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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 44 )

Updated On: 26-Jan-2026
Page 44 of 793
PDF with 3960 Questions

The Residual Dividend Model is characterized as which of the following?

  1. Dividend paid = EBIT (1 - combined state/federal tax rate) - preferred dividends - interest expense
  2. Dividend paid = EBIT - Interest expense (1 - combined state/federal tax rate)
  3. Dividend paid = EBIT - capital expenditures
  4. None of these answers
  5. Dividend paid = EBITA - proposed capital expenditures - interest expense
  6. Dividend paid = EBIT - Retained earnings which are necessary to maintain the firm's optimal capital budget

Answer(s): E

Explanation:

The Residual Dividend Model is characterized by a firm paying out all earnings to common stockholders beyond that which is necessary to maintain the firm's optimal capital budget. Answer C correctly illustrates the calculation of the dividend paid according to the Residual Dividend Model.



10 months ago, a firm had leased a downtown office for $5,000 per month. The lease runs for the next 2.5 years. The current office space of similar size rents at $4,000 per month. If the firm uses the space exclusively for a project over the next 6 months, the opportunity cost related to this equals ________.

  1. $5,000 per month
  2. insufficient information
  3. $4,000 per month
  4. zero

Answer(s): C

Explanation:

Opportunity cost is based on current market cost. It does not matter what the firm originally paid or agreed to pay for the property in question. Of course, since taxes are based on actual costs, the afte rtax opportunity cost is definitely affected by historical contracts currently in force.



A firm's capital structure consists of 35% debt with an after-tax cost of 5.2%. Common equity makes up 55% of

the structure and the rest is made up of preferred equity. The preferred stock has a coupon of 7% and the required rate of return on the common stock is 13.7%. The firm's WACC is ________.

  1. 10.06%
  2. 15.61%
  3. none of these answers
  4. 13.24%
  5. 12.19%
  6. 11.95%
  7. 14.39%

Answer(s): C

Explanation:

To get the WACC in this case, you need to have information on the cost of preferred stock. This is not necessarily equal to the coupon rate on the preferred equity. Rather, it is the discount rate that equates the present value of the perpetual payments on the preferred equity to its current price. Without the price information, you cannot get the cost of preferred equity and hence, WACC cannot be calculated.



When a mature firm raises the dividend, signaling theory implies that its stock price ________. When a growth firm cuts the dividend, signaling theory implies that its stock price ________.

  1. will fall; may rise or fall
  2. will rise; will fall
  3. will fall; will rise
  4. will rise; may rise or fall

Answer(s): D

Explanation:

The signaling theory is properly applicable only to mature firms which have had stable dividend policies. In its pure form, the theory regards dividend changes as signals of management's forecasts of future earnings. Such an assumption is not fully justifiable for young, growth firms, which may cut dividends simply to supply retained earnings capital for expansion projects, without any signaling about the firm's future earnings prospects.
Indeed, many growth firms pay no dividends at all for quite some time without an adverse effect on their stock prices.
Hence, the increase in the dividend of a mature firm is taken as a signal by investors - under the signaling hypothesis - that the management's forecasts of future earnings are quite favorable, leading to a rise in the stock price. On the other hand, for a growth firm, such a signaling conclusion does not necessarily hold.



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 is the firm's cost of newly issued common stock?

  1. 16.5%
  2. 18.0%
  3. 10.0%
  4. 12.5%
  5. 15.5%

Answer(s): A

Explanation:

Cost of new common equity:
k(e) = ($2.20/$34) + 0.10 = 0.1647 = 16.5%.



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