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

CFA Institute CFA-LEVEL-1 Online Questions & Answers

• Question 461:

  Norine Benson is studying for the Level 1 CFA examination and is having difficulty with the broader concepts of capital budgeting. Her study partner, Henri Manz, tests her understanding by asking her to identify which of the following statements is TRUE?

  A. For mutually exclusive projects, the decision rule is to pick the project that has the highest net present value (NPV).
  B. If the change in current liabilities is greater than the change in current assets, it means that additional financing was needed and there is a cash outflow.
  C. An analyst can ignore inflation since price level expectations are built into the weighted average cost of capital (WACC).
  D. Replacement decisions involve mutually exclusive projects.
  D. Replacement decisions involve mutually exclusive projects.

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  Explanation

  Because replacement decisions involve either keeping the old asset or replacing the old asset, the projects are mutually exclusive. The decision rule for NPV is to pick the project with the highest positive NPV. Only projects with positive NPV add to the company's value. If a neither project has a positive NPV, neither project should be chosen. The statement about net working capital (NWC) is stated in the reverse of how we usually think of it: in NWC = Current Assets ?Current Liabilities. Here, the change in current liabilities exceeds the change in current assets and the result is negative, meaning the project frees up cash, creating a cash inflow. Because the WACC is adjusted for inflation, the analyst must adjust project cash flows upward to reflect inflation. If the cash flows are not adjusted for inflation, the NPV will be biased downward. (Reverse the preceding logic for deflation.)

• Question 462:

  Given that the correct value of a common stock is $43, the required rate of return on the stock is 17%, and next period's dividend will be $4. 50, using the infinite period Dividend Discount Model, what is the growth rate of dividends?

  A. Not enough information
  B. 7. 1%
  C. 6. 5%
  D. 8.4%
  E. 4. 8%
  C. 6. 5%

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  Explanation

  The infinite period Dividend Discount Model postulates that the current value of a common stock is equal to D1 / (k - g), where D1 is next period's dividend, k is the required rate of return, and g is the growth rate of dividends. Rearranging this yields g = k - D1/(current value). In this question, the dividend growth rate is equal to 0.17 - (4. 5 / 43) = 0.065 = 6. 5%.

• Question 463:

  What annual interest rate, compounded annually, is equivalent to 7% per year, compounded semiannually?

  A. 6. 87%
  B. 7. 05%
  C. 7. 12%
  D. 7. 02%
  E. 7%
  C. 7. 12%

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  Explanation

  Questions of this type are illustrating the concept of an Effective Interest Rate, which is a rate compounded annually that has the same effect as a rate compounded more often than one time a year. As such, a depositor or a creditor is indifferent between them, since they have the same effect. To solve this question, make any deposit and see how much is in the account after one year. The ratio of the ending FV to the beginning PV will indicate the annual rate earned. On the BAII Plus, press 2 N, 7 divide 2 = I/Y, 100 PV, 0 PMT, CPT FV. On the HP12C, press 2 n, 7 ENTER 2 divide i, 100 PV, 0 PMT, FV. The number displayed will be 107. 12. In other words, after one year, $100 has become $107. 12. An interest rate of 7. 12%, compounded annually, would cause a $100 deposit to become $107. 12 in one year. Choosing an initial deposit of $100 helps a great deal in these situations. Make sure the BAII Plus has the value of P/Y set to 1.

• Question 464:

  A preferred stock has a $100 par value and a dividend payout of $8 per year. Your required return is 10%. What is the value of the preferred stock?

  A. $90
  B. $180
  C. not enough information to calculate it
  D. $80
  D. $80

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  Explanation

  Value of preferred stock is Dividend/Required return or $8/0.1 = $80.

• Question 465:

  The P/E ratio is not determined by

  A. the ROE.
  B. the expected dividend growth rate for the stock.
  C. the expected dividend payout ratio.
  D. the required rate of return on the stock.
  A. the ROE.

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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. If we divide both sides of the infinite period Dividend Discount Model equation by expected earnings during the next 12 months, we get P/E = (D1/E) / (k - g). This equation shows that the P/E ratio is determined by the expected dividend payout ratio (D1/E), k, and g. ROE does not help determine the P/E ratio.

• Question 466:

  A firm's dividend growth rate is 3. 2% when the dividend payout ratio equals 37%. It is expected to pay a dividend of $2. 2 next year. If the cost of external equity for the firm equals 19.2% and the firm's stock is currently priced at $14. 1, the flotation cost of equity equals ________.

