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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 3901:

  In his determination of a project's NPV and IRR, a financial analyst with Smith, Kleen, and Beetchnutty indexes the project's anticipated cash flows for the expected effects of inflation. However, the discount rate applied to these cash flows does not factor an adjustment for inflation. Assuming a positive inflation figure for the every period in the project's lifespan, which of the following correctly describes the effects of the omission on the NPV and IRR calculations?

  A. NPV and IRR will be biased upward
  B. NPV and IRR will be biased downward
  C. NPV will be biased downward, IRR will be biased upward
  D. NPV will be biased upward, IRR will be unaffected
  E. NPV will remain unaffected, IRR will be biased downward
  F. NPV will be biased downward, IRR will be unaffected
  D. NPV will be biased upward, IRR will be unaffected

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  Explanation

  By failing to include an the effects of anticipated inflation in the discount rate applied to the project's cash inflows, this analyst is creating a situation in which the NPV calculations will be biased upward. This is due to the fact that the project's inflows have been adjusted for the anticipated effects of POSITIVE inflation, i.e. these cash flows have been indexed upward, while at the same time the rate at which these cash flows are being discounted has not increased. In effect, the cash inflows of the project are being overstated, and this will lead to an upward bias in the NPV calculation. Remember that the Internal Rate of Return calculation does not specify an explicit discount rate, rather calculates the discount rate that equates the cash inflows of a project with its cash outflows. The fact that this analyst has not incorporated the effects of inflation into the discount rate has no bearing on IRR, because the IRR equation does not call for a discount rate.

• Question 3902:

  Which of the following would not be reported as an extraordinary item?

  A. gain or loss on sale of fixed assets
  B. gain or loss from passing of a new law
  C. gain or loss from early retirement of debt
  D. uninsured loss from a flood
  A. gain or loss on sale of fixed assets

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  Explanation

  An item must be both unusual and infrequent (and material in amount) to be classified as extraordinary.

• Question 3903:

  Which of the following is a valid reason for an analyst to question the value of a deferred asset or justify capitalizing it?

  A. Rapid product obsolescence.
  B. Over estimation of future sales.
  C. All of these answers.
  D. The proper amortization might be substantially shorter that the one selected by management.
  E. Non-existence of future benefits.
  C. All of these answers.

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  Explanation

  The analyst needs to scrutinize all factors related to the value of deferred assets. Conditions such as rapid obsolescence can considerably shorten the time horizon that a future project's value is based upon. Further, management can be overly optimistic in the estimation of future sales; these sales may fall far short, or they may never materialize. It is the analysts' responsibility to research all facts available and come to an independent conclusion as to the validity of such claims.

• Question 3904:

  Clay Industries, a large industrial firm, is considering the development of an underwater drilling system which will greatly increase the productivity of deep-sea petroleum extraction. However, the development of the system involves substantial setup and implementation costs. If Clay Industries chooses to begin developing the new system, the firm will be forced to decline several other promising projects, due to a lack of available investment capital. Which of the following terms most correctly describes the problem faced by Clay Industries?

  A. Diminishing returns problem
  B. Marginal cost problem
  C. Principal/agent problem
  D. Opportunity cost problem
  E. Externality problem
  D. Opportunity cost problem

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  Explanation

  In this example, Clay Industries is faced with several mutually-exclusive projects. If the firm begins to develop the underwater drilling system, it will be forced to decline the acceptance of other projects. This is an opportunity cost problem.

• Question 3905:

  The Residual Dividend Policy leads to:

  A. the firm paying out a constant fraction of earnings as dividends.
  B. the firm maintaining a constant absolute amount of dividends.
  C. the firm maintaining a steady growth of dividends.
  D. a highly unstable dividend policy.
  D. a highly unstable dividend policy.

