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Test Prep CFA-Level-I Exam
CFA® Level I Chartered Financial Analyst (Page 155 )

Updated On: 11-Jan-2026
Page 155 of 793
PDF with 3963 Questions

Marc Juneau, equity analyst, has just been assigned the task of valuing Avalon Games, Inc. The company is expected to grow at 30 percent for the next two years. Beginning in the year 4, the growth rate is expected to reach seven percent and stabilize. The required return for this type of company in the non-electronic games sector is estimated at 13 percent. The dividend in year 1 is estimated at $3.00. Which of the following is closest to the value Juneau should calculate for the stock of Avalon Games?

  1. $71.88.
  2. $64.68.
  3. $73.01.
  4. $45.41.

Answer(s): A

Explanation:

The high "supernormal" growth in the first three years and the decrease in growth thereafter signals that we should use a combination of the multi-period and finite dividend growth models (DDM) to value the stock of Avalon Games.
Step 1:Determine the Dividend stream through year 4
Step 2:Calculate the value of the stock at the end of year 3 (using D4) Step 3:Calculate the PV of each cash flow stream at ke= 13%, and sum the cash flows.Note:We suggest you clear the financial calculator memory registers before calculating the value.



Note: 1Future values are entered in a financial calculator as negatives to ensure that the PV result is positive. It does not mean that the cash flows are negative.
Also, your calculations may differ slightly due to rounding. Remember that the question asks you to select the closest answer.



Following is a graph of the Industry Life Cycle with the names of the phases omitted.




Using the graph above, which of the following choices is INCORRECT?

  1. The return on equity (ROE) on new projects is likely greater than ke for firms in Phase B.
  2. The infinite period dividend discount model (DDM) works well for valuing firms in Phases C and D.
  3. In general, profit margins are lower in Phase A than in Phase B.
  4. For most companies, Phase C lasts the longest.

Answer(s): D

Explanation:

For most companies, Phase D, the Stabilization and Market Maturity Phase, lasts the longest. Phase C is the Mature Growth Phase.
The other statements are true. During Phase B, the Rapid Accelerating Growth Phase, it is likely that the firm is earning a higher return on new projects than the required rate of return. During this phase, investors likely prefer for the firm to reinvest rather than pay dividends. The infinite period DDM works well for valuing firms in Phase C, the Mature Growth Phase, and Phase D, the Stabilization and Market Maturity Phase. Remember that the infinite period DDM is most useful for a company with the following assumptions:
Phase A, the Pioneering Phase, is the start-up phase. Here, the market is small and firms incur major development costs. Sales growth is low and profit margins may be negative. In Phase B, the Rapid Accelerating Growth Phase, markets develop and demand grows exponentially. Competition is low and sales growth and profit margins are very high



An analyst just received the following information for Mythical Interactions, Inc. A senior equity trader in her group wants to know if he should purchase a large block of the stock. Based on the assumptions above, which of the following recommendations is CORRECT? The analyst should advise the trader to:

  1. not purchase the stock. It is overvalued by approximately $10.00.
  2. purchase the stock. It is undervalued by approximately $8.00.
  3. purchase the stock. It is undervalued by approximately $14.20.
  4. not purchase the stock. It is overvalued by approximately $14.20.

Answer(s): B

Explanation:

To determine whether the trader should purchase the stock, we need to determine if the stock is overvalued or undervalued. Given the information in this problem, we will use the price/earnings (P/E) ratio and the earnings per share (EPS) to calculate an estimated value.
The P/E ratio = Dividend Payout Ratio / (ke­ g),
EPS = [(Per share Sales Estimate) * (EBITDA%) ­ D (per share) ­ I (per share)] * (1 - t) = [($175 * 0.22) - $20 - $12] * (1 ­ 0.40) = $3.90
Value of stock = EPS * P/E = 13.725 * $3.90 = approximately$53.50 Conclusion:The trader should purchase a block of the stock. It is undervalued by the difference between the market price and the estimated value, $53.50 - $45.50, or approximately $8.00.



Which of the following statements about asset valuation is FALSE?

  1. The price to book value ratio can be used to value firms with negative cash flows.
  2. Economic value added (EVA®) measures the economic profit generated per dollar of invested capital.
  3. When estimating the profit margin of a company, the higher the export/import level, the higher the competition.
  4. The purpose of top-down stock analysis is to determine the best company within the best performing industry.

Answer(s): B

Explanation:

EVA measures management's ability to add value to the firm. One of the problems with the EVA calculation is that it is not measured relative to the capital invested in the firm. As a workaround, the ratio of EVA to capital is used, and it is this ratio that measures the economic profit generated per dollar of invested capital.
The other statements are true. Use Porter's five forces to determine the level of competition within an industry and to determine the company's strategy for dealing with that competition. Do not forget about the impact of foreign competitors!



Myra Addison, Luz Bazo, and Erik Jenss, three equity traders, are having a quick lunch around the corner from the exchange. Bazo's cell phone beeps, letting him know that he has a text message. He reads the message, then quietly tells Addison and Jenss that Badger Distributors, Inc. has just won exclusive rights to supply all major league baseball parks with uniforms for hot dog/soda vendors. Bazo stands up, gathers his unfinished lunch, and announces, "I'm going back to the exchange to trade." Jenss calmly eats his sandwich and says, "There's plenty of time to trade." Addison shakes her head and mutters, "It's too late already." Based on their reactions to the news on Badger Distributors, which statement best identifies the trading view of these three traders?

  1. Addison uses fundamental analysis, Bazo is a technician, and Jenss supports the efficient market hypothesis.
  2. Addison and Jenss both use fundamental analysis and Bazo is a technician.
  3. Addison and Jenss both use fundamental analysis and Bazo supports the efficient market hypothesis.
  4. Addison supports the efficient market hypothesis, Bazo uses fundamental analysis, and Jenss is a technician.

Answer(s): D

Explanation:

One major difference between technicians, fundamental analysis traders, and those who support the efficient market hypothesis is the speed at which they believe the market reflects new information, The order, from slowest to fastest, is: technical analysis (Jenss), fundamental analysis (Bazo), and efficient market hypothesis (Addison).



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