CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers

• Question 131:

  Assume the following information about an international telecommunications company.

  Retention rate = 0.91 Net income / sales = 0.21 Total assets / common equity = 3.125 Sales / total assets = 0.33

  What is the expected annual growth rate of this firm's dividends?

  A. 23.63%

  B. 1.77%

  C. The answer cannot be determined from the information provided.

  D. None of these answers is correct.

  E. 28.71%

  F. 19.71%

  Correct Answer: F

  A popular model for determining the growth rate of dividends is the following: g = RR * ROE

  Where: g = the expected growth rate of dividends, RR = the retention rate (this is equal to 1 - dividend

  payout ratio), and ROE = the return on equity.

  Although it may at first appear otherwise, all of the necessary information has been provided. Remember

  the Du Pont decomposition process for ROE, which breaks down the ROE figure into the following:

  ROE = (Net Income / Sales) * (Sales / Total Assets) * (Total Assets * Common Equity)

  Mathematically, this will break down into (Net Income / Common Equity), the ROE figure. The calculation

  of the return on equity for this company is as follows:

  ROE = [0.21 * 0.33 * 3.125] = 0.216563, or 21.66%.

  Now that the ROE figure has been determined, the calculation of the growth rate of dividends is as follows:

  g = [(0.91) * 0.2166] = 0.197072, or 19.71%.

• Question 132:

  Dwight and Clark (a large manufacturing firm) is a stable company reporting the following financial information:

  Earnings per share $1.50 Dividends per share $0.30 Net Income $10 million Equity $50 million

  Given the above information, calculate the company's expected dividend growth rate.

  A. 80%

  B. 20%

  C. 1.6%

  D. 16%

  E. 33%

  F. 8%

  Correct Answer: D

  The expected dividend growth rate = (Retention Rate) x (Return on Equity). Retention Rate = 1 - Payout Rate. Return on Equity = NI/E. Thus in this case the expected dividend growth rate = 1 - (.3/1.5) x ($10 million/$50 million) = (1 - .2) x (.2) = .16 or 16%.

• Question 133:

  Aggregate depreciation expense tends to

  A. decrease during recessions.

  B. always decrease.

  C. never decrease.

  D. decrease during the peak of the business cycle.

  E. decrease during the economic recoveries.

  Correct Answer: C

  Because depreciation expense is an estimate of fixed cost expense related to total fixed assets, it tends never to decrease because total fixed assets for a large number of firms (such as those in the SandP 400) tend never to decrease. The relevant question is by how much depreciation expense increases.

• Question 134:

  Which of the following affect the required rate of return on a stock?

  A. All of these can affect the required rate of return.

  B. Changes in the rate of inflation

  C. Changes in the exchange rate

  D. Changes in the real risk-free rate

  E. Changes in the risk premium

  Correct Answer: A

  The required rate of return is equal to the nominal risk-free rate (a function of the real risk-free rate and the rate of inflation) plus the risk premium. Changes in the exchange rate usually are included in the risk premium.

• Question 135:

  A portfolio manager with Churn Brothers Brokerage is examining the health care industry from the perspective of relative valuation. In her analysis, the portfolio manager examines the relationship between the historical earnings multiple of the health care industry and the historical earnings multiple of the entire market using a time series forecast. Which of the following best characterizes this method of estimating an earnings multiplier? Choose the best answer.

  A. Microanalysis

  B. Macroanalysis

  C. Linear regression

  D. Forbes method

  E. Simulation analysis

  Correct Answer: B

  The method profiled in this example is "macroanalysis," which is one of two methods for estimating the earnings multiplier of an industry. Macroanalysis involves examining the historical relationship between the earnings multiplier of an industry with that of the overall market. Macroanalysis forecasts often use a time series.