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  Explanation

  Under the Residual Dividend Policy, a firm first determines the amount of capital it requires for sufficiently profitable projects. It then uses retained earnings to supply equity capital and raises debt in the proper amount to maintain the target capital structure. If any earnings are left over after this, they are paid out as dividends. If not, the firm will not only not pay any dividends but also issues new equity for financing. Thus, the amount of dividends paid out can swing wildly from one year to the next, based on the current business conditions and future growth prospects.

• Question 3906:

  When formulating an investment policy for a client, all of the following fall under "investor constraints," except ________.

  A. liquidity needs
  B. regulatory and legal circumstances
  C. risk tolerance
  D. tax considerations
  E. expected cash flows
  F. investable funds
  G. investor preferences, circumstances and unique needs
  H. none of these answers
  C. risk tolerance

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  Explanation

  Risk tolerance is considered under "investor objectives."

• Question 3907:

  John's great-grandfather left him $50 when he died 80 years ago in an account paying 8% per year, compounded annually. How much would the account hold for John now?

  A. $407. 76
  B. $24,229.78
  C. $24,113. 90
  D. $22,504. 51
  E. $23,597. 74
  E. $23,597. 74

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  Explanation

  On the BAII Plus, press 80 N, 8 I/Y, 50 PV, 0 PMT, CPT FV. On the HP12C, press 80 n, 8 i, 50 PV, 0 PMT, FV. Note that the answer will be displayed as a negative number. Make sure that the BAII Plus has the P/Y value set to 1.

• Question 3908:

  If you deposit $250 a month, beginning next month, for 20 years into an account paying 7% per year, compounded monthly, how much is in your account after that last deposit?

  A. $58,205. 58
  B. $308,663. 09
  C. $148,833. 09
  D. $147,577. 02
  E. $130,231.66
  E. $130,231.66

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  Explanation

  On the BAII Plus, press 240 N, 7 divide 12 = I/Y, 0 PV, 250 PMT, CPT FV. On the HP12C, press 240 n, 7 ENTER 12 divide i, 0 PV, 250 PMT, FV. On the BAII Plus, make sure the value of P/Y is set to 1. Note that the answer is displayed as a negative number.

• Question 3909:

  Assume the following information about two individual projects. Project A Initial cash outflow: $175,000 Expected cash inflows t1: $75,000 t2: $65,000 t3: $35,000 t4: $35,000 t5: $15,000 Project B Initial cash outflow: $100,000 Expected cash inflows t1: $15,000 t2: $15,000 t3: $18,000 t4: $45,000 t5: $45,000 Assuming these projects are not mutually exclusive, and the cost of capital is 10%, which of the two should be undertaken according to NPV? Additionally, which of the two projects has the steeper NPV profile?

  A. Project B should be accepted, project A has a steeper NPV profile
  B. Project A should be accepted, project A has a steeper NPV profile
  C. Project B should be accepted, project B has a steeper NPV profile
  D. Both projects should be accepted, project A has a steeper NPV profile
  E. Project A should be accepted, project B has a steeper NPV profile
  F. Neither project should be accepted, project B has a steeper NPV profile
  E. Project A should be accepted, project B has a steeper NPV profile

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  Explanation

  The NPV of project B is found to be ($1,766. 21), and thus should not be accepted. However, project A has a positive NPV of $6,416. 14, and should be accepted. Project B is characterized as having the majority of its cash inflows occurring in later time periods, and thus is more sensitive to changes in the cost of capital. This is exemplified by a steeper NPV profile for project B.

• Question 3910:

  Under a periodic inventory system, how is COGS determined?

  A. Ending inventory is counted and subtracted from beginning inventory.
  B. Cost of goods sold is accumulated as sales are made.
  C. None of these answers is correct.
  D. The cost of ending inventory is subtracted from costs of goods available for sale.
  D. The cost of ending inventory is subtracted from costs of goods available for sale.

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  Explanation

  Under the periodic inventory system, only the ending inventory is counted and priced. Cost of goods sold is determined by deducting the cost of the ending inventory from the cost of goods available for sale.