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CFA-Level-I: CFA® Level I Chartered Financial Analyst
Free Practice Exam Questions (page: 61)
Updated On: 2-Jan-2026

Page 61 of 496
PDF with 3963 Questions

Which of the following is not a cash flow that results from the decision to accept a project?

  1. Externalities.
  2. Shipping and installation costs.
  3. Opportunity costs.
  4. Changes in working capital.
  5. Sunk costs.

Answer(s): E

Explanation:

Sunk cost is not a relevant cash flow.



A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?

  1. Retained earnings
  2. Cash
  3. None of these will change
  4. Paid-in capital
  5. Common stock

Answer(s): C

Explanation:

If a stock rises above a specific amount, management may declare, for example, a two-for-one stock split, where the number of shares outstanding doubles and the stock price is halved. Each stockholder would have more shares, but each share is worth less. Theoretically, a stock split should not affect the value of the firm.
They are generally used after a sharp price run-up to produce a large price reduction.



Consider the following information:
30 day T-Bill rate (Risk free rate) 7.2%
Common Stock Beta 0.8
Expected Rate of return for the market 15.0%
Net Worth to Total Asset Multiple .25
Calculate this firm's cost of retained earnings using the CAPM approach.

  1. 7.2%
  2. 13.44%
  3. 12.0%
  4. 9.6%
  5. 22.2%
  6. 10.2%

Answer(s): B

Explanation:

To calculate the cost of retained earnings for a firm using CAPM, one may use the following formula: Cost of retained earnings = risk free rate + ((expected rate of return on the market - risk free rate) x Beta). In this case the cost of retained earnings = 7.2% + ((15.0% - 7.2%) x 0.8 = 13.44%.



Lloyd Enterprises has a project, which has the following cash flows:
Year Cash Flows
0-$200,000
1 50,000
2 100,000
3 150,000
4 40,000
5 25,000
The cost of capital is 10 percent. What is the project's discounted payback?

  1. 2.3333 years
  2. 1.8763 years
  3. 2.4793 years
  4. 2.0000 years
  5. 2.6380 years

Answer(s): E

Explanation:

Discounted CFCumulative CF
0-200,000.00-200,000.00
145,454.55-154,545.45
282,644.63-71,900.82
Payback
3112,697.22+40,796.40
427,320.54+68,116.94
515,523.03+83,639.97
Payback period = 2 years + (71,900.82/112,697.22) = 2.638 years.



A firm initially has no debt in its capital structure. As it starts increasing its debt, the stock price begins to rise because of ________. After a threshold, an increase in debt reduces the stock price due to ________.

  1. none of these answers
  2. higher leverage; higher probability of default
  3. tax deductions; expected default and bankruptcy costs
  4. lower cost of retained earnings; higher cost of debt

Answer(s): C

Explanation:

Debt offers tax shelter for income that equity does not since interest paid on debt is tax deductible. Therefore, as the firm starts adding debt to its capital structure in lieu of equity, the stock price starts rising. However, at a threshold debt-to-equity level, the higher probability of default offsets the value of the debt shield. Beyond this, addition of more debt reduces the stock price.



Ace Consulting, a multinational corporate finance consulting firm, is examining the operations of Minishabby Farms, an Irish conglomerate who is considering the development of a new distilling process for their specialty spirits division. In order to determine the feasibility of the new distilling process, Ace Consulting is trying to determine the beta of the proposed project. In their analysis, Ace Consulting begins by identifying publicly- traded companies whose operations are solely within the distilling business. Ace identifies four such firms, determines the beta of each Company, and averages them together. This figure is used as the beta of the proposed project. Which of the following techniques most correctly describes this method of identifying individual project betas?

  1. Monte Carlo simulation
  2. Empirical smoothing
  3. Accounting beta method
  4. Relational method
  5. Pure play method
  6. Case study analysis

Answer(s): E

Explanation:

In this example, Ace Consulting has used the beta coefficient of four firms whose business is solely within the distilling process. These firms are "pure plays" in the distilling field. The Pure Play method of determining project betas is a popular technique in corporate finance, most likely due to its ease of use. However, the identification of "pure play" firms is often difficult for certain projects. In these cases, the second method of determining project betas is employed, the Accounting Beta method. "Monte Carlo simulation" is a method for evaluating stand-alone risk, and "empirical smoothing" is a fictitious term.



If the firm is being operated so as to maximize shareholder wealth, and if our basic assumptions concerning the relationship between risk and return are true, then which of the following should be true?

  1. If the beta of the asset is greater than the corporate beta prior to the addition of that asset, then the corporate beta after the purchase of the asset will be smaller than the original corporate beta.
  2. If the beta of the asset is smaller than the firm's beta, then the required return on the asset is greater than the required return on the firm.
  3. None of these answers are true.
  4. If the beta of an asset is larger than the corporate beta prior to the addition of that asset, then the required return on the firm will be greater after the purchase of that asset than prior to its purchase.
  5. If the beta of the asset is larger than the firm's beta, then the required return on the asset is less than the required return on the firm.

Answer(s): D

Explanation:

An increase in a project's beta will cause its stock price to decrease unless the increased beta were offset by a higher expected rate of return. Therefore, high-risk investments require higher rates of return, whereas low-risk investments require lower rates of return.



A project has the following cash flows over the next 5 years: $1,000, $600, $300, $1,200 and $1,400. Assume all cash flows occur at the end of a year. The project requires an initial cash outlay of $2,900. The project's cost of capital is 8%. The discounted payback period for the project equals ________.

  1. 4.11 years
  2. 3.84 years
  3. 4.81 years
  4. 4.36 years

Answer(s): D

Explanation:

The discounted payback period is defined as the expected number of years that would be required to recover the original investment using discounted cash flows. The discounted cash flow at the end of year N is obtained by dividing that year's cash flow by 1.08^N, since the project's cost of capital is 8%. Using this, the discounted cash flows are: $926, $514, $238, $882 and $953. Recovery occurs in the 5th year. At the beginning of the 5th year, the outstanding balance equals 2,900-926-514-238-882 = $340. Therefore, the discounted payback period = 4 + 340/953 = 4.36 years.



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