  The macroanalysis method is contrasted by microanalysis, which involves examining the variables underlying the earnings multiplier - the required rate of return, the growth forecast, and the dividend payout ratio. In microanalysis, these variables are examined for the industry and then compare them with the values of these variables for the entire market. "Simulation analysis" is a method of examining stand-alone risk, and the "Forbes method" is a fictitious term. "Linear regression" does not represent the best choice.

• Question 136:

  Given current earnings of $2.50 per share, an expected dividend growth rate of 12% and a P/E of 12.5, what is the value of the stock?

  A. $28.62

  B. $35.00

  C. $37.45

  D. None of these answers

  Correct Answer: B

  Value = 12.5 x ($2.50 * 1.12) = $35

• Question 137:

  A decline in this ratio below 30 percent is bullish, above 50 percent is bearish.

  A. Mutual Fund Cash Positions

  B. Short Sales by Specialists

  C. Relative Trend

  D. Dow Theory

  E. Margin Debt

  F. Block Uptick-Downtick Ratio

  G. Odd-Lot, Short-Sales Theory

  H. Diffusion Index

  Correct Answer: B

  The normal ratio of specialists' short sales to the total amount of short sales on the NYSE has become about 40 percent. Technicians view a decline in this ratio below 30 percent as a bullish sign because it means that specialists are attempting to minimize their participation in short sales. In contrast and increase in the proportion above 50 percent is a bearish sign.

• Question 138:

  Dividends-R-Us has just paid a cash dividend of $3.10 per share. If the growth rate is expected to be 3% and the price of the stock is $12.45, the expected return on the stock is:

  A. 24.90%

  B. 28.65%

  C. 25.65%

  D. 27.90%

  Correct Answer: B

  In the usual notation, the Dividend Discount Model gives Po = D1/(k-g). In this case, g = 3%, D1 = Do*(1 +g) = 3.1 * 1.03 = $3.193, Po = $12.45. Therefore, k = 28.65%

• Question 139:

  Using the macroanalysis approach to estimating a company's earnings multiplier, the multiplier is based on:

  I. the dividend payout ratio

  II. the required rate of return

  III. the company's relationship to the industry

  IV.

  the rate of growth

  V.

  the estimated earnings per share

  VI.

  the company's relationship to the market

  A.

  II, III, IV

  B.

  III, VI

  C.

  I, II, IV

  D.

  I, II, III, IV, V

  E.

  III, VI

  Correct Answer: B

  The earnings multiplier, under the microanalysis approach, is estimated based on its three components: the dividend payout ratio, the required rate of return, and the rate of growth. Under the Macroanalysis approach, it is estimated from the relationships among the firm, its industry and the market. The estimates derived from each approach are resolved to settle on one estimate.

• Question 140:

  Which of the following is not a stage in the industry life cycle?

  A. Mature growth

  B. Mezzanine stage

  C. Development

  D. Market maturity and decline

  E. Accelerating growth

  F. Growth deceleration and decline

  Correct Answer: B

  The industry life cycle is divided into five distinct stages. Specifically, the industrial life cycle progresses

  from the development stage to an accelerating growth stage to a mature growth stage to a market

  maturation and stabilization stage.

  Finally, the fifth stage of the industrial life cycle is characterized by decelerating growth and sales decline.

  As an industry or company progresses through the industrial life cycle, sales begin to grow rapidly

  (accelerating growth) then slow considerably as the product or service begins to reach critical mass

  (mature growth). During the mature growth stage, the industry or company grows at a slower pace, until

  eventually growth begins to slow considerably (market maturity and stabilization) as the market for the

  industry or company's products becomes more completely defined. An industry or company typically

  reaches the fifth stage of the industrial life cycle, growth deceleration and decline, only after many years of

  stabilization. For example, the automobile industry made automobiles widely available in the early 20th

  century, and has experienced a period of stabilization for nearly 50 years. The market for automobiles has

  arguably not progressed to the growth deceleration and decline stage, as automobile sales are still

  experiencing single digit annual growth.