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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 89 )

Updated On: 26-Jan-2026
Page 89 of 793
PDF with 3960 Questions

The opportunity costs of a project refer to:

  1. the costs already incurred in developing the project.
  2. none of these answers.
  3. the costs that would be incurred in one or more of mutually exclusive projects that are rejected in favor of the project selected.
  4. the costs incurred due to the effects of the project on the firm's other projects at hand.

Answer(s): B

Explanation:

The cash flows that could be earned if the assets were not used for the project but elsewhere are known as "opportunity costs." None of the given choices fits this definition. Note that the costs already incurred in developing the project are called "sunk costs," the costs incurred due to the effects of the project on the firm's other projects at hand are "externality" or "spill-over" costs. "The costs that would be incurred in one or more of mutually exclusive projects that are rejected in favor of the project selected" looks tempting but is not an opportunity cost.



Green Grocers is deciding among two mutually exclusive projects. The two projects have the following cash flows:
Project A Project B
Time Cash Flows Cash Flows
0-$50,000-$30,000
110,000 6,000
215,000 12,000
340,000 18,000
420,000 12,000
The company's cost of capital is 10 percent (WACC = 10%). What is the net present value (NPV) of the project with the highest internal rate of return (IRR)?

  1. $7,090
  2. $12,510
  3. $8,360
  4. $11,450
  5. $15,200

Answer(s): E

Explanation:

NPV(A) = $15,200; IRR(A) = 21.3811%.
NPV(B) = $7,092; IRR(B) = 19.2783%.
Project A has the highest IRR, so the answer is $15,200.



Dandy Product's overall weighted average required rate of return is 10 percent. Its yogurt division is riskier than average, its fresh produce division has average risk, and its institutional foods division has below-average risk. Dandy adjusts for both divisional and project risk by adding or subtracting 2 percentage points. Thus, the maximum adjustment is 4 percentage points. What is the risk-adjusted required rate of return for a low-risk project in the yogurt division?

  1. 8%
  2. 10%
  3. 14%
  4. 12%
  5. 6%

Answer(s): B

Explanation:

k(YD) = 10% + 2% = 12%.
However, for a low-risk project, Dandy Product subtracts 2 percentage points. Therefore, the required rate of return is 10 percent.
k(YD,Low risk project) = 10% + 2% - 2% = 10%.



Alvarez Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 60 percent of sales, so the company's current operating income is $700,000. The company's interest expense is $500,000. What is the company's degree of total leverage (DTL)?

  1. 3.500
  2. 6.000
  3. 1.714
  4. 3.100
  5. 3.250

Answer(s): B

Explanation:

DTL = (S - VC)/(EBT - I)
= ($3,000,000 - $1,800,000)/($700,000 - $500,000)
= 6.



Intelligent Semiconductor is considering issuing additional common stock. The current yield to maturity on the firm's outstanding senior long-term debt is 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. In the past, the firm has assumed a 265 basis point risk premium when calculating the cost of equity. What is the cost of equity for this proposed common stock issue using the Bond-Yield-plus-Risk-Premium approach?

  1. 15.65%
  2. 16.15%
  3. 18.24%
  4. 11.20%
  5. The cost of equity using the Bond-Yield-plus-Risk-Premium approach cannot be calculated from the information provided.

Answer(s): A

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 Bond-Yield-plus- Risk-Premium approach. This method is a rather ad hoc procedure used by finance professionals, and involves adding a subjective "risk premium" to the yield to maturity of the firm's outstanding debt. This approach should be used with a degree of caution, as the subjective nature of the procedure leaves significant room for variation in estimates. In using the Bond-Yield-Plus-Risk-Premium approach, a subjective risk premium is added to the yield to maturity of the firm's outstanding long-term debt, and the calculation of the correct answer in this case is as follows: {yield to maturity of the outstanding senior debt 13% + subjective risk premium 2.65%}=15.65%.



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