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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 3851:

  The management of Clay Industries have adhered to the following capital structure: 50% debt, 35% common equity, and 15% perpetual preferred equity. The following information applies to the firm:

  Before-tax cost of debt = 9.5%

  Combined state/federal tax rate = 35%

  Expected return on the market = 14. 5%

  Annual risk-free rate of return = 6. 25%

  Historical Beta coefficient of Clay Industries Common Stock = 1.24

  Annual preferred dividend = $1.55

  Preferred stock net offering price = $24. 50

  Expected annual common dividend = $0.80

  Common stock price = $30.90

  Expected growth rate = 9.75%

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

  A. 9.82%
  B. 6. 93%
  C. 8.36%
  D. 10.02%
  E. The WACC for Clay Industries cannot be calculated from the information provided.
  F. 9.79%
  C. 8.36%

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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 Dividend-Yield-plus-Growth-Rate, or Discounted Cash Flow, approach. To calculate the cost of common equity using this approach, divide the expected annual dividend by the selling price of the outstanding common stock, and add the expected growth rate. Using the DCF method, the cost of common equity can be found as follows: {[$0.80/$30.90] + 9.75%} = 12. 34%. The after-tax cost of debt can be found by multiplying the yield to maturity of the firm's outstanding long-term debt (9.5%) by (1-tax rate). Using this method, the after-tax cost of debt is found as 6. 175%. 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 6. 327%. Incorporating these figures into the WACC equation gives the answer of 8.355%.

• Question 3852:

  You have a stock that you are holding for one year. It has an estimated dividend payout of $1.10 and an expected sale price of $22. Using the dividend discount model, calculate the value of the stock if your required rate of return is 14%.

  A. $23. 10
  B. $20.26
  C. $22
  D. not enough information to calculate it
  B. $20.26

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  Explanation

  Bring both dividend and expected sale price to present value and sum the two: V = $1.10/1.14 + $22. 00/1.14 = $20.26

• Question 3853:

  Firms X and Y, similar in all respects, recently bought identical securities. However, X has classified the securities as "held-to-maturity" securities while Y has categorized them as "available-for-sale" securities. Which of the following statements is/are true as a result of this difference?

  I. X and Y will show same assets on their balance sheets over time.

  II. X will have a higher income volatility than Y.

  III.

  X and Y will show different total equity values.

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

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  Explanation

  "Available-for-sale" securities are reported at their fair market value on the balance sheet while "held- to-maturity" securities are carried at amortized historical cost. Therefore, the reported assets for X and Y will be different over time. Hence, they will also show different equities because liabilities for the two firms are the same. However, changes in the market value of available-for-sale securities are charged directly to the retained earnings account, without going through the income statement. On the other hand, changes in the market value of "held-to-maturity" securities are not even recognized on financial statements due to historical cost accounting. For both the classifications, interest and dividend payments are attributed to the income. So the income volatility is not affected due to the classification.

• Question 3854:

  A firm has a cash conversion cycle of 31.6 days. It turns over its inventory on average in 43. 1 days and pays off its payables in an average of 23. 2 days. Its receivables turnover ratio equals ________.

  A. 31.2
  B. 42. 3
  C. 14. 9
  D. 25. 1
  A. 31.2

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  Explanation

  CCC = (Average receivables collection period) plus (Average inventory processing time) minus (Average payables payment period).

  Hence, 31.6 = Average receivables collection period + 43. 1 - 23. 2, giving

  Average receivables collection period = 31.6 - 43. 1 + 23. 2 = 11.7 days. Since Average receivables collection period = 365/receivables turnover, the receivables turnover ratio equals 365/11.7 = 31.2.

• Question 3855:

  When the output of an economy exceeds the economy's full-employment capacity, then

  A. aggregate supply will increase until the economy can produce the output at the existing price level.
  B. aggregate demand will decline until full-employment equilibrium is restored at a lower price level.
  C. unemployment will exceed the economy's natural unemployment.
  D. wages and prices will rise until full employment is restored at a higher price level.
  D. wages and prices will rise until full employment is restored at a higher price level.

