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: 56)

Page 56 of 496
PDF with 3963 Questions

The management of Clay Industries have adhered to the following capital structure: 50% debt, 45% common equity, and 5% perpetual preferred equity. The following information applies to the firm: Before-tax cost of debt = 7.5% Combined state/federal tax rate = 35% Expected return on the market = 14.5% Annual risk-free rate of return = 5.25% Historical Beta coefficient of Clay Industries Common Stock = 1.15 Annual preferred dividend = $1.35 Preferred stock net offering price = $17.70 Expected annual common dividend = $0.45 Common stock price = $30.90 Expected growth rate = 11.75% Subjective risk premium = 3.8% Given this information, and using the Capital Asset Pricing Model to calculate the component cost of common equity, what is the Weighted Average Cost of Capital for Clay Industries?

  1. 15.31%
  2. 11.30%
  3. 9.92%
  4. 9.968%
  5. The WACC for Clay Industries cannot be calculated from the information.
  6. 10.05%

Answer(s): D

Explanation:

The calculation of the Weighted Average Cost of Capital is as follows: {fraction of debt * [yield to maturity on outstanding long-term debt][1-combined state/federal income tax rate]} + {fraction of preferred stock * [annual dividend/net offering price]} + {fraction of common stock * cost of equity}. The cost of common equity can be calculated using three methods, the Capital Asset Pricing Model (CAPM), the Dividend-Yield-plus-Growth-Rate (or Discounted Cash Flow) approach, and the Bond- Yield-plus-Risk-Premium approach. In this example, you are asked to calculate the cost of common equity using the Capital Asset Pricing Model (CAPM). This approach involves the following equation: {risk-free rate +beta[expected return on the market - risk-free rate]}.
Specifically, the calculation of the component cost of common equity using the CAPM is as follows: {[5.25% + 1.15(14.5%-5.25%]} = 15.888%. The after-tax cost of debt can be found by multiplying the yield to maturity on the firm's outstanding long-term debt (7.5%) by (1-tax rate). Using this method, the after-tax cost of debt is found as 4.875%. The calculation of the cost of perpetual preferred stock is relatively straightforward, simply divide the annual preferred dividend by the net offering price. Using this method, the cost of preferred stock is found as 7.627%. Incorporating these figures into the WACC equation gives the answer of 9.968%.



Buchanan Brothers anticipates that its net income at the end of the year will be $3.6 million (before any recapitalization). The company currently has 900,000 shares of common stock outstanding and has no debt. The company's stock trades at $40 a share. The company is considering a recapitalization where it will issue $10 million worth of debt at a yield to maturity of 10 percent, and use the proceeds to repurchase common stock. Assume the stock price remains unchanged by the transaction, and the company's tax rate is 34 percent. What will be the company's earnings per share if it proceeds with the recapitalization?

  1. $4.52
  2. $5.54
  3. $2.23
  4. $3.26
  5. $2.45

Answer(s): A

Explanation:

After issuing the debt, the company can repurchase $10,000,000/$40 = 250,000 shares leaving 650,000 shares outstanding. We still need to find the expected NI after issuing the debt. We're given the anticipated NI is $3.6 million. Thus, the EBIT (before the debt issue) can be found as follows: $3,600,000 = EBIT(1 - 0.34) or EBIT = $5,454,545.45. The company will pay $1,000,000 in interest after issuing the debt so the new EBT will be $5,454,545.45 - $1,000,000 = $4,454,545.45. Also, the new NI figure will be: $4,454,545.45(1 - 0.34) = $2,940,000. Finally, $2,940,000/650,000 = $4.52 is the EPS after the recapitalization.



Rollins Corporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock, which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant growth firm, which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk- premium method to find k(s). The firm's net income is expected to be $1 million, and its dividend payout ratio is 40 percent. Flotation costs on new common stock total 10 percent, and the firm's marginal tax rate is 40 percent. What is Rollins' cost of retained earnings using the bond-yield-plus-risk-premium approach?

  1. 16.6%
  2. 16.0%
  3. 16.9%
  4. 14.1%
  5. 13.6%

Answer(s): B

Explanation:

Cost of retained earnings (Bond yield plus risk premium approach): k(s) = 12.0% + 4.0% = 16.0%.



