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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 94 )

Updated On: 26-Jan-2026
Page 94 of 793
PDF with 3960 Questions

A stock has a beta of 1.1 and the risk-free rate is 5.5%. Its dividend growth rate is 4.1% and the dividend payout ratio is 38%. If the market risk premium is 7.3%, the P/E ratio of the stock equals ________.

  1. 7.19
  2. 6.73
  3. 3.86
  4. 4.03

Answer(s): D

Explanation:

The required rate of return on the stock can be found using CAPM, which gives Rstock = k = Rf + beta*(Rm - Rf) = 5.5% + 1.1*7.3% = 13.53%. Therefore, P0/E1 = dividend payout/(k - g) = 0.38/(0.1353 - 0.041) = 4.03.



Davis Corporation is faced with two independent investment opportunities. The Corporation has an investment policy, which requires acceptable projects to recover all costs within 3 years. The Corporation uses the discounted payback method to assess potential projects and utilizes a discount rate of 10 percent. The cash flows for the two projects are:
Time Project A Project B
0-100,000-$80,000
140,000 50,000
240,000 20,000
340,000 30,000
430,000 0
Which investment project(s) does the company invest in?

  1. Project B only.
  2. Project A only.
  3. Neither Project A or Project B.
  4. Project A and Project B.

Answer(s): A

Explanation:

The sum of the PVs of the t = 1, t = 2, and t = 3 cash flows at t = 0 for Project A is $99,474.08. Thus, the discounted payback period of Project A exceeds 3 years and Project A is not acceptable. The PVs of the t = 1, t = 2, and t = 3 cash flows at t = 0 for Project B are $45,454.55, $16,528.93, and $22,539.44, respectively. These PVs sum to $84,522.92, which is greater than the cost of the project, indicating that the discounted payback period is less than 3 years. Thus, Project B will be undertaken.



The president of Real Time Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $40,000, and it falls into the MACRS 3-year class. Purchase of the computer would require an increase in net working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 3 years and then be sold for $25,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent. What is the net investment required at t = 0?

  1. -$36,600
  2. -$40,000
  3. -$38,600
  4. -$42,000
  5. -$37,600

Answer(s): D

Explanation:

Initial investment:
Cost($40,000)
Change in NWC(2,000)
($42,000)



A financial analyst is examining shares of Floweration.com, a sprawling Internet "dot com" company, in an attempt to evaluate the firm for possible investment. In her analysis, the financial analyst has determined the following information for the most recent fiscal year:
Sales $2,250,000
Total fixed cost $1,300,000
Total variable cost $305,000
Interest expense $5,750
EBIT $645,000
Amortization expense $4,550
Given this information, what is the Degree of Total Leverage for Floweration.com?

  1. 2.843
  2. 3.064
  3. 1.731
  4. 3.488
  5. 3.043

Answer(s): E

Explanation:

The Degree of Total Leverage (DTL) demonstrates how a given change in sales will impact a firm's EPS. The equation used for calculating the DTL is as follows: {[Sales - variable costs] / [sales - variable costs - fixed costs
- interest expense]}. Incorporating the given values for these components into the DTL equation yields the following: {[Sales $2,250,000 - variable costs $305,000] / [sales $2,250,000 - variable costs $305,000 - fixed costs $1,300,000 - interest expense $5,750]}=3.043. While somewhat intuitively appealing, "EBIT" and "amortization expense" are not explicitly incorporated into the DTL equation.



A project requires an initial outlay of 650. It also needs capital spending of 700 at the end of year 1 and 900 at the end of year 2. It has no revenues for the first 2 years but receives 1,200 in year 3, 1,600 in year 4 and 2,300 in year 5. The project's cost of capital is 10%. The discounted payback period equals ________.

  1. 2.26 years
  2. 4.02 years
  3. 3.19 years
  4. 3.46 years

Answer(s): B

Explanation:

The cash flows of the project starting at the end of year 1 are:
-700, -900, +1,200, +1,600, +2,300
The discounted payback period is defined as the expected number of years that would be required to recover the original investment using discounted cash flows. The discounted cash flow at the end of year N is obtained by dividing that year's cash flow by 1.1N, since the project's cost of capital is 10%. Using this, the discounted cash flows are:
-636, -744, +902, +1,093, +1,428.
Recovery occurs in the 5th year. At the beginning of the 5th year, the outstanding balance equals 650 + 636 + 744 - 902 - 1093 = 35. Therefore, the discounted payback period = 4 + 35/1428 = 4.02 years.



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