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

• Question 151:

  What is the first step in a top-down equity valuation approach?

  A. Forecast the direction of general economy.

  B. Select the security you think will perform best based on your economic and industry forecast.

  C. Project the economic outlook for each industry under review.

  D. All steps would be taken simultaneously.

  Correct Answer: A

  A projection of the general economic outlook is the first stage for a top-down approach.

• Question 152:

  Marie Vaszquez, a semiconductor analyst with Smith, Kleen and Beetchnutty, has been working on a determination of an EPS figure for a semiconductor index. In her analysis, she has found the following:

  1.

  Regressing sales for the series against Nominal GDP, the sales figure for the index has been estimated at: $22.14.

  2.

  Analyzing capacity utilization rates, foreign competition, rates of inflation and unit labor costs, the operating profit margin for the series has been determined to be: 40%.

  3.

  Creating a time series based upon inputs such as levels of capital expenditures and PPandE turnover, next year's depreciation-per-share has been determined to be: $1.95.

  4.

  Creating a time series based upon levels of debt outstanding and prevailing debt yields, the interest expense for next year is determined to be: $0.23 per share.

  5.

  Coordinating his research with a legislative consultant, the corporate tax rate for this series has been estimated at: 37.3%.

  Using this information, what is the EPS figure for this stock market series?

  A. None of these answers is correct.

  B. $1.82

  C. $4.42

  D. $6.14

  E. $2.49

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

  Correct Answer: A

  The EPS figure for this series is found as $4.19. Thus, none of the answers is correct.

  All of the necessary information has been provided in this example. To determine the EPS for a stock

  market series, the following steps are necessary:

  Step 1: Estimate sales-per-share for the series:

  Step 2: Estimate operating profit margin for the series

  Step 3: Estimate the depreciation-per-share for next year

  Step 4: Estimate the interest expense-per-share for the next year

  Step 5: Estimate next year's corporate tax rate

  Once these five steps have been completed, the calculation of EPS for a stock market series is found by

  the following:

  EPS = [(Sales per share * Operating profit margin) - Depreciation-per-share - Interest Expense] * (1 Corporate Tax Rate)

  The calculation of EPS for this stock market series is shown as follows: EPS = [($22.14 * 0.40) - $1.95 $0.23] * (1 - 0.373) = $4.19

• Question 153:

  Which of the following measures can differ greatly among countries?

  A. Specific components of ROE

  B. Retention rates

  C. Total asset/equity ratios

  D. All of these answers

  Correct Answer: D

  The differences in retention rate or the components of ROE in different countries result from differences in accounting practices as well as alternative management performance or philosophy.

• Question 154:

  Which of the following usually occurs at the beginning of an economic recovery (after a recession)?

  A. Profit margin decreases.

  B. Productivity decreases.

  C. Unit labor costs increase slowly or decrease.

  D. Unit labor costs increase greatly.

  Correct Answer: C

  At the beginning of an economic recovery, capacity utilization increases from its low recession level.

  Workers do not yet ask for much higher wages, and productivity increases, leading to a decrease or only a

  slow increase in unit labor costs.

  Profit margin increases as a result of these trends.

• Question 155:

  At which stage in an industry life cycle would growth most likely be able to be estimated most accurately?

  A. pioneering development

  B. mature growth

  C. deceleration of growth and decline

  D. rapid accelerating growth

  E. stabilization and market maturity

  Correct Answer: E

  During this stage, the industry growth rate matches the growth rate of the segment of the economy of which the industry is a part. Sales are highly correlated with an economic series.

• Question 156:

  Which of the following is the formula for the value of preferred stock?

  A. dividend multiplied by the required rate of return

  B. dividend divided by the required rate of return

  C. required rate of return divided by the dividend

  D. the present value of an infinite stream of dividends

  Correct Answer: B

  The value of preferred stock is the stated annual dividend divided by the required rate of return on preferred stock.

• Question 157:

  Holding everything else equal, which of the following firms would likely have a high payout ratio? Further, as time progresses (in the long run), would the retention ratio of similar firms be expected to increase or decrease?

  A. Automobile manufacturer; increase

  B. Specialty retailer; decrease

  C. Pharmaceutical firm; decrease

  D. Specialty retailer; increase

  E. Automobile manufacturer; decrease

  F. Pharmaceutical firm; increase

  Correct Answer: E

  Remember that a positive relationship exists between the maturity of an industry and the payout ratio of firms within that industry. The automobile industry is a mature industry, more so than most other industries including pharmaceuticals or specialty retailers. As an industry advances in maturity, growth of the overall industry will decline. As growth opportunities diminish, companies within the industry will be forced to pay out a larger proportion of their earnings as dividends; i.e. the dividend payout ratio of firms within the industry will increase. Remember that the retention ratio is equal to (1 - the dividend payout ratio). Thus, the retention ratio of companies will likely decline as the industry advances in maturity. The relationship between the dividend payout ratio and the maturity of the industry is negative and loosely linear. As an industry becomes more mature, growth opportunities decline. This relationship is also loosely linear.

