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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 64 )

Updated On: 26-Jan-2026
Page 64 of 793
PDF with 3960 Questions

Copybold Corporation is a start-up firm considering two alternative capital structures--one is conservative and the other aggressive. The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75. Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine. The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000. The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000. Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent. The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share. What is the coefficient of variation of expected EPS under the aggressive capital structure plan?

  1. 2.45
  2. 1.00
  3. 1.18
  4. 3.76
  5. 2.88

Answer(s): A

Explanation:

Calculate coefficient of variation
Expected EPS(Aggressive):
E(EPS) = 0.6 EPS(Feast) + 0.4 EPS(Famine) = (0.6)($1.44) + 0.4(-$0.96) = $0.48. Standard deviation SD(EPS-aggressive) = [0.6($1.44 - $0.48)^2 + 0.4(-$0.96 - $0.48)^2]^1/2 = [0.5530 + 0.8294]^1/2 = 1.176.
CV(Aggressive) = 1.176/0.48 = 2.45.



Clay Industries, a large industrial firm, is evaluating the sales of its existing line of coiled machine tubing. In their analysis, the operating managers of Clay Industries have identified the following information related to the coiled machine tubing division and its product:
Average variable cost of $100.50
Average sales price of $167.75
Breakeven quantity of 15,985 units
Which of the following best describes the total fixed cost for this product?

  1. $1,114,800
  2. The calculation of the total fixed production costs for this product cannot be calculated from the information given.
  3. $875,000
  4. None of these answers is correct.
  5. $925,000
  6. $1,075,000

Answer(s): F

Explanation:

To calculate the breakeven quantity for a product, use the following equation: {Fixed operating costs/[avg. sales price per unit - variable cost per unit]}. To determine the total fixed production cost of this product, we must rearrange the standard equation using algebra, in a manner such that the resulting equation resembles the following: [$167.75 - $100.50]
* 15,985 units = X. Solving for X, which represents the total fixed production costs, yields an answer of $1,075,000.



Santorum Co. has a capital structure which consists of 50 percent debt, 30 percent common stock, and 20 percent preferred stock. The company's net income was just reported to be $1,000,000. The company pays out 40 percent of its net income as dividends. How large of a capital budget can the company have, without having to issue additional common stock or change its capital structure?

  1. $600,000
  2. $2,000,000
  3. $1,200,000
  4. $200,000
  5. $180,000

Answer(s): B

Explanation:

The retained earnings break point indicates the size of the capital budget when not issuing additional common stock. BP(RE) = ($1,000,000(1 - 0.4))/0.30 = $2,000,000.
BP = break point; RE = retained earnings



The management of Intelligent Semiconductor is considering two mutually exclusive projects, which are detailed below:
Project A
Electron looping apparatus
Initial investment outlay ($6,000,000)
t1: $2,750,000
t2: $1,250,000
t3: $1,250,000
t4: $2,750,000
Cost of capital of 10.55%
Project B
Optical switching apparatus
Initial investment outlay ($5,040,000)
t1: $1,000,000
t2: $1,000,000
t3: $1,500,000
t4: $1,500,000
t5: $1,500,000
t6: $750,000
t7: $300,000
t8: $50,000
Cost of capital of 10.55%
Assuming no taxes, a $0.00 salvage value at the end of the each project's life, as well as the ability to replicate each project identically at the end of its lifespan, which is the superior investment according to the Common Life approach? Additionally, what are the NPV and IRR of the superior project over the common life?

  1. Project B, NPV $305,221; IRR 13.65%
  2. None of these answers
  3. Project B, NPV $287,725.32; IRR 12.38%
  4. Project A, NPV $465,515; IRR 12.78%
  5. Project A, NPV $462,038; IRR 12.72%

Answer(s): E

Explanation:

The Replacement Chain, or "Common Life" approach, is a useful method which allows two or more projects with unequal lives to be examined. In the Replacement Chain approach, the lifespans of each project being examined are multiplied in such a way that the resulting projects share a "common life." In this example, the Optical Switching apparatus has a lifespan of eight periods, while the electron looping apparatus has a four- period lifespan. The common multiple of both projects is 8, and by replicating the cash flows of the electron looping project through period 4, i.e. by carrying out the project for an additional cycle, we can arrive at a "common life" for both projects. Carrying out the electron-looping project through eight periods will yield the following series of cash flows:
Electron looping apparatus
t0: ($6,000,000)
t1: $2,750,000
t2: $1,250,000
t3: $1,250,000
t4: [$2,750,000 + ($6,000,000)]=($3,250,000)
t5: $2,750,000
t6: $1,250,000
t7: $1,250,000
t8: $2,750,000
By incorporating these cash flows into your calculator, you will find a NPV of $462,038 for this project, as well as an IRR of 12.72%. The Optical Switching apparatus has a NPV of $287,725 and an IRR of 12.38%.



Which of the following statements is most correct?

  1. Sunk costs should be ignored in capital budgeting.
  2. None of these answers are correct.
  3. Externalities should be ignored in capital budgeting.
  4. All of these answers are correct.
  5. Opportunity costs should be ignored in capital budgeting.

Answer(s): A

Explanation:

Sunk costs should be ignored. The other statements are false.



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