is more volatile than net profits.
  C. are used to estimate aggregate net sales for the firms in a stock market series such as the SandP 400. About 40% of the variance in percentage changes in SandP 400 net profits can be attributed to percentage changes in the GNP. Net sales are more volatile than GNP.
  D. are used to estimate aggregate net profits for the firms in a stock market series such as the SandP 400. About 80% of the variance in percentage changes in SandP 400 net profits can be attributed to percentage changes in the GNP. Net profits are more volatile than GNP.
  C. are used to estimate aggregate net sales for the firms in a stock market series such as the SandP 400. About 40% of the variance in percentage changes in SandP 400 net profits can be attributed to percentage changes in the GNP. Net sales are more volatile than GNP.

  ---

  Explanation

  There is a strong relationship between GNP percentage changes and SandP 400 net sales percentage changes; about 40% of the variance of SandP 400 net sales percentage changes is due to percentage changes in the GNP. Estimating GNP changes allows one to then estimate net sales changes based on a regression formula.

• Question 3850:

  According to Chebyshev's Theorem, what percent of the observations lie within plus and minus 1.75 standard deviations of the mean?

  A. Cannot compute because it depends on the shape of the distribution
  B. 56%
  C. 95%
  D. 67%
  E. None of these answers
  D. 67%

  ---

  Explanation

  Chebyshev's theorem applies regardless of the shape of the distribution. The minimum proportion that lie within k standard deviations of the mean is at least 1-[1/(k^2)]. In this case k = 1.75. k^2 = 3. 0625. So we get 67%.