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Free Test Prep CFA-Level-I Exam Questions (page: 54)

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Two projects being considered are mutually exclusive and have the following projected cash flows:
Year Project A Project B
0-$50,000-$50,000
115,9900
215,9900
315,9900
415,9900
515,990100,560
At what rate (approximately) do the NPV profiles of Projects A and B cross?

  1. The NPV profiles of these two projects do not cross.
  2. 11.5%
  3. 6.5%
  4. 16.5%
  5. 20.0%

Answer(s): B

Explanation:

Solve for numerical PVIFA and PVIF and obtain corresponding interest rates from table. Project A:50,000 = 15,990(PVIFA(Irr,5))
3.12695 = PVIFA(IrrA,5)
IRR(A) = 18%
Project B:50,000 = 100,560(PVIF(IrrB,5)0
0.49722 = PVIF(IrrB,5)
IRR(B) = 15%
Solving for the crossover rate of 11.49% requires interpolation, which is not covered in the text. However, by using trial and error and an NPV profile drawing, the student can select the correct multiple choice answer, 11.5%. Drawing an NPV profile drawing using the calculated IRRs, and the NPVs at k = 0%, shows that there is a crossover rate. Of the responses listed in the problem, 16.5% and 20.0% are clearly too high, since the IRR (B) is 15%. At k = 6.5% the NPVs are not equal, thus 11.5% must be the correct response.



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 Intelligent'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 existing facilities ($10,500)
Initial cash outlay ($50,000)
t1: $15,000
t2: $11,000
t3: $11,000
t4: $15,000
t5 $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 after the fifth year, which of the following choices best represents the payback period for this investment?

  1. 4 years
  2. 3.75 years
  3. 3.13 years
  4. 3.87 years
  5. 4.23 years

Answer(s): D

Explanation:

Remember that the rental expense of the firm's existing facilities is a sunk cost, and should not be incorporated into the calculation. This is due to the fact that the rental expense is not incremental in nature, and is unaffected by the acceptance of the project in question. In this example, the payback period is approximately 3.87 years.
After the third year, $37,000 of the initial $50,000 investment has been recouped, leaving $13,000 to be recovered. The following period has a cash inflow of $15,000, exceeding the $13,000 amount required to completely "pay back" the initial investment. To calculate the period required, divide the $13,000 left to be recouped by the $15,000 cash inflow during period 4. This will yield an answer of 0.8667, which is added to the three-year period already passed, giving an answer of 3.87 years. While somewhat appealing in a simplistic sense, the payback period is not an advisable method for valuation and analysis of capital projects, primarily due to the fact that this method completely ignores the time value of money principle which governs the field of finance.



A financial analyst with Mally, Feasance & Company is examining shares of Microscam International. Assume the following information:
Retention Rate: 72%
EPS: $2.16
Growth Rate: 21%
Discount Rate: 14.50%
Tax Rate: 35%
Using this information, what is the ROE for Microscam International?

  1. 5.88%
  2. 15.12%
  3. 56.88%
  4. 33.40%
  5. The answer cannot be calculated from the information provided.
  6. 29.17%

Answer(s): F

Explanation:

To determine the ROE for Intelligent, the equation used to determine the dividend growth rate must be manipulated. The dividend growth rate equation to be used is originally structured as follows: {g = ROE(1 - Dividend Payout Ratio)}.
The original equation must be rearranged using algebra, and will yield the following: {ROE = g / Retention Rate of Dividends}. Imputing the given information into this equation will yield the following:
{ROE = 0.21 / 0.72}.
Solving for ROE will yield a figure of 29.17%.
As you can see, neither the discount rate nor the tax rate is incorporated into the equation. Additionally, remember that (1 - Dividend Payout Ratio) is the same thing as the Retention Rate of Dividends.



Congress considered a tax plan that would reduce capital gains tax rates from the existing levels. The current maximum capital gains rate is 28 percent compared with a maximum rate of 31 percent for ordinary personal

income. With this tax bill, which of the following statements is least correct for an investor in a high personal tax bracket?