  A. 1.78%
  B. 0.89%
  C. 2. 50%
  D. 1.91%
  C. 2. 50%

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  Explanation

  IF F is the percentage flotation cost and P is the amount of new equity raised per new share, then Ke = D1/[P(1-F)] + g, where Ke is the cost of external equity. Here, g = 3. 2%, D1 = $2. 2, P = $14. 1 and Ke = 19.2%. Therefore, 19.2% = 2. 2/ (14. 1*(1-F)) + 3. 2%. Solving for F gives F = 2. 5%.

• Question 467:

  What is the annual Internal Rate of Return of this series of annual cash flows: Year 0: <$4,000>, Year 1: $2,000, Year 2: $0, Year 3: $0, Year 4 number).

  A. 14. 04%
  B. 15. 28%
  C. 11.61%
  D. 25. 29%
  E. 12. 59%
  B. 15. 28%

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  Explanation

  On the BAII Plus, press CF 2nd CLRWork 4000 +/- ENTER DownArrow 2000 ENTER DownArrow DownArrow 0 ENTER DownArrow DownArrow 0 ENTER DownArrow DownArrow 4000 ENTER DownArrow DownArrow 2nd Quit. Then press Irr CPT. On the HP12C, press these keys: 4000 CHS BlueShift CFo 2000 BlueShift CFj 0 BlueShift CFj 0 BlueShift CFj 4000 BlueShift CFj. Then press YellowShift Irr. The "DownArrow" represents the downward-pointing arrow on the top row of the BAII Plus keyboard. Make sure the BAII Plus has the P/Y value set to 1.

• Question 468:

  Mid-State Electric Company must clean up the water released from its generating plant. The company's cost of capital is 10 percent for average projects, and that rate is normally adjusted up or down by 2 percentage points for high- and low-risk projects. Clean-up Plan A, which is of average risk, has an initial cost of -$1,000 at Time 0, and its operating cost will be -$100 per year for its 10-year life. Plan B, which is a high-risk project, has an initial cost of -$300, and its annual operating cost over Years 1 to 10 will be -$200. What is the proper PV of costs for the better project?

  A. -$1,642. 02
  B. -$1,430.04
  C. -$1,728.19
  D. -$1,525. 88
  E. -$1,614. 46
  E. -$1,614. 46

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  Explanation

  The first thing to note is that risky cash outflows should be discounted at a lower discount rate, so in this case we would discount the riskier Project B's cash flows at 10% - 2% = 8%. Project A's cash flows would be discounted at 10%.

  Now we would find the PV of the costs as follows:

  Project AProject B

  CF(0) = -1,000CF(0) =-300

  CF(1-10) = -100CF(1-10)=-200

  I =10.0I= 8.0

  Solve for NPV = -$1,614. 46. Solve for NPV = -$1,642. 02.

  Project A has the lower PV of costs. If Project B had been evaluated with a 12% cost of capital, its PV of costs would have been -$1,430.04, but that would have been wrong.

• Question 469:

  Ace Consulting, a corporate finance consulting firm, is examining the operations of Intelligent Semiconductor and has determined the following information: Sales $1,000,000 Total variable costs $270,000 Total fixed costs $400,000 Interest expense $75,000 EBIT $325,000 Given this information, what is the degree of total leverage for Intelligent Semiconductor?

  A. 1.342
  B. 2. 863
  C. 1.4925
  D. 3. 077
  E. 2. 292
  B. 2. 863

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  Explanation

  The Degree of Total Leverage (DTL) demonstrates how a given change in sales will impact a firm's EPS. The equation used for calculating the DTL is as follows: {[Sales - variable costs] / [sales - variable costs - fixed costs - interest expense]}. Incorporating the given values for these components into the DTL equation yields the following: {[Sales $1,000,000 - variable costs $270,000] / [sales $1,000,000 - variable costs $270,000 - fixed costs $400,000 - interest expense $75,000]}=2. 863. The EBIT figure is not explicitly incorporated into the DTL equation.

• Question 470:

  A researcher has decided to create a frequency distribution using the following classes:

  30-45, 45-60, 60-75, 76 and over.

  The selection of this set involves which of the following?

  I. non-overlapping classes.

  II. open-ended classes.

  III.

  equal class intervals

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

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  Explanation

  Note that "76 and over" is an open-ended class. Also, the classes are overlapping (for e.g., the classes "30-45" and "45-60" have the point "45" in common).