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Test Prep CFA-Level-I Exam
CFA® Level I Chartered Financial Analyst (Page 21 )

Updated On: 26-Jan-2026
Page 21 of 793
PDF with 3963 Questions

Consider the following three projects:
Project A
Initial cash outflow: $1,000,000
Cash inflows as follows
t1: $500,000
t2: $450,000
t3: $150,000
t4: $150,000
t5: $150,000
Project B
Initial cash outflow: $1,000,000
Cash inflows as follows
t1: $150,000
t2: $150,000
t3: $150,000
t4: $450,000
t5: $500,000
Project C
Initial cash outflow $1,000,000
Cash inflows as follows
t1: $280,000
t2: $280,000
t3: $280,000
t4: $280,000
t5: $280,000
Assuming no taxes, an 8.5% cost of capital, along with a $0.00 salvage value at the end of the fifth year, what is the NPV of each project? Additionally, which of the three projects has the steepest NPV profile?

  1. Project A NPV: $276,837; Project B NPV: $40,334; Project C NPV: $103,380; Project A has a steepest NPV profile
  2. Project A NPV: $ 267,837; Project B NPV: $44,330, Project C NPV: $135,820; Project A has a steepest NPV profile
  3. Project A NPV: $168,513.54 Project B NPV: $40,334; Project C NPV: $103,380; Project B has a steepest NPV profile
  4. Project A NPV: $168,531.54; Project B NPV: $40,334; Project C NPV: $103,380; Project C has a steepest NPV profile
  5. Project A NPV: $168,513.54, Project B NPV: $14,550; Project C NPV: $103,380; Project B has the steepest NPV profile
  6. Project A NPV: $276,837; Project B NPV: $114,550; Project C NPV: $135,820; Project A has a steepest NPV profile

Answer(s): C

Explanation:

Due to the fact that project B is characterized by having the majority of its cash inflows occurring during later time periods, it is more sensitive to changes in the cost of capital. This fact is exemplified by a steeper NPV profile.



Intelligent Semiconductor, a diversified technology company, is considering two mutually-exclusive projects.
Assume the following information:
Project A
Initial cash outlay: ($500,000)
t1: $125,000
t2: $125,000
t3: $155,000
t4: $285,000
Cost of capital 11.35%
Project B
Initial cash outlay ($395,000)
t1: $170,000
t2: $160,000
t3: $175,000
Cost of capital 11.35%
Assuming no taxes, a $0.00 salvage value at the end of each projects' life, and the ability for each project to be replicated identically, identify the superior project according to the Replacement Chain approach. Additionally, what is the NPV and IRR of the superior project over the common life?

  1. Project B, NPV $25,577.90, IRR 13.30%
  2. Project A, NPV $18,954.46, IRR 10.33%
  3. Project B, NPV $35, 417.16, IRR 15.67%
  4. Project B, NPV $35,417.16, IRR 13.30%
  5. The Replacement Chain approach cannot be applied to these projects.
  6. Project A, NPV $22,256.14, IRR 12.22%

Answer(s): D

Explanation:

The Replacement Chain, or "Common Life" approach, is a useful analysis method which allows two or more projects with unequal lives to be examined. In the Replacement Chain approach, the lifespans of each project being examined are multiplied in such a way that the resulting projects share a "common life." In this example, Project A has a lifespan of 4 periods, whereas Project B has a lifespan of 3. The common multiple of both is 12, and to transform each project into one which has a twelve period lifespan, multiply project A by 3 and Project B by 4. Doing so will result in the following series of cash flows for Project A:
Project A
t0 ($500,000)
t1: $125,000
t2: $125,000
t3: $155,000
t4: [$285,000 + ($500,000)]=($215,000)
t5: $125,000
t6: $125,000
t7: $155,000
t8: [$285,000 + ($500,000)]=($215,000)
t9: $125,000
t10 $125,000
t11: $155,000
t12: $285,000
Multiplying project B by 4 will result in the following cash flows: t0 ($395,000)
t1: $170,000
t2: $160,000
t3: [$175,000 + ($395,000)]=($220,000)
t4: $170,000
t5: $160,000
t6: [$175,000 + ($395,000)]=($220,000)
t7: $170,000
t8: $160,000
t9: [$175,000 + ($395,000)]=($220,000)
t10: $170,000
t11: $160,000
t12 $175,000
Solving for NPV and IRR will determine that Project B is superior on both figures, with an NPV of $35,417.16, and an IRR of 13.301%. Project A has a NPV of $22,256.14 and an IRR of 12.22%.



Suppose capital gains are taxed at 32% and realized income is taxed at 38%. The tax preference theory implies that as the dividend pay-out ratio is increased, the cost of equity:

  1. increases or decreases.
  2. increases.
  3. remains unaffected.
  4. decreases.

Answer(s): B

Explanation:

Since the capital gains tax rate is lower than the realized income tax rate, investors would prefer to defer the realization of this income through the capital gains component. Hence, increasing the payout ratio will make the stock less attractive and depress the price, raising the cost of equity.



Clay Industries, a large industrial firm, is examining the capital structure of one of its Lebanese subsidiaries. The management of Clay Industries has identified the following information:
EBIT $1,000,000
EPS $1.88
Interest paid $121,590
Sales $1,940,000
Cost of debt 6.60%
Given this information, what is the Degree of Financial Leverage for this operating division?

  1. 1.940
  2. 1.138
  3. 1.551
  4. The Degree of Financial Leverage cannot be calculated from the information provided.
  5. 1.197
  6. 1.063

Answer(s): B

Explanation:

To calculate the DFL, the financial analyst needs to determine the EBIT and interest paid for a predetermined time period. To calculate the Degree of Financial Leverage, the following equation is used: {EBIT/[EBIT - interest paid]}. Incorporating the given information into this equation yields the following: {EBIT $1,000,000 / [EBIT $1,000,000 - interest paid $121,590]}= 1.138.
The Degree of Financial Leverage measures the percentage change in EPS which results from a given percentage change in EBIT. Remember that any preferred stock dividends must be incorporated into the DFL calculation, and that the DFL can never be less than one.



Which of the following factors in the discounted cash flow approach to estimating the cost of common equity is the least difficult to estimate?

  1. All of these answers are equally difficult to estimate.
  2. Expected rate of return.
  3. Required return.
  4. Dividend yield.
  5. Expected growth rate.

Answer(s): D

Explanation:

It is easy to determine the dividend yield since the dividend and the price of the stock are known. It is more difficult to establish a proper growth rate or beta as required in the other factors.



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