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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 30 )

Updated On: 26-Jan-2026
Page 30 of 793
PDF with 3960 Questions

Which of the following statements is most correct?

  1. If a company does a 2-for-1 stock split, its stock price will roughly double.
  2. An open-market dividend reinvestment plan is likely to be attractive to companies that are looking to issue additional shares of common stock.
  3. All of these answers are correct.
  4. None of the answers are correct.
  5. Stock repurchases have the effect of reducing financial leverage.

Answer(s): D

Explanation:

A new stock type of DRIP would result in raising new capital for the firm. Stock repurchases increase financial leverage. In a 2-for-1 stock split, the stock price will be halved.



A financial analyst with Smith, Kleen, & Beetchnutty is examining shares of Claypool Manufacturing for possible investment. Assume the following information:

Sales: $50,000,000
Fixed costs: $33,000,000
Variable costs: $8,500,000
Interest expense: $900,000
Tax rate: 35%
Weighted Average Cost of Capital: 11.50%
Beta coefficient: 0.96

Common shares outstanding: 4,000,000
Using this information, what are the earnings per share (EPS) for Claypool Manufacturing?

  1. $1.34
  2. $1.40
  3. The answer cannot be determined from the information provided.
  4. $1.70
  5. $1.24
  6. $1.11

Answer(s): E

Explanation:

The EPS figure is perhaps the single most popular term in the field of conventional equity investments, along with the Price-to-Earnings Ratio (P/E). Any glance into financial media and business periodicals will undoubtedly uncover numerous instances in which the EPS figure is cited or discussed. While quite popular and useful, most investors, and many business professionals, undoubtedly do not understand the mechanics behind the EPS calculation, and an investigation into the components of EPS is a valuable learning experience.
The EPS calculation is found by the following equation:
{EPS = [(Sales - Fixed Costs - Variable Costs - Interest Expense)(1 - Tax Rate)] / [# of Common Shares Outstanding]}
Additionally, the EPS figure can be found by:
{EPS = [(EBIT - Interest Expense)(1 - Tax Rate) / # of Common Shares Outstanding]} Incorporating the given information into the first EPS equation will yield the following: {EPS = [($50,000,000 - $33,000,000 - $8,500,000
- $900,000)(1 - 0.35)] / 4,000,000} = $1.24.



The net cash flow attributable to an investment project is known as which of the following terms?

  1. Sunk Cost
  2. Opportunity Cost
  3. Incremental Cash Flow
  4. Cannibalization
  5. Externality

Answer(s): C

Explanation:

Incremental cash flow is defined as the net cash flow attributable to an investment project.



Following an internal investigation into her professional business activities, a financial analyst with Smith, Kleen & Beetchnutty admits that in her NPV and IRR calculations, she has failed to index all cash flows for the effects of anticipated inflation. However, the analyst claims that the discount rate she has used in her calculations does take into effect anticipated inflation.
Which of the following correctly describes the effects this will have on the NPV and IRR calculations?

  1. NPV will be biased downward, IRR will be biased upward
  2. NPV will be biased upward, IRR will be biased downward
  3. Both NPV and IRR will be biased downward
  4. Both NPV and IRR will remain unaffected
  5. NPV will be biased downward, IRR will be unaffected
  6. Both NPV and IRR will be biased upward

Answer(s): C

Explanation:

By failing to index the cash flows of projects in her NPV analysis, while at the same time including an adjustment for inflation into the discount rate, this analyst has biased the NPV calculation downward. This is because the cash inflows are being understated by the inflation-adjusted discounting. This phenomenon will skew the NPV figure downward. Remember that while 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 remains that the cash flows in the calculation have not been indexed for the effects of positive inflation. What has happened here is that cash flows have been understated, and this will bias the IRR calculation downward.



Your company has decided that its capital budget during the coming year will be $20 million. Its optimal capital structure is 60 percent equity and 40 percent debt. Its earnings before interest and taxes (EBIT) are projected to be $34.667 million for the year. The company has $200 million of assets; its average interest rate on outstanding debt is 10 percent; and its tax rate is 40 percent. If the company follows the residual dividend policy and maintains the same capital structure, what will its dividend payout ratio be?

  1. 35%
  2. 30%
  3. 15%
  4. 20%
  5. 25%

Answer(s): E

Explanation:

Capital budget = $20 million.
Optimal capital structure: 60% equity, 40% debt.
EBIT = $34.667 million.
Assets = $200 million.
k(d) = 10%; T = 40%. Dividend Payout = ?
Debt = 0.40($200 million) = $80 million.
Interest = 0.10($80 million) = $8 million.
EBIT$34.667
-INT8.000
EBT$26.667
Taxes (40%)10.667
NI$16.000
Equity needed = 0.60($20 million) = $12 million.
Net Income$16
-Equity needed12
Amount left for dividend$4
Dividend Payout = $4/$16 = 25%.



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