CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers
Question 211:
You have a stock that you are holding for one year. It has an estimated dividend payout of $2.50 and an expected sale price of $43. Using the dividend discount model, calculate the value of the stock if your required rate of return is 12%.
Which of the following is not an advantage of technical analysis?
A. Requires the use of audited financial statements
B. Technical analysis is not time-consuming
C. Can catch market trends and reversals close to their occurrence
D. Does not rely heavily on financial figures and accounting statements
E. Does not assume that securities prices move in observable trends
Correct Answer: A
One of the major advantages cited by technical analysts is that technical analysis does not rely heavily on financial statements. Technical analysts believe that securities markets "price in" material information gradually, and that securities prices move in identifiable trends and patterns. An astute technical analyst, it is argued, can identify superior investment opportunities by recognizing the implicit trends exhibited by securities prices and quantifiable past performance data. This belief is in striking contrast with the Weak Form EMH, and is arguably the greatest criticism raised against technical analysis.
Question 213:
An analyst with Smith, Kleen and Beetchnutty is examining shares of Mission Industries for possible investment. Due to the development of several new products, the growth of Mission Industries is expected to temporarily exceed its long-term rate of growth. Specifically, Mission Industries is anticipated to grow at an 18% annual rate for the next three years, then return to its long-term rate of growth of 13% per year. The Company recently paid an annual dividend of $0.75, and similar investments have warranted a 14.5% per year rate of return.
Using the information provided, what is the value of Mission Industries common stock? Use the two-stage dividend growth rate model.
A. $80.62
B. The answer cannot be determined from the information provided.
C. $81.44
D. $115.12
E. None of these answers is correct.
F. $64.16
Correct Answer: F
The multi-stage dividend discount model is a more realistic way of valuing fast-growing companies that pay dividends. With this model, it is necessary to estimate the above-average, or "supernormal," rate of growth, as well as the long-term rate of growth. Once these growth rates have been determined, they are used to calculate the anticipated annual dividends leading up to the point at which the growth rate decelerates to the long-run rate of growth.
Incorporating the given information into the two-stage dividend discount model will yield the following
P = {[$0.75 * 1.18) / 1.145] + [($0.885 * 1.18) / 1.31103] + [($1.04312 * 1.18) / 1.50112] + [($1.23088 * 1.13) / (.145 - .13)]/1.50112} which can further be developed into:
A price level at which the demand for a stock is expected to increase significantly is best characterized by which of the following?
A. Reversal level.
B. Support level.
C. Resistance level.
D. More than one of these answers is correct.
E. Rotation price.
Correct Answer: B
Technical analysts frequently examine historical price information to determine important "support" and "resistance" levels. A support level is a price range at which the demand for a stock is expected to increase, i.e. buying pressure will increase forcing the stock price upward, or will prevent it from moving down. A resistance level is a price range at which the supply of a stock is expected to increase significantly, forcing the price of the stock down, or preventing it from advancing.
"Rotation price" and "reversal level" are largely fictitious terms.
Question 215:
Assume the following information about a large-scale oil drilling company.
Net income / sales = 0.18 Total assets / common equity = 1.82 Sales / total assets = 0.70 Dividend payout ratio = 0.35
What is the expected annual growth rate of this firm's dividends?
A. 4.50%
B. The answer cannot be determined from the information provided.
C. 14.90%
D. 8.03%
E. None of these answers is correct.
F. 30.42%
Correct Answer: C
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 = [0.18 * 0.70 * 1.82] = 0.22932, or 22.93%.
Now that the ROE figure has been determined, the calculation of the growth rate of dividends is as follows:
g = [(1 - 0.35) * 0.2293] = 14.9045%
Question 216:
The "dollar-weighted" rate of return measure incorporates which of the following in its return calculation?
A. None of these answers is correct.
B. Modified Internal Rate of Return
C. Net Present Value
D. More than one of these answers is correct.
E. Discounted Payback Period
F. Internal Rate of Return
Correct Answer: F
Performance measurement is an important consideration for the CFA candidate, and can be a particularly difficult task in situations where the portfolio under consideration is subject to additions and withdrawals. Two performance measurement tools discussed in the Level I readings are the "dollar-weighted rate of return" and the "time-weighted rate of return." In fact, the dollar-weighted rate of return is simply another name for the IRR equation. In investment management applications, the IRR equation is commonly referred to as the "dollar-weighted rate of return" because it accounts for the timing and scope of all cash flows.
Question 217:
Rhonda McWilliams, CFA, is examining the financial performance of a large manufacturing company, and has assimilated the following information:
Adjusted operating profit before tax: $32,000,000 Cash operating taxes: $11,000,000 Cost of capital: 15% per year Total capital employed: $130,670,000
Using this information, what is the Economic Value Added for this manufacturing firm? Further, should the management of this Company be considered to have created value for shareholders? Choose the best answer.
