CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers

• Question 941:

  Which of the following methods of measuring a project's stand-alone risk is characterized by using a computer to analyze a project's NPV across a wide range of values for numerous input variables? (Hint: This style of analysis evolved from methods used to examine probabilities in casino gambling.)

  A. Sensitivity Analysis

  B. Monte Carlo Simulation

  C. Scenario Analysis

  D. Probability Analysis

  E. None of these answers

  Correct Answer: B

  When measuring stand-alone risk using Monte Carlo Simulation, the use of a computer and a rather complex software package is necessary. In Monte Carlo Simulation, the expected ranges of inputvariables are specified, and random numbers are incorporated into the analysis function, producing a NPV value across a wide range of possible situations. Monte Carlo Simulation is so named because the technique evolved largely from methods used to analyze probabilities in casino gambling. Scenario analysis involves the establishment of a "best case" and "worst case" scenario, which is compared to a predetermined "base case." Sensitivity Analysis seeks to determine the sensitivity of a project's NPV to changes in specific input variables, and "Probability Analysis" can be conducted using simple statistical formulas. None of these three methods absolutely require the use of a computer or complex statistical software package.

• Question 942:

  A financial analyst with Smith, Kleen and Beetchnutty is examining shares of a publicly-traded specialty

  brewer. Assume the following information:

  EPS: $1.83

  ROE: 19.00%

  Growth rate of dividends: 10.85%

  Discount rate: 12.50%

  Tax Rate 35%

  Using this information, what is the dividend payout ratio for this specialty brewer? Further, what is the

  annual dividend?

  A. 50.76%, $0.93

  B. The answer cannot be determined from the information provided.

  C. 42.90%, $0.79

  D. 38.13%, $0.70

  E. 57.11%, $1.05

  F. 42.90%, $1.05

  Correct Answer: C

  To determine the dividend payout ratio, the equation used to determine the growth rate of dividends must be manipulated. This equation is originally structured as follows: {g = ROE (1 - Dividend Payout Ratio)} In order to determine the Dividend Payout Ratio, the equation must be rearranged to the following: {(1 Dividend Payout Ratio) = Growth Rate of Dividends / ROE}. Imputing the given information into this equation will yield: {(1 - Dividend Payout Ratio) = 0.1085/0.19)} = 0.57105 Finally, subtracting this answer from 1 will yield the answer of 42.90% for the dividend payout ratio. (Remember that the original answer, 0.57105, is the retention rate, not the dividend payout ratio). In order to determine the annual dividend, take the Dividend Payout Ratio, which was found to be 42.90%, and multiply this figure by the Earnings Per Share calculation, which is given as $1.83. This will yield an annual dividend of $0.785

• Question 943:

  Which of the following Companies has the highest degree of financial leverage? Firm A EBIT: $1,500,000 Interest Paid: $130,000 Total Operating Expenses: $600,000 Fixed Operating Expenses: $350,000 Firm B EBIT: $400,000 Interest Paid: $55,000 Total Operating Expenses: $1,300,000 Fixed Operating Expenses: $1,000,000 Firm C EBIT: $500,000 Interest Paid: $45,000 Total Operating Expenses: $6,000,000 Fixed Operating Expenses: $4,750,000 Firm D EBIT: $995,000

  Interest Paid: $105,000 Total Operating Expenses: $5,000,000 Fixed Operating Expenses: $3,000,000 Firm E EBIT: $995,000 Interest Paid: $120,000 Total Operating Expenses: $5,900,000 Fixed Operating Expenses: $2,000,000

  A. Firm D

  B. Firm A

  C. Firm B

  D. Firm C

  E. Firm E

  Correct Answer: C

  The Degree of Financial Leverage (DFL) measures the percentage change in EPS that results from a given percentage change in EBIT. Financial Leverage is the second component of total leverage, along with Operating Leverage. The equation used to calculate the Degree of Financial Leverage is as follows: {DFL = [EBIT/(EBIT - Interest Paid)]}. In this example, Firm B has the highest DFL, with a figure of 1.15942. Remember that the Degree of Financial Leverage can never be less than one, and can never be negative In a situation where thecompany under examination has zero interest expense, the DFL would be equal to one, i.e. the EBIT is equal to the EBIT minus the interest expense. Another important note to remember is that in calculating the Degree of Financial Leverage, dividend payments to preferred stockholders should be included in the interest expense figure. Operating expenses are not factored into the DFL calculation, rather are used in the determination of Operating Leverage.

