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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 68 )

Updated On: 26-Jan-2026
Page 68 of 793
PDF with 3960 Questions

Which of the following is false?

  1. All of these answers.
  2. The IRR and NPV rules do not always give the same project rankings.
  3. A project with a higher IRR is always preferable to a project with a lower IRR.
  4. Both IRR and NPV rules are based on cash flow discounting.

Answer(s): C

Explanation:

You should always use the NPV criterion for selecting projects. The IRR method can give project rankings different from the NPV criterion depending on the type of cash flows of the project as well as the cost of capital involved. Further, a project with a higher NPV at the project's cost of capital can have a lower IRR than another project with lower NPV. Therefore, (III) is false.



Which of the following cannot be eliminated through diversification?

  1. Stand-alone risk
    II. Unsystematic risk
    III. Systematic risk
    IV. Market risk
  2. Beta risk
    VI. Corporate risk
    VII. Alpha risk
    VIII. Gamma risk
  3. I, II, V, VII, VIII
  4. I, III, IV, VI, VII, VIII
  5. I, II, V, VI
  6. II, III, VI
  7. III, IV, V

Answer(s): E

Explanation:

Of the various components of asset risk, only systematic risk cannot be diversified away. Systematic risk measures that part of asset risk that is inherent regardless of the level of diversification, and is measured by the Beta coefficient. Systematic risk is also referred to as "market risk" and "beta risk." Corporate risk is defined as the variability of an asset's expected returns without taking into consideration the effects of shareholder diversification. This is one step away from Stand-alone Risk, which measures the risk of an asset, not only without taking into consideration the effect of shareholder diversification, but of company diversification as well.
Stand-alone risk assumes that the asset in question is the only asset of the firm and that the securities of the firm are the only assets in investors' portfolios. Corporate risk takes into consideration that firms will diversify their asset bases. Stand-alone risk is defined as the variability of an asset's expected returns if it were the only asset of a firm and the stock of that firm was the only security in an investor's portfolio. This type of risk is definitively reduced through diversification, and is commonly referred to as "unsystematic risk."



Which of the following firms has the highest degree of financial leverage? Firm A
EBIT: $1,000,000
Interest Paid: $50,000
Total Operating Expenses: $900,000
Fixed Operating Expenses: $350,000
Firm B
EBIT: $490,000
Interest Paid: $15,000
Total Operating Expenses: $300,000
Fixed Operating Expenses: $180,000
Firm C
EBIT: $1,500,000
Interest Paid: $75,000
Total Operating Expenses: $3,000,000
Fixed Operating Expenses: $2,250,000
Firm D
EBIT: $875,000
Interest Paid: $75,000
Total Operating Expenses: $3,000,000
Fixed Operating Expenses: $2,000,000
Firm E

EBIT: $1,250,000
Interest Paid: $90,000
Total Operating Expenses: $2,900,000
Fixed Operating Expenses: $1,750,000

  1. Firm E
  2. Firm C
  3. Firm D
  4. Firm B
  5. Firm A

Answer(s): C

Explanation:

The Degree of Financial Leverage (DFL) measures the percentage change in EPS that results from a given percentage change in EBIT. Financial Leverage is the second component of total leverage, along with Operating Leverage. The equation used to calculate the Degree of Financial Leverage is as follows: {DFL = [EBIT/(EBIT - Interest Paid)]}. In this example, Firm D has the highest DFL, with a figure of 1.09375.
Remember that the Degree of Financial Leverage can never be less than one, and can never be negative In a situation where the company under examination has zero interest expense, the DFL would be equal to one, i.e.
the EBIT is equal to the EBIT minus the interest expense. Another important note to remember is that in calculating the Degree of Financial Leverage, dividend payments to preferred stockholders should be included in the interest expense figure. Operating expenses are not factored into the DFL calculation, rather are used in the determination of Operating Leverage.



Which of the following factors affect a firm's cost of capital?

  1. Tax rates
  2. Investment Policy
  3. All of these answers
  4. Dividend Policy
  5. The level of interest rates
  6. Capital Structure Policy

Answer(s): C

Explanation:

Each of these factors may affect a firm's cost of capital. As interest rates rise, the cost of debt will also rise forcing firms to pay a higher rate of interest on debt capital (bonds). Tax rates also affect the cost of debt.
Furthermore, a lower capital gains tax rate relative to ordinary income tax rates will affect the cost of equity capital relative to the cost of debt capital. Capital structure policy will affect the weighted average cost of capital (WACC), as well as affect the riskiness of both equity and debt capital. A change in the level of capital risk will in turn also affect the WACC. Dividend policy including the level of dividends and stability of dividends will have a direct affect on the cost of equity capital. Finally, a firm's WACC is affected by its investment policy. The types of investments that a firm undertakes and the riskiness of those investments are reflected in the WACC.



The length of time required for an investment's cash flows, discounted at the investment's cost of capital, to

cover its cost is known as ________.

  1. Weighted Average Cost of Capital (WACC)
  2. Payback Period
  3. Discounted Payback Period
  4. Net Present Valuing
  5. Optimal Capital Structure
  6. Capital Budgeting

Answer(s): C

Explanation:

Discounted Payback Period is defined as the length of time required for an investment's cash flows, discounted at the investment's cost of capital, to cover its cost.



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