Cisco®
CompTIA
Checkpoint
ISC
EC-Council
EXIN
Fortinet
ITIL®
Juniper
Microsoft
VMware
Avaya
SAP
Google
Salesforce
Amazon
Palo Alto Networks
ISC2
All Vendors
  2. Home
  3. Exams
  4. Test Prep
  5. CFA-Level-I

Free Test Prep CFA-Level-I Exam Questions (page: 43)

Page 43 of 496
PDF with 3963 Questions

Of the commonly-employed methods for evaluating capital projects, which of the following offers the most useful, reliable, and germane results for the financial analyst?

  1. Internal Rate of Return
  2. Discounted Payback Period
  3. Net Present Value
  4. Payback Period

Answer(s): C

Explanation:

In analyzing capital projects, particular weight should be given to Net Present Value (NPV) calculations, as this method is viewed as the most reliable and realistic of the four major capital budgeting analysis methods. Net Present Value calculations are superior to Internal Rate of Return calculations in that NPV works regardless of the size or timing of cash flows, and has a more flexible incorporation of the appropriate discount rate. Payback period should be viewed as the most inferior of the four methods, asit does not incorporate the "time-value of money" principle into its calculation. The Discounted Payback Period is only a slightly improved version of the basic Payback Period.



Which of the following statements is most correct?

  1. Corporations should fully account for sunk costs when making investment decisions.
  2. All of the answers are correct.
  3. The rate of depreciation will not affect operating cash flows, because depreciation is not a cash expense.
  4. Corporations should fully account for opportunity costs when making investment decisions.
  5. None of the answers are correct.

Answer(s): D

Explanation:

Cash flow = Net income + depreciation; therefore, depreciation affects operating cash flows. Sunk costs should be disregarded when making investment decisions, while opportunity costs should be considered when making investment decisions, as they represent the best alternative use of an asset.



Which of the following is false?

  1. All of these answers.
  2. The IRR and NPV rules do not always give the same project rankings.
  3. A project with a higher IRR is always preferable to a project with a lower IRR.
  4. Both IRR and NPV rules are based on cash flow discounting.

Answer(s): C

Explanation:

You should always use the NPV criterion for selecting projects. The IRR method can give project rankings different from the NPV criterion depending on the type of cash flows of the project as well as the cost of capital involved. Further, a project with a higher NPV at the project's cost of capital can have a lower IRR than another project with lower NPV. Therefore, (III) is false.



Which of the following cannot be eliminated through diversification?

  1. Stand-alone risk
    II. Unsystematic risk
    III. Systematic risk
    IV. Market risk
  2. Beta risk
    VI. Corporate risk
    VII. Alpha risk
    VIII. Gamma risk
  3. I, II, V, VII, VIII
  4. I, III, IV, VI, VII, VIII
  5. I, II, V, VI
  6. II, III, VI
  7. III, IV, V

Answer(s): E

Explanation:

Of the various components of asset risk, only systematic risk cannot be diversified away. Systematic risk measures that part of asset risk that is inherent regardless of the level of diversification, and is measured by the Beta coefficient. Systematic risk is also referred to as "market risk" and "beta risk." Corporate risk is defined as the variability of an asset's expected returns without taking into consideration the effects of shareholder diversification. This is one step away from Stand-alone Risk, which measures the risk of an asset, not only without taking into consideration the effect of shareholder diversification, but of company diversification as well.
Stand-alone risk assumes that the asset in question is the only asset of the firm and that the securities of the firm are the only assets in investors' portfolios. Corporate risk takes into consideration that firms will diversify their asset bases. Stand-alone risk is defined as the variability of an asset's expected returns if it were the only asset of a firm and the stock of that firm was the only security in an investor's portfolio. This type of risk is definitively reduced through diversification, and is commonly referred to as "unsystematic risk."



Which of the following firms has the highest degree of financial leverage? Firm A
EBIT: $1,000,000
Interest Paid: $50,000
Total Operating Expenses: $900,000
Fixed Operating Expenses: $350,000
Firm B
EBIT: $490,000
Interest Paid: $15,000
Total Operating Expenses: $300,000
Fixed Operating Expenses: $180,000
Firm C
EBIT: $1,500,000
Interest Paid: $75,000
Total Operating Expenses: $3,000,000
Fixed Operating Expenses: $2,250,000
Firm D
EBIT: $875,000
Interest Paid: $75,000
Total Operating Expenses: $3,000,000
Fixed Operating Expenses: $2,000,000
Firm E

EBIT: $1,250,000
Interest Paid: $90,000
Total Operating Expenses: $2,900,000
Fixed Operating Expenses: $1,750,000