• Question 944:

  Which of the following statements is most correct?

  A. None of these answers are correct.

  B. All of these answers are correct.

  C. Opportunity costs should not be incorporated into capital budgeting decisions.

  D. Relevant externalities should be incorporated into capital budgeting decisions.

  E. Sunk costs should be incorporated into capital budgeting decisions.

  Correct Answer: D

  Sunk costs should not be taken into consideration. Opportunity costs should be taken into consideration.

• Question 945:

  In the real world, dividends ________.

  A. are usually changed every year to reflect earnings changes

  B. fluctuate more widely than earnings

  C. tend to be a lower percentage of earnings for mature firms

  D. are usually set as a fixed percentage of earnings

  E. usually exhibit greater stability than earnings

  Correct Answer: E

  Most firms and stockholders expect earnings to grow over time with dividends growing virtually the same as earnings. In the past, a "stable dividend policy" meant a company paid the same dollar dividend for several years in a row, but today it means increasing the dividend at a reasonably steady rate. From an investor's viewpoint, the most stable policy is that whose dividend growth rate is predictable. The second most stable policy is where stockholders can reasonably be sure that the current dividend will not be reduced. The least stable is where earnings and cash flows are so volatile that investors cannot count on the company to maintain the current dividend. Since profits and cash flow vary over time for a firm, one would suggest that firms should vary their dividends over time, increasing them when cash flows are large and lowering them when cash is low relative to investment opportunities. However, many stockholders rely on dividends and reducing dividends may send incorrect signals, which could drive the stock price. Thus, maximizing a firm's stock price requires a balance of its internal fund requirements against the desires of the stockholders

• Question 946:

  A company is considering an expansion project. The company's CFO plans to calculate the project's NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the company's cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?

  A. All of the answers are correct.

  B. Any interest expenses associated with the project.

  C. None of the answers are correct.

  D. Any opportunity costs associated with the project.

  E. Any sunk costs associated with the project.

  Correct Answer: D

  Sunk costs should be excluded from the analysis, and interest expense is incorporated in the WACC and not the cash flows.

• Question 947:

  The date on which the right to the current dividend no longer accompanies a stock is known as the:

  A. Payment Date

  B. Declaration Date

  C. Expiration Date

  D. Ex-Dividend Date

  E. Holder-of-Record Date

  Correct Answer: D

  The Ex-Dividend date is the date on which the right to the current dividend no longer accompanies the stock. This date is usually four days prior to the holder-of-record date.

• Question 948:

  A firm currently has 3 million dollars worth of 6% debt outstanding. It can currently borrow in the capital markets at the rate of 7.2%. The firm faces a 40% tax rate. Its marginal after-tax cost of debt is about:

  A. 7.2%

  B. 6%

  C. 3.6%

  D. 4.3%

  Correct Answer: D

  Since debt interest is tax-deductible, the after-tax cost of debt equals 7.2%*(1-40%) = 4.32%. Note that bonds issued in the past are of no relevance since it is the current cost of borrowing that is of concern.

• Question 949:

  Assume a project has normal cash flows (i.e., the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct?

  A. All else equal, a project's IRR increases as the cost of capital declines.

  B. None of the answers are correct.

  C. All of the answers are correct.

  D. All else equal, a project's NPV increases as the cost of capital declines.

  E. All else equal, a project's MIRR is unaffected by changes in the cost of capital.

  Correct Answer: D

  Since the present value of each cash flow is discounted at the project's cost of capital, the NPV will increase as the cost of capital declines, and the NPV will decline as the cost of capital increases. This relationship is plotted on the net present value profile.

• Question 950:

  For a typical firm with a given capital structure, which of the following is correct? (Note: All rates are after taxes.)

  A. None of these answers.

  B. k(e) > k(s) > WACC > k(d).

  C. WACC > k(e) > k(s) > k(d).

  D. k(d) > k(e) > k(s) > WACC.

  E. k(s) > k(e) > k(d) > WACC.

  Correct Answer: B

  k(d) = interest rate on the firm's new debt; k(e) = component cost of external equity, or equity obtained by issuing new common stock as opposed to retaining earnings; k(s) = component cost of retainedearnings (or internal equity). Typically, the cost of equity is higher than the cost of retained earnings because of flotation costs involved in issuing new common stock. The cost of debt is the lowest because it is the relevant cost of new debt, taking into account the tax deductibility of interest, and because of this deductibility of interest, it is the lowest component. The WACC is a weighted average of all the components, so it would be somewhere in the middle.