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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 56 )

Updated On: 26-Jan-2026
Page 56 of 793
PDF with 3960 Questions

A project requires an initial outlay of $600. Over the next 5 years, it expects to have cash outflows of $200, $300, $175, $350 and $150. The revenues over the same period equal $100, $400, $700, $550 and $800. Assume that these cash flows occur at year-end. The project's payback period equals ________.

  1. 2.91 years
  2. 3.38 years
  3. 4.11 years
  4. 3.82 years

Answer(s): B

Explanation:

The payback period is defined as the expected number of years that would be required to recover the original investment. In particular, Payback period = Years before full recovery + (unrecovered cost at the start of payback year)/(net cash flow in the payback year) To calculate the payback period, you must have the stream of net cash flows = Revenues - out flows. The net cash flows over the next 5 years are $(100-200), $(400-300), $(700-175), $(550-350) and $(800-150) i.e. the net cash flows are: -$100, $100, $525, $200 and $650. The complete recovery of the total outlay of $600 + $100 (year 1 net outflow) occurs in the 4th year. At the beginning of the 4th year, the outstanding balance equals 600+100-100-525 = $75. Therefore, payback period = 3 + 75/200 = 3.375 years.



Hensley Corporation uses breakeven analysis to study the effects of expansion projects it considers. Currently, the firm's plastic bag business segment has fixed costs of $120,000, while its unit price per carton is $1.20 and its variable unit cost is $0.60. The firm is considering a new bag machine and an automatic carton folder as modifications to its existing production lines. With the expansion, fixed costs would rise to $240,000, but variable cost would drop to $0.41 per unit. One key benefit is that Hensley can lower its wholesale price to its distributors to $1.05 per carton (i.e., its selling price), and this would likely more than double its market share, as it will become the lowest cost producer. What is the change in the breakeven volume with the proposed project?

  1. 100,000 units
  2. 75,000 units
  3. 0 units
  4. 175,000 units
  5. 200,000 units

Answer(s): D

Explanation:

Calculate the old and new breakeven volumes using the old data and new projections: Old Q(BE) = $120,000/ ($1.20 - $0.60) = $120,000/$0.60 = 200,000 units.
New Q(BE) = $240,000/($1.05 - $0.41) = $240,000/$0.64 = 375,000 units.
Change in breakeven volume = 375,000 - 200,000 = 175,000 units.



If a firm uses debt financing (Debt ratio = 0.40) and sales change from the current level, which of the following statements is most correct?

  1. The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt.
  2. The percentage change in EBIT will equal the percentage change in net income.
  3. The percentage change in net operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income (NI).
  4. Since debt is used, the degree of operating leverage must be greater than 1.
  5. The percentage change in net operating income will be less than the percentage change in net income.

Answer(s): E

Explanation:

The greater the use of fixed assets, the more sensitive EBIT will be to changes in sales. Interest charges on debt are included in net income and not operating income, as the use of debt financing will have an impact on net income when sales change.



Intelligent Semiconductor is considering issuing additional common stock. The firm has an after-tax cost of debt of 8.55%, with the yield to maturity on the firm's outstanding senior long-term debt at 13%. The company's combined federal/state income tax is 35%. The risk-free rate of return is 5.6%, and the annual return on the broadest market index is expected to be 13.5%. Shares of Intelligent Semiconductor have a historical beta of

1.6, and in the past, the firm has assumed a 265 basis point risk premium when calculating the cost of equity. The firm's next dividend is expected to be $0.50 per share, and the dividend has been growing at a 12% annual rate. Finally, the firm's common stock is priced at $24.78. What is the cost of equity for this firm using the Dividend-Yield-plus-Growth-Rate, or Discounted Cash Flow (DCF) approach?

  1. 18.24%
  2. The cost of equity using the DCF approach cannot be calculated from the information provided.
  3. 16.15%
  4. 14.02%
  5. 15.65%
  6. 11.20%

Answer(s): D

Explanation:

The cost of issuing common stock can be calculated using several methods, including the Bond-Yield- Plus- Risk-Premium approach, Discounted Cash Flow method, or by using the Capital Asset Pricing Model. In this example, you have been asked to calculate the cost of equity using the Discounted Cash Flow method, which is commonly referred to as the Dividend-Yield-plus-Growth-Rate approach. In calculating the cost of equity using this approach, the following components are necessary: next expected annual dividend, growth rate of dividends, and the current stock price. Everything else provided in this example is largely irrelevant. The calculation of the cost of equity using the DCF approach is as follows: {[next annual dividend $0.50 / common stock $24.78] + expected dividend growth rate 12%} = 14.018%.



Clay Industries, a diversified industrial firm, is considering investing into a new manufacturing facility which would allow the Company to expand its operations into a promising new market for industrial motors, specifically the High Temperature Superconducting, or HTS motors. This project is one of many currently under consideration for Clay Industries, and the amount of R&D expense allocated toward researching this new manufacturing facility is residual in nature. The following information applies to this new project.
R&D expense for the quarter $15,000
Initial cash outlay ($45,000)
t1: ($40,000)
t2: ($10,000)
t3: $40,000
t4: $40,000
t5: $16,000
t6: $25,000
Assuming no taxes and a $0.00 salvage value at t6, which of the following best represent the IRR for his project?

  1. 7.039%
  2. This project will have multiple IRR at any discount rate
  3. The IRR cannot be calculated due to the fact that no discount rate has been provided
  4. The IRR cannot be calculated due to the fact that the project has uneven cash flows
  5. 2.639%

Answer(s): A

Explanation:

Remember that the quarterly R&D expense is a sunk cost, and one which cannot be directly attributable to this project. Because this quarterly R&D expense is not incremental in nature, it should be omitted from the IRR calculation. Additionally, the fact that this project has uneven cash flows is irrelevant for our calculation of IRR.
To determine the IRR for this project, the following information is necessary: the initial investment outlay, the amount of each period's cash inflow, and the number of periods. In calculating IRR, no discount rate is necessary, so the last answer is incorrect. The calculation of the IRR is found as follows: incorporate the initial investment outlay of ($45,000) as Cfo, for CO1=($40,000), CO2=($10,000), CO3=$40,000, CO4=$40,000, CO5=$16,000, CO6=$25,000, CPT IRR. This yields an IRR of 7.039%.



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