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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 14 )

Updated On: 26-Jan-2026
Page 14 of 793
PDF with 3960 Questions

An investment of $1,000 will return $60 annually forever. What is its internal rate of return?

  1. 6.00%
  2. 60.00%
  3. 16.67%
  4. cannot be determined
  5. 0.60%

Answer(s): A

Explanation:

$1,000 = $60/Irr; IRR = 0.06 = 6%.



Which of the following statements is most correct?

  1. We ideally would like to use historical measures of the component costs from prior financing in estimating the appropriate weighted average cost of capital.
  2. The cost of a new equity issuance could possibly be lower than the cost of retained earnings if the market risk premium and risk-free rate decline by a substantial amount.
  3. None of these statements.
  4. In the weighted average cost of capital calculation, we must adjust the cost of preferred stock for the tax exclusion of 70% of dividend income.
  5. All of these statements.

Answer(s): C

Explanation:

Unlike interest expense on debt, preferred dividends are not deductible, hence there are no tax savings associated with the use of preferred stock. The component costs of WACC should reflect the costs of new financing not historical measures. The cost of issuing new equity is always greater than the cost of retained earnings because of the existence of flotation costs.



The Present Value of a project's cash flows when its cost of capital equals its internal rate of return :

  1. equals zero.
  2. is positive.
  3. is negative.
  4. could be all of these answers.

Answer(s): B

Explanation:

The IRR is by definition the discount rate at which the NPV = 0. Therefore, at this point, the PV is greater than zero, since the initial outlay is always non-zero and NPV = PV - cash outlay.



A Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity.
The firm's current after-tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate. The firm's preferred stock currently sells for $90 a share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock.

Ross expects to retain $15,000 in earnings over the next year. Ross' common stock currently sells for $40 per share, but the firm will net only $34 per share from the sale of new common stock.

The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year.

What will be the WACC above the break point?

  1. 11.9%
  2. 8.3%
  3. 12.5%
  4. 14.1%
  5. 10.6%

Answer(s): A

Explanation:

Preferred stock return: 10/80 = 12.5% WACC = 6%(0.40) + 12.5%(0.10) + 16.5%(0.50) = 11.90%.



Polk Products is considering an investment project with the following cash flows:
tCash Flow
0-100,000
140,000
290,000
330,000
460,000
The company has a 10 percent cost of capital. What is the project's discounted payback?

  1. 2.67 years
  2. 1.86 years
  3. 2.49 years
  4. 1.67 years
  5. 2.11 years

Answer(s): B

Explanation:

The PV of t = 1 CF is found as follows: N = 1, I = 10, PMT = 0, FV = 40,000, and, thus PV = - $36,363.64.
Similarly, find the PV of t = 2 CF which is $74,380.17. Since the sum of these PVs is greater than the t = 0 CF of $100,000, we know the discounted payback is less than two years. We can now solve for the discounted payback period as follows: DP = 1 + ($100,000 - $36,363.64)/$74,380.17 = 1.86.



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