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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 53 )

Updated On: 26-Jan-2026
Page 53 of 793
PDF with 3960 Questions

Which of the following statements is correct?

  1. "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.
  2. If corporate tax rates were decreased while other things were held constant, and if the Modigliani Miller tax- adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to increase their use of debt.
  3. The optimal capital structure is the one which simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS.
  4. None of these statements are true.
  5. If corporate tax rates were decreased while other things were held constant, and if the Modigliani Miller tax- adjusted tradeoff theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt.

Answer(s): E

Explanation:

If corporate tax rates were decreased while other things were held constant, and if the MM tax- adjusted tradeoff theory of capital structure were correct, corporations would decrease their use of debt because the tax shelter benefit would not be as great as when tax rates are high. Business risk is the riskiness of the firm's operations if it uses no debt. The optimal capital structure does not maximize EPS, and the degree of total leverage shows how a given change in sales will affect earnings per share.



Which of the following are practical difficulties associated with capital structure and degree of leverage analyses?

  1. All of these statements are correct.
  2. None of the statements represent a serious impediment to the practical application of leverage analysis in capital structure determination.
  3. Managers' attitudes toward risk differ and some managers may set a target capital structure other than the one that would maximize stock price.
  4. Managers often have a responsibility to provide continuous service; they must preserve the long-run viability of the enterprise. Thus, the goal of employing leverage to maximize short-run stock price and minimize capital cost may conflict with long-run viability.
  5. It is nearly impossible to determine exactly how P/E ratios or equity capitalization rates are affected by different degrees of financial leverage.

Answer(s): A

Explanation:

Two projects being considered are mutually exclusive and have the following projected cash flows:
Year Project AProject B
0-$50,000-$50,000
115,6250
215,6250
315,6250
415,6250
515,62599,500



If the required rate of return on these projects is 10 percent, which would be chosen and why?

  1. Project B because it has the higher IRR.
  2. Neither, because both have IRRs less than the cost of capital.
  3. Project B because it has the higher NPV.
  4. Project A because it has the higher IRR.
  5. Project A because it has the higher NPV.

Answer(s): C

Explanation:

NPV(A) = $15,625(PVIFA(10%,5)) - $50,000 = $15,625(3.7908) - $50,000 = $59,231.25 - $50,000 = $9,231.25.
NPVB = $99,500(PVIF(10%,5)) - $50,000 = $99,500(0.6209) - $50,000 = $61,779.55 - $50,000 = $11,779.55.
NPV(B) > NPV(A); $11,779.55 > $9,231.25; Choose Project B.



A financial analyst with Smith, Kleen, and Beetchnutty is examining shares of Clever Industries, for possible investment. Clever Industries is involved in textile manufacturing, and the firm has been growing at a steady rate for much of the last nine decades. The analyst is trying to determine the appropriate current price range for Clever shares, and has ascertained the following information:
Expected annual dividend = $0.35
Expected sustainable annual growth rate = 15%
Investors required rate of return = 18.6%
Given this information, what is the appropriate current price for Clever Industries common stock?

  1. $10.28
  2. The current price of Clever Industries cannot be determined from the given information.
  3. $1.88
  4. $2.33
  5. $9.72

Answer(s): E

Explanation:

To calculate the appropriate stock price for Clever using the given information, the appropriate equation is as follows: {expected annual dividend/[investor's required rate of return - expected growth rate]}. Incorporating the given information into this equation yields a stock price of $9.722. Remember that this model to stock valuations is most appropriate for firms who are in the constant growth stage. Another important note to remember is that this model will yield realistic results only in those instances in which the investor's required rate of return exceeds the expected growth rate.



A set of projects where only one can be accepted is known as ________.

  1. Project Net Worth Optimization
  2. Equity Enhancement
  3. Independent Projects
  4. Optimal Capital Budgeting
  5. Mutually Exclusive Projects

Answer(s): E

Explanation:

Mutually Exclusive Projects are defined as a set of projects where only one can be accepted.



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