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Test Prep CFA-Level-I Exam
CFA® Level I Chartered Financial Analyst (Page 13 )

Updated On: 26-Jan-2026
Page 13 of 793
PDF with 3963 Questions

Martin Corporation's common stock is currently selling for $50 per share. The current dividend is $2.00 per share. If dividends are expected to grow at 6 percent per year and if flotation costs are 10 percent, then what is the firm's cost of retained earnings and what is its cost of new common stock?

  1. 10.71%; 10.24%
  2. 10.24%; 10.71%
  3. 11.38%; 10.71%
  4. 10.24%; 11.38%
  5. 9.31%; 9.86%

Answer(s): B

Explanation:

Cost of retained earnings:
k(s) = $2.12/$50 + 0.06 = 10.24%.
Cost of new common equity:
k(e) = $2.12/($50(1-.10)) + 0.06 = 10.71%.



A stock has a beta of 0.44 and the market risk premium is 7.9%. Its dividend growth rate is 4.25% and its P/E ratio is 8.7. If the firm has a dividend payout ratio of 70%, the risk-free rate equals ________.

  1. 6.81%
  2. 7.12%
  3. 8.82%
  4. 4.56%

Answer(s): C

Explanation:

Po/E1 = dividend payout/(k - g) Therefore, 8.7 = 0.7/(k - 0.0425), giving expected return = k = 12.3%.
Now, the CAPM expected return on the stock is given by k = Rf + beta*(Rm - Rf). Therefore, 12.3% = Rf + 0.44*7.9%, giving risk-free rate = 8.82%.



Which of the following may be used as mechanisms to motivate managers to act in the best interest of the stockholders?

  1. Managerial compensation
    II. Direct stockholder intervention
    III. Threat of firing
    IV. Threat of takeover
  2. IV only
  3. I only
  4. I, II, III & IV
  5. III only
  6. I, II & III
  7. II only

Answer(s): C

Explanation:

Managerial compensation may be designed to not only attract and retain the best managerial talent for a firm, but also to align the management's action with the interest of the shareholders. Direct intervention is another mechanism that may be used to motivate management into acting in the owner's best interest. This in practice is executed with a wide degree of success. The threat of firing may also be used as well as the threat of hostile takeovers. The threat of a hostile takeover is strongest when a company is under performing and/or its stock is undervalued.



Given the following net cash flows, determine the IRR of the project:
TimeNet cash flow
0$1,520
1-1,000
2-1,500
3-500

  1. 36%
  2. 28%
  3. 32%
  4. 24%
  5. 20%

Answer(s): D

Explanation:

Time line:
0123 Periods
1,520-1,000-1,500500
Financial calculator solution: Using cash flows,
Inputs: CF(0) = 1,520; CF(1) = -1,000; CF(2) = -1,500; CF(3) = 500.
Output: IRR% = 23.98%.



International Transport Company is considering building a new facility in Seattle. If the company goes ahead with the project, it will spend $2 million immediately (at t = 0) and another $2 million at the end of Year 1 (t = 1). It will then receive net cash flows of $1 million at the end of Years 2 - 5, and it expects to sell the property for $2 million at the end of Year 6. The company's cost of capital is 12 percent, and it uses the modified IRR criterion for capital budgeting decisions. Which of the following statements is most correct?

  1. The regular IRR is less than the cost of capital. Under this condition, the modified IRR will also be less than the regular IRR.
  2. The project should be accepted because the modified IRR is greater than the cost of capital.
  3. If the regular IRR is less than the cost of capital, then the modified IRR will be greater than the regular IRR.
    That situation applies in this case.
  4. The project should be rejected because the modified IRR is less than the regular IRR.
  5. Given the data in the problem, the modified IRR criterion indicates that the project should be accepted.
    However, the NPV is negative. This demonstrates that the modified IRR criterion is not always a valid decision method for projects such as this one.

Answer(s): C

Explanation:

PV(Outflows) = -$2,000,000 - $2,000,000/1.12 = -$3,785,714.
TV(Inflows) = $1,000,000(FVIFA(12%,4))(1.12) + $2,000,000
= $1,000,000(4.7793)(1.12) + $2,000,000 = $7,352,816.
1 + MIRR = [7,352,816/3,785,714]^1/6; MIRR = 11.7%.
Since the MIRR is less than the cost of capital, the IRR is less than the MIRR.



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