The opportunity costs of a project refer to:

  1. the costs already incurred in developing the project.
  2. none of these answers.
  3. the costs that would be incurred in one or more of mutually exclusive projects that are rejected in favor of the project selected.
  4. the costs incurred due to the effects of the project on the firm's other projects at hand.

Answer(s): B

Explanation:

The cash flows that could be earned if the assets were not used for the project but elsewhere are known as "opportunity costs." None of the given choices fits this definition. Note that the costs already incurred in developing the project are called "sunk costs," the costs incurred due to the effects of the project on the firm's other projects at hand are "externality" or "spill-over" costs. "The costs that would be incurred in one or more of mutually exclusive projects that are rejected in favor of the project selected" looks tempting but is not an opportunity cost.



Green Grocers is deciding among two mutually exclusive projects. The two projects have the following cash flows:
Project A Project B
Time Cash Flows Cash Flows
0-$50,000-$30,000
110,000 6,000
215,000 12,000
340,000 18,000
420,000 12,000
The company's cost of capital is 10 percent (WACC = 10%). What is the net present value (NPV) of the project with the highest internal rate of return (IRR)?

  1. $7,090
  2. $12,510
  3. $8,360
  4. $11,450
  5. $15,200

Answer(s): E

Explanation:

NPV(A) = $15,200; IRR(A) = 21.3811%.
NPV(B) = $7,092; IRR(B) = 19.2783%.
Project A has the highest IRR, so the answer is $15,200.



Dandy Product's overall weighted average required rate of return is 10 percent. Its yogurt division is riskier than average, its fresh produce division has average risk, and its institutional foods division has below-average risk. Dandy adjusts for both divisional and project risk by adding or subtracting 2 percentage points. Thus, the maximum adjustment is 4 percentage points. What is the risk-adjusted required rate of return for a low-risk project in the yogurt division?

  1. 8%
  2. 10%
  3. 14%
  4. 12%
  5. 6%

Answer(s): B

Explanation:

k(YD) = 10% + 2% = 12%.
However, for a low-risk project, Dandy Product subtracts 2 percentage points. Therefore, the required rate of return is 10 percent.
k(YD,Low risk project) = 10% + 2% - 2% = 10%.



Alvarez Technologies has sales of $3,000,000. The company's fixed operating costs total $500,000 and its variable costs equal 60 percent of sales, so the company's current operating income is $700,000. The company's interest expense is $500,000. What is the company's degree of total leverage (DTL)?

  1. 3.500
  2. 6.000
  3. 1.714
  4. 3.100
  5. 3.250

Answer(s): B

Explanation:

DTL = (S - VC)/(EBT - I)
= ($3,000,000 - $1,800,000)/($700,000 - $500,000)
= 6.



Intelligent Semiconductor is considering issuing additional common stock. The current yield to maturity on the firm's outstanding senior long-term debt is 13%. The company's combined federal/state income tax is 35%. The risk-free rate of return is 5.6%, and the annual return on the broadest market index is expected to be 13.5%. Shares of Intelligent Semiconductor have a historical beta of 1.6. In the past, the firm has assumed a 265 basis point risk premium when calculating the cost of equity. What is the cost of equity for this proposed common stock issue using the Bond-Yield-plus-Risk-Premium approach?

  1. 15.65%
  2. 16.15%
  3. 18.24%
  4. 11.20%
  5. The cost of equity using the Bond-Yield-plus-Risk-Premium approach cannot be calculated from the information provided.

Answer(s): A

Explanation:

The cost of issuing common stock can be calculated using several methods, including the Bond-Yield- Plus- Risk-Premium approach, Discounted Cash Flow method, or by using the Capital Asset Pricing Model. In this example, you have been asked to calculate the cost of equity using the Bond-Yield-plus- Risk-Premium approach. This method is a rather ad hoc procedure used by finance professionals, and involves adding a subjective "risk premium" to the yield to maturity of the firm's outstanding debt. This approach should be used with a degree of caution, as the subjective nature of the procedure leaves significant room for variation in estimates. In using the Bond-Yield-Plus-Risk-Premium approach, a subjective risk premium is added to the yield to maturity of the firm's outstanding long-term debt, and the calculation of the correct answer in this case is as follows: {yield to maturity of the outstanding senior debt 13% + subjective risk premium 2.65%}=15.65%.



Viewing page 56 of 496
Viewing questions 441 - 448 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