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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 48 )

Updated On: 26-Jan-2026
Page 48 of 793
PDF with 3960 Questions

Firms A and B have the same fixed costs in producing widgets. However, firm A charges 15% more than firm B for a widget while its variable costs per widget are 12% lower than those of B. If firm A sells a widget for 35% above its variable costs, the break-even point for B is ________ times higher than that for A.

  1. 2.0
  2. 9.2
  3. 3.3
  4. 2.5

Answer(s): B

Explanation:

The break-even quantity, Q, is given by Q = FC/(P - V), where FC = total fixed costs, P = average sale price per unit and V = average variable cost per unit.
You're given that FCA = FCB, PA = 1.35VA, PA = 1.15PB and VA = 0.88VB. Therefore, PB = (1.35/1.15)VA = 1.174VA and VB = (1/0.88)VA = 1.136V
E. This gives QA/QB = FC(PA-VA)/FC(PB-VB) = (PB - VB)/(PA - VA) = (1.174 - 1.136)/(1.35 - 1) = 0.109.
Thus, the break-even point for B is (1/0.109) = 9.21 times that for A.



Assume you are the director of capital budgeting for an all-equity firm. The firm's current cost of equity is 16 percent; the risk-free rate is 10 percent; and the market risk premium is 5 percent. You are considering a new project that has 50 percent more beta risk than your firm's assets currently have, i.e., its beta is 50 percent larger than the firm's existing beta. The expected return (IRR) on the new project is 18 percent. Should the project be accepted if beta risk is the appropriate risk measure?

  1. Yes; its IRR is greater than the firm's cost of capital.
  2. No; a 50 percent increase in beta risk gives a risk-adjusted required return of 24 percent.
  3. No; the project's risk-adjusted required return is 1 percentage point above its IRR.
  4. Yes; the project's risk-adjusted required return is less than its IRR.
  5. No; the project's risk-adjusted required return is 2 percentage points above its IRR.

Answer(s): C

Explanation:

Calculate the beta of the firm, and use to calculate project beta:
k(s) = 0.16 = 0.10 + (0.05)b. b = 1.2.
b(Project) = b(Firm)1.5 b(Project) is 50% greater than current b(Firm) b(Project) = (1.2)1.5 = 1.8.
Calculate required return on project, k(Project), and compare to IRR.
Project: k(Project) = 0.10 + (0.05)1.8 = 0.19 = 19%. IRR = 0.18 = 18%.
Since the required return is one percentage point greater than the expected IRR, the firm should not accept the new project.



Ace Consulting, a multinational corporate finance consulting firm, is analyzing the profitability of a new line of superconductors designed by Clay Industries, a large industrial firm. In their analysis, Ace Consulting has developed a detailed statistical model that generates random values for key variables, and these random numbers are incorporated into the analysis. Using this proprietary statistical software, Ace Consulting is allowed to formulate a computer-based model of the superconductor's expected cash flows and NPV, given any randomly selected value for seven essential variables. Which of the following choices best describes this technique for measuring stand-alone risk?

  1. Relational computation analysis
  2. Monte Carlo simulation
  3. Sensitivity analysis
  4. Scenario analysis
  5. Regression analysis
  6. Marco Polo simulation

Answer(s): B

Explanation:

In this example, Ace Consulting has developed a statistical model which generates random values for seven key variables. Using this information, Ace can provide Clay Industries with an expected range of NPV and IRR for any assumed variable values. This process is referred to as Monte Carlo simulation, and is so named because the first Monte Carlo models were incorporated into the mathematical analysis of Casino gambling.



Cepeda Corporation requires a computer system for the next ten years, and is in the process of choosing among two mutually exclusive alternatives. System A costs $50,000 today, and will produce positive net cash flows of $12,000 a year for the next ten years (t = 1 through t = 10). System B costs $30,000 today and will produce positive net cash flows of $11,000 a year for the next five years. After five years, System B can be replaced under the same terms. The company's cost of capital is 10 percent. What is the equivalent annual annuity (EAA) of the best system?

  1. $6,261.18
  2. $3,862.73
  3. $5,002.39
  4. $3,086.07
  5. $2,373.48

Answer(s): B

Explanation:

First find the NPV's of each system over its initial life.
System A: CF(0) = -50,000; CF(1-10)= 12,000; I = 10; solve for NPV = $23,734.81. System B: CF(0) = -30,000; CF(1-5)= 11,000; I = 10, solve for NPV = $11,698.65. Second, find the value of the EAA of each system.
System A: N = 10; I = 10; PV = -23,734.81; FV = 0; solve for PMT = EAA = $3,862.73. System B: N = 5; I = 10; PV = -11,698.65; FV = 0; solve for PMT = EAA = $3,086.07. Given System A has a higher EAA, it is the better of the two systems.



Rollins Corporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock, which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant growth firm, which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk- premium method to find k(s). The firm's net income is expected to be $1 million, and its dividend payout ratio is 40 percent. Flotation costs on new common stock total 10 percent, and the firm's marginal tax rate is 40 percent.
What is Rollins' retained earnings break point?

  1. $800,000
  2. $1,000,000
  3. $1,200,000
  4. $1,400,000
  5. $600,000

Answer(s): B

Explanation:

Retained earnings = 0.6($1,000,000) = $600,000.
BP(RE) = $600,000/0.6 = $1,000,000.



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