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  Explanation

  Higher than full employment output will cause resource prices to rise (i.e. the price of labor and other prices in the economy) which will result in decreased demand for labor and a contraction of aggregate supply. The economy will toward its long run equilibrium output.

• Question 3856:

  Braun Industries is considering an investment project, which has the following cash flows: tProject Cash Flows 0-$1,000 1 400 2 300 3 500 4 400 The company's WACC is 10 percent. What is the project's payback, internal rate of return and net present value?

  A. Payback = 2. 6, IRR = 24. 12%, NPV = $300.
  B. Payback = 2. 6, IRR = 21.22%, NPV = $260.
  C. Payback = 2. 4, IRR = 21.22%, NPV = $260.
  D. Payback = 2. 6, IRR = 21.22%, NPV = $300.
  E. Payback = 2. 4, IRR = 10.00%, NPV = $600.
  B. Payback = 2. 6, IRR = 21.22%, NPV = $260.

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  Explanation

  Payback = 2 + 300/500 = 2. 6 years.

  IRR: -1000 + 400/(1+Irr)^1 + 300/(1+Irr)^2 + 500/(1+Irr)^3 + 400/(1+Irr)^4 = 0: IRR = 21.22%.

  NPV = -1000 + 400/(1+.10)^1 + 300/(1+.10)^2 + 500/(1+.10)^3 + 400/(1+.10)^4 = $260.46.

• Question 3857:

  Arizona Rock, an all-equity firm, currently has a beta of 1.25, and k(RF) = 7 percent and k(M) = 14 percent. Suppose the firm sells 10 percent of its assets (beta = 1.25) and purchases the same proportion of new assets with a beta of 1.1. What will be the firm's new overall required rate of return, and what rate of return must the new assets produce in order to leave the stock price unchanged?

  A. 15. 750%; 15. 645%
  B. 14. 750%; 15. 750%
  C. 15. 645%; 14. 700%
  D. 15. 750%; 14. 700%
  E. 15. 645%; 15. 645%
  C. 15. 645%; 14. 700%

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  Explanation

  b(old, firm) = 1.25.

  k(old, firm) = 0.07 + (14 - 7)1.25 = 15. 75%.

  b(new, firm) = 0.9(1.25) + 0.1(1.1) = 1.235.

  k(new, firm) = 0.07 + 1.235(0.07) = 15. 645%.

  k(new, assets) = 0.07 + 1.1(0.07) = 14. 7%.

• Question 3858:

  Standard III includes which of the following?

  A. None of these answers
  B. Professional Misconduct
  C. Duty to Employer
  D. Prohibition against Plagiarism
  E. All of these answers
  F. Use of Professional Designation
  C. Duty to Employer

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  Explanation

  Standard III deals with Obligation to Inform Employer of Code and Standards, Duty to Employer, Disclosure of Conflicts to Employer, Disclosure of Additional Compensation Arrangements and Responsibilities of Supervisors.

• Question 3859:

  The coefficient of variation of a distribution X is twice that of Y. If X and Y have the same means, the variance of Y is:

  A. half that of X.
  B. twice that of X.
  C. none of these answers.
  D. same as that of X.
  C. none of these answers.

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  Explanation

  The coefficient of variation equals the standard deviation divided by mean. Since X and Y have the same mean, X must have a standard deviation which is twice that of Y for its coefficient of variation to be twice that of Y. Then, the variance of X is 2^2 = 4 times that of Y.

• Question 3860:

  Using the infinite period Dividend Discount Model, what is the value of a stock with the following characteristics?

  Current dividend $6

  Long term dividend growth rate 8%

  Required rate of return 12%

  A. $96. 00
  B. $75. 00
  C. $14. 25
  D. $48.00
  E. $162. 00
  F. $72. 00
  E. $162. 00

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  Explanation

  The infinite period DDM indicates that:

  Value = (Dividend for period 1)/k-g where k is the required rate of return and g is the growth rate. In this case, Value = ($6 x 1.08)/(.12-.08) = $6. 48/.04 = $162.