  1. A 2-for-1 stock split is announced for a stock that the investor currently holds. The company had split the stock because the stock price had increased beyond the desired price range and is expected to continue to grow. This is good news to the investor because it means that any gains from increased stock value will be taxed at a new lower capital gains rate when the stock is sold.
  2. None of these statements are correct.
  3. One of the companies in the investor's portfolio recently announced that it will embark on a stock repurchase plan. The lower capital gains tax rate will reduce the investor's taxes if he/she decides to tender some shares of stock in the company.
  4. All of these statements are correct.
  5. The stock of a company that pays high cash dividends and has a dividend reinvestment plan (DRIP) is a good investment for this individual because he/she will receive more money that can then be reinvested in the company's stock.

Answer(s): E

Explanation:

In a dividend reinvestment plan, the stockholder must pay taxes on the dividend amount, even though stock and not cash has been received.



Which of the following is/are true about operating cash flows of a project?

  1. The annual operating cash flow equals operating income minus net non-cash expenses.
    II. Financing costs are excluded from the operating cash flows.
    III. Project evaluation is based on net cash flows, not net income.
  2. III only
  3. I, II & III
  4. I only
  5. II & III
  6. I & III
  7. II only
  8. I & II

Answer(s): D

Explanation:

The annual operating cash flow equals operating income plus net non-cash expenses. Financing costs are excluded since they are accounted for in the discounting process through the use of WACC.



Vanderheiden Inc. is considering two average-risk alternative ways of producing its patented polo shirts. Process S has a cost of $8,000 and will produce net cash flows of $5,000 per year for 2 years. Process L will cost $11,500 and will produce cash flows of $4,000 per year for 4 years. The company has a contract that requires it to produce the shirts for 4 years, but the patent will expire after 4 years, so the shirts will not be produced after 4 years. Inflation is expected to be zero during the next 4 years. If cash inflows occur at the end

of each year, and if Vanderheiden's cost of capital is 10 percent, by what amount will the better project increase Vanderheiden's value?

  1. $1,179.46
  2. $1,237.76
  3. $677.69
  4. $1,312.31
  5. $1,098.89

Answer(s): B

Explanation:

0 k = 10%1234
S
-8,0005,0005,0005,0005,000
-8,000
-3,000
IRR(S) = 16.26%.
NPV(S) = $1,237.76. (extended NPV)
0 k = 10%1234
L
-11,5004,0004,0004,0004,000
IRR(L) = 14.66%.
NPV(L) = $1,179.46.



Intelligent Semiconductor, a diversified technology company, is evaluating the sales of its cadmium silicon transistor coils, and has identified the following information:
Fixed production costs for these transistors are $800,000
Average sales price per unit is $505.50
Break-even quantity of 4,084
Which of the following best describes the average variable cost for this product?

  1. $424.16
  2. $195.89
  3. $20.84
  4. $309.61
  5. The average variable cost cannot be determined from the information provided.

Answer(s): D

Explanation:

To calculate the break-even quantity for a product, use the following equation: {Fixed operating costs/[avg.
sales price per unit - variable cost per unit]}. To determine the average variable cost of this product, we must rearrange the standard equation using algebra, in a manner such that the resulting equation resembles the following: {[$800,000/4,084] + X = $505.50}. This equation is further rearranged into the following: {$195.89 + X = $505.50}. Finally, the ending equation becomes:{X = $505.50 - $195.89}. Solving for X yields an average variable cost per unit of $309.61.



Martin Corporation currently sells 180,000 units per year at a price of $7.00 per unit; its variable cost is $4.20 per unit; and fixed costs are $400,000. Martin is considering expanding into two additional states which would increase its fixed costs to $650,000 and would increase its variable unit cost to an average of $4.48 per unit. If Martin expands it expects to sell 270,000 units at $7.00 per unit. By how much will Martin's break-even sales dollar level change?

  1. $910,667
  2. $183,333
  3. $456,500
  4. $1,200,000
  5. $805,556

Answer(s): E

Explanation:

Calculate the initial breakeven volume in dollars:
Old S(BE) = FC/(1-(VC/S)) = $400,000/1-(4.20/7.00) = $1,000,000.
Calculate the new breakeven volume in sales dollars:
New S(BE) = FC/(1-(VC/S)) $650,000/1-(4.48/7.00) = $1,805,556.
The increase in SB = $1,805,556 - $1,000,000 = $805,556.



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