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Free Test Prep CFA-Level-I Exam Questions (page: 48)

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Firmica recently bought a fleet of trucks which fall in the 5-year MACRS class for $135,000, with an additional $10,000 for shipping, minor taxes and paperwork. The trucks are expected to last for 7 years and have a total salvage value of $25,620. The recovery allowance for year 1 in the 5-year MACRS class is 20% and in the second year, it is 32%. In the second year, the depreciation expense arising from the fleet equals ________.

  1. $46,400
  2. $34,560
  3. $43,200
  4. $37,120

Answer(s): A

Explanation:

You should remember four things about MACRS:
1. Salvage value is never considered in calculating the depreciable basis.
2. The depreciable basis equals the purchase price plus all shipping and installation costs. 3. The depreciable basis does not change over the life of the asset in question.
4. Depreciation expense for any given year equals the allowed recovery percentage in that MACRS class times the depreciable basis.
Therefore, in this case, the depreciable basis equals $135,000 + $10,000 = $145,000 and the year 2 depreciation equals $145,000*32% = $46,400.



An individual investor approaches you and asks, "If I were to purchase a fund with a load of 6 percent, and I used $6,200 to purchase the fund, what dollar amount would the shares purchased be?"

  1. $6,200.
  2. $5,828.
  3. $6,572.
  4. $372.

Answer(s): B

Explanation:

6,200 x .94 = 5,828



Intelligent Semiconductor is considering the development of a new data storage medium, which will allow tremendous increases in the efficiency of its customer's high-end server lines. The development of the new system will take place in the firm's existing facilities, and the storage costs for the additional equipment are expected to be residual in nature. The following information applies to this project:
Rent expense for the firm's existing facilities ($10,500)
Initial cash outlay ($50,000)
t1: $15,000
t2: $11,000
t3: $11,000
t4: $15,000
t5 ($10,000)
t6 ($10,000)
t7 $25,000
Discount rate: 9%
Assuming no taxes or related charges, that the initial cash outlay does not include any sunk costs, and a $0.00 salvage value at t7, what is the MIRR of this project?

  1. 7.262%
  2. 6.231%
  3. None of these answers
  4. 12.461%
  5. This problem has more than one MIRR
  6. 14.606%

Answer(s): A

Explanation:

In this example, you are asked to calculate the Modified Internal Rate of Return for a project. In calculating the MIRR for this project, the rent cost of $10,500 is ignored because this expense represents a sunk cost.
Remember that sunk costs are irrelevant in capital budgeting decisions, and should not beincorporated into the calculation. This is due to the fact that sunk costs are not incremental in nature, and are not directly related to the acceptance of the project in question, i.e. these costs have already been incurred or have been earmarked for payment. The following illustration details the calculation of the Terminal Value (TV) for the MIRR calculation in this case: {[$15,000 *1.6771] + [11,000 * 1.53862] + [11,000 * 1.41158] + [$15,000 * 1.29503] + [$25,000 * 1]} = TV $102,034.15. The calculation of the present value of the cash outflows is found by discounting the cash outflows of periods 5 and 6 and adding them to the initial cash outlay as follows: {-$50,000 + [- $10,000/1.53862] + [-$10,000/1.6771]= PV of cash outflows ($62,462.00). Incorporating these figures into your calculator's cash flow worksheet will yield the MIRR of 7.2623%. The calculation is found by the following: PV= ($62,462.00), FV= $102,034.15, PMT=0, N=7, CPT I/Y ---7.2623%. The modified IRR has a significant advantage over the regular IRR, in the fact that MIRR assumes cash flows from all projects are reinvested at some explicit rate, while the regular IRR assumes that all cash flows are reinvested at the project's IRR. This allows for much greater flexibility.



Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows. Project L has total, undiscounted cash inflows of $16,000, while S has total undiscounted inflows of $15,000. Further, at a discount rate of 10 percent, the two projects have identical NPVs. Which project's NPV will be more sensitive to changes in the discount rate?

  1. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all costs of capital.
  2. Neither project is sensitive to changes in the discount rate, since both have NPV profiles which are horizontal.
  3. Project S.
  4. The solution cannot be determined unless the timing of the cash flows is known.
  5. Project L.