• Question 158:

  A technical analyst with Churn Brothers brokerage is examining shares of Allcycles.com, believing that the shares are overvalued. In his analysis, this technical analyst has gathered the following information about Allcycles' common stock.

  Net worth: $15,381,000 Number of common shares outstanding: 1,200,000 Current stock price: $20.30 per share Required return: 15.35% per year Expected growth rate: 12.80% per year Next dividend: $0.15 per share Earnings per share: $1.65

  Using this information, what is the price-to-book ratio for Allcycles.com?

  A. The answer cannot be calculated from the information provided.

  B. 3.57

  C. None of these answers is correct.

  D. 15.81

  E. 12.30

  F. 1.584

  Correct Answer: F

  The book value of a common stock is found by dividing the net worth of a company by the number of outstanding shares. While there exist several different methods for calculating net worth, the most simplistic involves subtracting total liabilities from total assets, giving us the shareholder's equity figure.

  Investment professionals often see the book value as a "floor" for common stock prices, and the price-tobook ratio is quite popular in the field of investment management. The calculation of the price-to-book ratio involves the following equation:

  Price-to-book ratio = {P0 / (Net worth / # of common shares outstanding)}

  In this example, all of the necessary information has been provided. Imputing these figures into the pricetobook value equation will yield the following:

  Price-to-book value = {$20.30 / ($15,381,000 / 1,200,000)} = 1.584.

  As you can see, the required rate of return, along with the expected growth rate, is not necessary in the calculation of the price-to-book ratio. Any time the price-to-book ratio is greater than one, a stock is said to be "trading at a premium to book." Frequently, investment professionals will use the term "intrinsic value" when referring to the book value. A figure of less than one for the price-to-book ratio is commonly referred to as "trading at a discount to book." Stocks trading below book value are often sought after by value investors, who believe these shares have been discounted below their liquidation value.

  While the price-to-book value is a useful tool in the stock selection process, it possesses some important flaws. One problem with the Price-To-Book Ratio is that one of the terms - Book Value - is so easily manipulated. Valuation of inventory and real estate are easily adjusted on the books. Stock buy-backs and write-offs of exceptional items also deflate Book Value, making high priced stocks seem overvalued.

• Question 159:

  The support level of a stock is the price at which the technician expects:

  A. a substantial supply of the stock.

  B. the stock price to break out of the rising trend channel.

  C. a substantial demand for the stock.

  D. a stable trading volume.

  Correct Answer: C

  The support level can be thought of as a temporary floor on the stock price in the sense that if the price falls below this level, additional demand will shore up the price.

• Question 160:

  An analyst with Smith, Kleen, and Beetchnutty is trying to determine an earnings per share (EPS) estimate for a health-care index, and has gathered the following information:

  Sales per share: $600 Next year's operating profit margin: 38% Next year's depreciation per share: $95 Next year's interest expense: $81 Next year's common stock dividend: $1.50 Next year's corporate tax rate: 35%

  Using this information, what is the EPS figure for this stock market series?

  A. $104.73

  B. $32.83

  C. $33.80

  D. $128.80

  E. The answer cannot be calculated from the information provided.

  F. None of these answers is correct.

  Correct Answer: C

  The estimation of EPS for a stock market series involves five steps. Specifically, to determine an estimate of EPS for a stock market series, it is necessary to:

  Estimate the sales per share Estimate next year's operating profit (EBIDT), or operating profit margin Estimate next year's depreciation per share Estimate next year's interest expense per share Estimate next year's corporate tax rate

  Once estimates for these components have been determined, they are put into the following equation:

  EPS for a stock market series = {[(Sales per share * operating profit margin) - depreciation per share interest expense per share] * (1 - corporate tax rate).

  Imputing the given information into this equation will yield the following:

  EPS for a stock market series = {[($600 * 0.38) - $95 - $81] * (1 - 0.35)} = $33.80

  If you chose $128.80, remember that the depreciation figure is not added back to the EPS calculation. What we are looking at is an operating earnings after tax figure, not a cash-based figure.

  If you chose $32.83, remember that common stock dividends are not incorporated into the EPS figure, only interest payments on debt and preferred securities.

  If you chose $104.73, remember to subtract the depreciation and interest expense figures from the EBIDT figure, not from the sales figure itself. In other words, multiply the sales figure by the operating profit margin, THEN subtract the depreciation and interest expense figures.