A. $4,129,500; management has provided economic value
B. $5,504,350; management has provided economic value
C. $1,399,500; management has provided economic value
D. $6,330,000; management has not provided economic value
E. $6,330,000; management has provided economic value
F. None of these answers is correct.
Correct Answer: C
Economic Value Added, a value-based measure of economic profit, is a registered trademark of Stern, Stewart and Company. The equation used to calculate EVA is as follows:
EVA = {Net Operating Profits Less Adjusted Taxes - [Total Capital Employed * (Cost of Capital)]}.
In this case, the NOPLAT figure must be calculated manually by subtracting the Cash Operating Taxes from the Adjusted Operating Profit before Tax (AOPBT) figure. Doing so will produce an answer of$21,000,000 for the Net Operating Profit less Adjusted Taxes figure. Now that the necessary information has been determined, the calculation of EVA is as follows: EVA = {$21,000,000 - ($130,670,000 * 0.15)} = $1,399,500
A positive EVA calculation indicates that management has provided economic profits to shareholders, as evidenced by the fact that the opportunity cost of capital employed is less than the AOPAT figure. In this example, the management of Intelligent Semiconductor should be considered as providing shareholder value, and due to the cash-based nature of the EVA calculation, this finding is lithified.
The calculation of Adjusted Operating Profit Before Taxes (AOPBT), and Cash Operating Taxes are important. The calculation of AOPBT is as follows:
Operating profit (after depreciation and amortization) + Implied interest on operating leases + any increase in the LIFO reserve + goodwill amortization = Adjusted Operating Profit Before Taxes.
Cash Operating Taxes, another important component of EVA, is calculated as follows:
Cash Operating Taxes = Income Tax Expense + tax benefit from interest expenses + tax benefit from interest on leases + taxes on non-operating income
Adjusted Operating Profit Before Taxes minus Cash Operating Taxes = Net Operating Profit Less Adjusted Taxes (NOPLAT). Subtracting the dollar cost of capital from the NOPLAT figure will yield the EVA.
Question 218:
A preferred stock has a $100 par value and a dividend payout of $8 per year. What is the value of the preferred stock?
A. $102.61
B. not enough information to calculate it
C. $89.65
D. $93.24
Correct Answer: B
The missing information is the required rate of return in order to discount the dividend payout.
Question 219:
The specific estimate approach to estimating an earnings multiplier involves
A. inferring the direction of change in the multiplier based on derivations of specific estimates for its three major components.
B. inferring the direction of change in the multiplier based on predictions for change in its ten major components.
C. inferring the direction of change in the multiplier based on predictions for changes in its three major components.
D. inferring the direction of change in the multiplier based on derivations of the specific estimates for its ten major components.
Correct Answer: A
The specific estimate approach derives a specific estimate for the earnings multiplier based on a range of estimates of the dividend payout ratio, the required rate of return, and the growth rate in earnings and dividends.
Question 220:
An intern with Churn Brothers Brokerage has been asked to calculate the Price-to-earnings ratio for Clay Industries. She has been provided with the following information:
D0 = $1.25 g = 12% per year k = 15.5% per year Earnings per share: $2.78
Using this information, what is the price-to-earnings ratio for Clay Industries?
A. None of these answers is correct.
B. 17.05
C. 14.39
D. 21.27
E. 15.21
F. 12.85
G. The answer cannot be calculated from the information provided.
Correct Answer: C
By dividing each side of the infinite period dividend discount equation by the EPS figure, it is possible to determine the P/E ratio. This is illustrated as follows:
P/E = (D1 / EPS)/(k-g)
Where: D1 = the dividend at t1, EPS = the earnings per share calculation for t1, k = the required rate of return, and g = the expected growth rate.
Manipulating the infinite period dividend discount model to solve for the PE is a rather intuitive process.
Consider the fact that an investment's value is truly nothing more than the present value of all future returns. So said, dividing both sides of the infinite period dividend discount model equation by the EPS figure should yield the appropriate multiple, or "earnings multiplier." This is the price-to-earnings ratio. In this example, we are provided all of the necessary information. However, the dividend at t1 must be calculated manually by multiplying D0 by (1 + growth rate). This will yield a figure of $1.40 for D1. Now that D1 has been determined, we can solve for the P/E. Imputing all the given information into the equation provided above will yield the following:
P/E = ($1.40 / $2.78) / (15.5% - 12%) = 14.39
If you chose 12.85, remember that it is the dividend at t1 that is used in the determination of the P/E, not the dividend at t0.
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