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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 78 )

Updated On: 26-Jan-2026
Page 78 of 793
PDF with 3960 Questions

A stock has a beta of 0.85 and the risk-free rate is 6.95%. Its dividend growth rate is 5.2% and its P/E ratio is 11.6. If the firm has a dividend payout ratio of 63%, the market risk premium equals ________.

  1. 5.91%
  2. 6.54%
  3. 5.15%
  4. 4.33%

Answer(s): D

Explanation:

P0/E1 = dividend payout/(k - g) Therefore, 11.6 = 0.63/(k - 0.052), giving expected return = k = 10.63%. Now, the CAPM expected return on the stock is given by k = Rf + beta*(Rm - Rf). Therefore, 10.63% = 6.95% + 0.85*market premium, giving market premium = (10.63 - 6.95)%/0.85 = 4.33%.



Which of the following statements is most correct?

  1. Generally, we do not need to adjust project cash flows to take into account the effects of inflation, since inflation is not accounted for in the cost of capital.
  2. All of these statements are correct.
  3. For comparing mutually exclusive projects with unequal lives, replacement chain analysis leads to the same decision as obtained by calculating the equivalent annual annuity (EAA).
  4. In comparing mutually exclusive projects with unequal lives, you should always choose the project which has the highest NPV.
  5. The rate of depreciation affects accounting statements, but has no effect on the firm's capital budgeting decisions.

Answer(s): C

Explanation:

The replacement chain analysis and the equivalent annual annuity methods lead to the same decision.
Depreciation affects a firm's cash flow, which affects its capital budgeting decisions. The project with the highest extended NPV should be chosen. The cost of capital reflects inflation; therefore, project cash flows must be adjusted for inflation.



Which of the following figures is not explicitly incorporated into the earnings per share (EPS) calculation?

  1. Variable costs
  2. Common shares outstanding
  3. Interest expense
  4. None of these answers
  5. Fixed costs
  6. Sales

Answer(s): D

Explanation:

The EPS figure can be found using two principal equations. The first is illustrated as follows:
{EPS = [(Sales - Fixed Costs - Variable Costs - Interest Expense)(1 - Tax Rate)] / [# of Common Shares Outstanding]}
Additionally, the EPS figure can be found by:
{EPS = [(EBIT - Interest Expense)(1 - Tax Rate) / # of Common Shares Outstanding]} As you can see, all of the choices listed are expressly incorporated into the EPS calculation.



A firm's capital structure has a debt-to-equity ratio of 1.2. The pretax cost of debt is 6.8% and the weighted average cost of capital of the firm equals 9.8%. The risk-free rate in the economy is 6.2% the expected rate of return on the market is 14%. The firm must pay 35% of its gross income in taxes. The beta of the stock equals ________.

  1. 1.02
  2. 1.64
  3. 1.3
  4. 0.91

Answer(s): C

Explanation:

Since the debt interest is tax deductible, the after-tax cost of debt equals 6.8%*(1-0.35) = 4.42%. Since the D/E ratio = 1.2, (D+E)/E = 2.2, giving E/(D+E) = 0.455. Thus, equity forms 45.5% of the capital whiledebt forms 54.5%. The WACC is then equal to 0.455*RE + 0.545*4.42% = 9.8% (given). Solving gives RE = 16.24%. If B is the beta of the stock, then using CAPM, 16.24% = 6.2% + B*(14% - 6.2%), giving B = 1.29.



Which of the following equations correctly illustrates the calculation of the Weighted Average Cost of Capital (WACC)?

  1. None of these answers
  2. {{Percentage of debt* [coupon on outstanding debt * (1 - combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/(required rate of return)]} + {percentage of common equity * cost of common equity}}
  3. {{Percentage of debt * [coupon on outstanding debt * (1 + combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/(offering price - flotation costs)]} + {percentage of common equity * cost of common equity}}
  4. {{Percentage of debt* [yield to maturity of outstanding debt * (1 - combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/(offering price - flotation costs)]} + {percentage of common equity * cost of common equity}}
  5. {Average cost of equity + average cost of debt + average cost of preferred stock}* subjective divisor
  6. {Percentage of debt * [coupon on outstanding debt * (1 + combined state/federal tax rate)]} + {percentage of preferred stock * [annual preferred dividend/(offering price + flotation costs)]} + {percentage of common equity * cost of common equity}}

Answer(s): D

Explanation:

The Weighted Average Cost of Capital is a fundamentally important concept within the field of corporate finance, and the CFA candidate should have a complete understanding of both the mechanics of the WACC figure, as well as the relationships between its components. In calculating the cost of outstanding common equity, there exist three distinct methods, the Dividend-Yield-plus- Growth-Rate, or Discounted Cash Flow approach, the Capital Asset Pricing Model (CAPM), and the Bond-Yield-plus-Risk-Premium approach. It is important for the CFA candidate to have a complete understanding of each method, along with their weaknesses and advantages.



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