Answer(s): E

Explanation:

The NPV profile plots a project's NPV against the discount rates. The higher the undiscounted inflows, the steeper the NPV profile, and the steeper the NPV profiles, the more sensitive the project is to discount rate changes.



Which of the following statements is correct?

  1. The cost of debt used in calculating the WACC is an average of the after-tax cost of new debt and of outstanding debt.
  2. Preferred stock does not involve any adjustment for flotation cost since the dividend and price are fixed.
  3. The cost of new common equity includes an adjustment for flotation costs which is expressed as a fixed percentage of the current stock price. The flotation percentage is determined jointly by the current price of the firm's stock and its growth rate.
  4. The opportunity cost principle implies that if the firm cannot invest retained earnings and earn at least k(s) (component cost of retained earnings or internal equity), it should pay these funds to its stockholders and let them invest directly in other assets that do provide this return.
  5. Capital components are the types of capital used by firms to raise money. All capital comes from one of three types: long-term debt, preferred stock, and equity.

Answer(s): D

Explanation:

The firm's after-tax earnings belong to its stockholders. All earnings remaining after interest and preferred dividends belong to them, and these earnings serve to compensate stockholders for the use of their capital.
The firm may either pay out earnings as dividends or retain them and reinvest them in the firm. If the firm retains earnings, there is an opportunity cost involved - stockholders could have received the earnings as dividends and invested the money in other investments. Thus, the firm should earn on its retained earnings at least as much as the stockholders themselves could have earned on alternative investments of comparable risk.



Foxglove Corp. is faced with an investment project. The following information is associated with this project:
Allowable
Depreciation
YearNet Income*for 3-Yr. MACRS class
1 $50,000 0.33
2 60,000 0.45
3 70,000 0.15
4 60,000 0.07
*Assume no interest expenses and a zero tax rate. The project involves an initial investment of $100,000 in equipment that falls in the 3-year MACRS class and has an estimated salvage value of $15,000. In addition, the company expects an initial increase in net working capital of $5,000, which will be recovered in year 4. The cost of capital for the project is 12 percent. What is the project's net present value? (Round your final answer to the nearest whole dollar.)

  1. $153,840
  2. $168,604
  3. $162,409
  4. $159,071
  5. $182,344

Answer(s): B

Explanation:

Step 1 Calculate depreciation:
Dep 1 = 100,000(0.33) = 33,000.
Dep 2 = 100,000(0.45) = 45,000.
Dep 3 = 100,000(0.15) = 15,000.
Dep 4 = 100,000(0.07) = 7,000.
Step 2 Calculate cash flows:
CF 0 = -100,000 - 5,000 = -105,000.
CF 1 = 50,000 + 33,000 = 83,000.
CF 2 = 60,000 + 45,000 = 105,000.
CF 3 = 70,000 + 15,000 = 85,000.
CF 4 = 60,000 + 7,000 + 5,000 + 15,000 = 87,000.
Step 3 Calculate NPV:
Use CF key on calculator. Enter cash flows shown above. Enter I/YR = 12%. Solve for NPV = $168,604.



Chandler Communications' CFO has provided the following information:
* The company's capital budget is expected to be $5,000,000.
* The company's target capital structure is 70 percent debt and 30 percent equity.
* The company's net income is $4,500,000. If the company follows a residual dividend policy, what portion of its net income should it pay out as dividends this year?

  1. 66.67%
  2. 40.00%
  3. 33.33%
  4. 60.00%
  5. 50.00%

Answer(s): A

Explanation:

$5,000,000 x 0.3 = $1,500,000 of retained earnings needed to fund the capital budget. $4,500,000 - $1,500,000 = $3,000,000 of net income available for dividends. Dividend payout ratio = $3,000,000/$4,500,000 = 0.6667, or 66.67%.



If the MM hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct?

  1. All of these statements are true.
  2. The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis.
  3. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends.
  4. None of these statements are true.
  5. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/Po = a + b(g)) would be equal to +1.0.

Answer(s): D

Explanation:

None of these statements are correct. Miller and Modigliani argued that the value of the firm depends only on the income produced by its assets, not on how this income is divided between dividends and retained earnings.



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