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

• Question 261:

  Assume the following information about a textile manufacturing company. Dividend retention rate = 0.20

  Total assets / common equity = 2.01 Net income / sales = 0.09 Sales / total assets = 0.67

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

  A. None of these answers is correct.

  B. 8.22%

  C. 12.12%

  D. 5.40%

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

  F. 9.70%

  Correct Answer: A

  The correct value for the growth rate of dividends for this textile-manufacturing firm is an abysmally low 2.42%. Thus, none of the answers is correct. 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 = [0.09 * 0.67 * 2.01] = 0.121203, or 12.12%.

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

  g = [(0.20) * 0.1212] = 0.02424, or 2.42%

• Question 262:

  A stock paid an $18 per share dividend this year. Dividends are expected to grow at 5% per year, forever. What is the value of the stock is the appropriate discount rate is 10% per year?

  A. $18.12

  B. $37.80

  C. Not able to compute with the above data.

  D. $378.00

  Correct Answer: D

  Value = $18.9/(0.10-0.05)=$378.00

• Question 263:

  The returns on an investment are based on

  A. earnings before taxes and interest.

  B. net earnings.

  C. dividends.

  D. gross earnings.

  E. a variety of different forms.

  Correct Answer: E

  Earnings may not reflect real returns because of accounting methods, and other reasons. Returns come in a number of different forms, including dividends, interest payments, and capital gains.

• Question 264:

  An economist with Smith, Kleen and Beetchnutty Institutional Brokerage has been examining a stock market series and is trying to determine the anticipated rate of return for the series. In her research, this economist has determined the following information:

  Anticipated ending series value: 11,800 Expected dividends during the period: $521 Observed beginning series value: 10,050.14 Required rate of return: 17.50% per year

  What is the anticipated annual rate of return for this stock market series? (Assume a one-year holding period.)

  A. 12.23%

  B. 22.60%

  C. 24.41%

  D. None of these answers is correct.

  E. 19.24%

  Correct Answer: B

  To calculate the expected rate of return for a stock market series, the following information must be known:

  The beginning value for the series

  The anticipated ending value for the series, and

  The amount of any dividends and/or distributions during the period

  Once this information has been determined, the expected return on a stock market index can be found by employing the following equation:

  E(R) = [(EV - BV + Div) / BV]

  Where: E(R) = the expected return on the stock market series, EV = the anticipated ending value for the series, BV = the observed beginning value for the series, and Div = the amount of any dividends paid during the period.

  In this example, all of the necessary information has been provided and the calculation of the expected return on this stock market series is found as follows:

  E(R) = [$11,800 - $10,050.14 + $521] = 22.60%

  This figure is significantly higher than the required rate of return. Assuming that the anticipated ending value and expected dividends prove accurate, investment in this stock market series is likely advisable.

• Question 265:

  What is the value of a stock that is expected to pay a $10 per share dividend in a year's time, and to be selling for $30 per share at the end of the year? The appropriate discount rate is 10% per year.

  A. $40.61

  B. $36.36

  C. $30.35

  D. Not able to compute with the above data.

  Correct Answer: B

  Value = $40/1.10=$36.36.

• Question 266:

  The second step of the three-step, top-down approach to valuation is to decide to allocate investment funds

  A. among corporations and types of securities.

  B. among industries.

  C. among industries and types of securities within those industries.

  D. among industries and corporations.

  Correct Answer: B

  The second step of the three-step, top-down approach to valuation is the analysis of alternative industries, which attempts only to determine which industries will prosper, and which will fail (thereby determining investment strategy across industries). The security type decision is made in the first step, and the decision of individual firm investments is made in the third step.

• Question 267:

  If a stock that you are holding for one year has an estimated dividend payout of $2.50 and an expected sale price of $43, what is the value of the stock?

  A. $22

  B. $23.10

  C. $20.26

  D. not enough information to calculate it

  Correct Answer: D

  To determine the value of a stock held for one year, it is necessary to estimate the dividend to be received during the period, the expected sale price at the end of the period and its required rate of return. The required rate of return in this case is not given.

• Question 268:

  Which of the following are the two general approaches to the valuation process?

  A. The top-down, three-step approach, and the bottom-down, two-step approach

  B. The top-down, three-step approach, and the bottom-up stock picking approach

  C. The bottom-up, three-step approach, and the Monte Carlo approach

  D. The top-down, two-step approach, and the bottom-up, three-step approach

  Correct Answer: B

  Advocates of the top-down, three-step approach believe that the economy and industry have an important effect on total returns of individual stocks. Advocates of the bottom-up stock picking approach believe that it is possible to find stocks that will have superior returns regardless of the economy and industry.

• Question 269:

  A resistance level

  A. is the price range below the current price at which the technical analyst would expect the stock supply to increase, pushing down its price below that range. A stock nearing that range would be a good candidate for short selling because of the negative price support that it would receive.

  B. is the price range above the current price at which the technical analyst would expect the stock supply to increase, abruptly reversing any price increase. A resistance level tends to develop after the stock has experienced a decline from a higher price level.

  C. is the price range above the current price at which the technical analyst would expect the stock price to get an added boost of demand, pushing its price even higher. If the stock price makes it to the

  resistance level, future gains are expected.

  D. is the price range below the current price at which the technical analyst would expect the stock to get an added boost of demand, keeping its price from falling below that range. The resistance level is usually near the 12-week low.

  Correct Answer: B

  Technical analysts believe that investors who have acquired a stock at a higher price will look for an opportunity to sell it near their break-even points. A resistance level is the target price range that these investors look for to sell their stock at minimum or no loss. Such a price range tends to develop after the stock has experienced a decline from a higher price level.

• Question 270:

  A stock has an expected dividend growth rate of 2.4%. The firm has just announced a dividend of $2.30 per share, with an ex dividend date 3 days from now. Investors expect a rate of return of 12% from the stock and the stock is trading at $26.12. The stock is:

  A. insufficient information.

  B. overpriced.

  C. underpriced.

  D. fairly priced.

  Correct Answer: B

  In the usual notation, the Dividend Discount Model gives Po = D1/(k-g). In this case, g = 2.4%, D1 = Do*(1 +g) = 2.3 *1.024 = $2.355, Po = $26.12. Therefore, k = g + D1/Po = 2.4% + 2.355/26.12 = 11.42%. Thus, the rate of return built into the price is less than that required by the investors, implying that the stock is overpriced. Another way of seeing this is to find the price that will give k = 12%. This price equals P = 2.355/(12% - 2.4%) = $24.53. Since the stock is trading at a price higher than this, it is overpriced (by $1.59).