  1. Firm E
  2. Firm C
  3. Firm D
  4. Firm B
  5. Firm A

Answer(s): C

Explanation:

The Degree of Financial Leverage (DFL) measures the percentage change in EPS that results from a given percentage change in EBIT. Financial Leverage is the second component of total leverage, along with Operating Leverage. The equation used to calculate the Degree of Financial Leverage is as follows: {DFL = [EBIT/(EBIT - Interest Paid)]}. In this example, Firm D has the highest DFL, with a figure of 1.09375.
Remember that the Degree of Financial Leverage can never be less than one, and can never be negative In a situation where the company under examination has zero interest expense, the DFL would be equal to one, i.e.
the EBIT is equal to the EBIT minus the interest expense. Another important note to remember is that in calculating the Degree of Financial Leverage, dividend payments to preferred stockholders should be included in the interest expense figure. Operating expenses are not factored into the DFL calculation, rather are used in the determination of Operating Leverage.



Which of the following factors affect a firm's cost of capital?

  1. Tax rates
  2. Investment Policy
  3. All of these answers
  4. Dividend Policy
  5. The level of interest rates
  6. Capital Structure Policy

Answer(s): C

Explanation:

Each of these factors may affect a firm's cost of capital. As interest rates rise, the cost of debt will also rise forcing firms to pay a higher rate of interest on debt capital (bonds). Tax rates also affect the cost of debt.
Furthermore, a lower capital gains tax rate relative to ordinary income tax rates will affect the cost of equity capital relative to the cost of debt capital. Capital structure policy will affect the weighted average cost of capital (WACC), as well as affect the riskiness of both equity and debt capital. A change in the level of capital risk will in turn also affect the WACC. Dividend policy including the level of dividends and stability of dividends will have a direct affect on the cost of equity capital. Finally, a firm's WACC is affected by its investment policy. The types of investments that a firm undertakes and the riskiness of those investments are reflected in the WACC.



The length of time required for an investment's cash flows, discounted at the investment's cost of capital, to

cover its cost is known as ________.

  1. Weighted Average Cost of Capital (WACC)
  2. Payback Period
  3. Discounted Payback Period
  4. Net Present Valuing
  5. Optimal Capital Structure
  6. Capital Budgeting

Answer(s): C

Explanation:

Discounted Payback Period is defined as the length of time required for an investment's cash flows, discounted at the investment's cost of capital, to cover its cost.



In an examination of several capital projects, the management of a large international conglomerate attempts to calculate the Weighted Average Cost of Capital for the firm. The Company is capitalized according to the following schedule based on market values: 55% debt
36% common stock
9% perpetual preferred stock
Additionally, assume the following information:
Yield on outstanding debt: 8.95%
Tax rate: 35%
Annual preferred dividend: $0.70
Preferred stock price: $8.90
Return on equity: 17.36%
Dividend payout ratio: 45%
Cost of common stock: 15.10%
Using this information, what is the WACC for this large multinational conglomerate?

  1. 10.11%
  2. 9.34%
  3. None of these answers.
  4. 9.29%
  5. 9.78%
  6. The answer cannot be completely calculated from the information provided.

Answer(s): B

Explanation:

In order to calculate the WACC, it is necessary to first calculate the component cost of debt, common equity, and preferred equity. Once the cost of these components is determined, they are imputed into the WACC equation, which is as follows: {WACC = [(% weight of debt securities * cost of debt) + (% weight of common stock * cost of common stock) + (% weight of preferred stock * cost of preferred stock)]} To calculate the component cost of debt, use the following equation:
{Cost of debt = [yield on outstanding debt securities * (1 - tax rate)} Factoring in the given information into this equation would yield the following:
{After-tax cost of debt = [8.95% * (1 - 0.35%)]} = 5.818%
To calculate the component cost of outstanding preferred stock, the following equation must be used:
{Cost of preferred stock = [annual dividend / preferred stock price]} {Cost of preferred stock - = [$0.70 / $8.90]} = 7.865%.
The final component of the WACC calculation, the cost of common equity, has been provided as 15.10%.
Now that the after-tax costs of debt, preferred stock, and common stock have been determined, the WACC calculation can be found. The calculation of the WACC is as follows:
{[0.55 * 0.05818] + [0.36 * 0.1510] + [0.09 * 0.07865]} = 9.344%.



Viewing page 43 of 496
Viewing questions 337 - 344 out of 3963 questions



Post your Comments and Discuss Test Prep CFA-Level-I exam prep with other Community members:

CFA-Level-I Exam Discussions & Posts