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

• Question 311:

  The value of an asset is the ________ of its expected future cash flows.

  A. none of these answers

  B. weighted sum

  C. future value

  D. sum

  Correct Answer: A

  The value of an asset is the net present value or NPV of its expected future cash flows.

• Question 312:

  Assume the following information about a manufacturing company. Sales / total assets = 0.85 Net income / sales = 0.14 Total assets / common equity = 2.2 Dividend payout ratio = 0.50

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

  A. 6.55%

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

  C. 18.07%

  D. 13.09%

  E. 12.15%

  Correct Answer: D

  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 = [0.14 * 0.85 * 2.2] = 0.2618, or 26.18%.

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

  g = [(1 - 0.50) * 0.2618] = 13.09%

• Question 313:

  A stock's expected return is estimated by estimating its future value. These future values are derived by:

  A. predicting the stock's beta

  B. predicting the stock's earnings per share and dividend-payout ratio

  C. predicting the stock's earnings per share and expected earnings multiplier

  D. predicting the stock's earnings per share and rate of growth

  Correct Answer: C

  A stock's expected return is estimated by estimating its future value. These future values are derived by predicting the stock's earnings per share and expected earnings multiplier. The earnings per share is a function of the sales forecast and the estimated profit margin while the earnings multiplier is a function of the estimated P/E ratio (based on industry and market comparisons) or the estimated dividend-payout ratio, the required rate of return and the rate of growth.

• Question 314:

  Assume the following information about a publicly traded pharmaceutical firm:

  Revenue: $25,000,000 Cash flow: $8,750,000 Net worth per share: $12.97 Number of common shares outstanding: 1,750,000 Current stock price per share: $41.32

  Using this information, what are the price-to-sales, price-to-book, and price-to-cash flow ratios, respectively?

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

  B. 0.35, 0.31, 0.024

  C. 2.89, 3.19, 8.44

  D. 0.35, 4.62, 0.024

  E. 2.89, 3.19, 8.26

  Correct Answer: E

  To calculate the price-to-sales ratio, divide the market price of a common stock by its sales-per share

  figure. The equation for the price-to-sales ratio is as follows:

  Price-to-sales ratio = [P0 / sales per share].

  Incorporating the given information into this equation will yield the following: Price-to-sales ratio = [$41.32 /

  ($25,000,000 / 1,750,000)] = 2.8924 The calculation of the price-to-book ratio involves dividing the market

  price of a common stock by its net worth per share. The equation for the price-to-book ratio is as follows:

  Price-to-book ratio = [P0 / net worth per share].

  Where: net worth per share = (total assets - total liabilities) / # of common shares outstanding.

  In this example, the net worth figure has been converted to a per-share basis, and the calculation of the

  price-to-book ratio is straightforward:

  Price-to-book ratio = ($41.32 / $12.97) = 3.18581

  The calculation of the price-to-cash flow ratio involves dividing the market price of a common stock by the cash-flow-per-share figure. The calculation of the price-to-cash flow ratio is as follows:

  Price-to-cash flow = (P0 / cash flow per share) In this example, the cash flow figure must be converted to a per-share basis, as follows: Cash-flow-pershare = ($8,750,000 / 1,750,000) = $5.00 Now that the cash-flow-per-share has been determined, the price-to-cash-flow ratio can be calculated. Incorporating the given information into this equation will yield the following:

  Price-to-cash flow = [$41.32 / $5} = 8.264

• Question 315:

  Assume the following information about a publicly traded regional bank:

  Revenue: $25,000,000 Cash flow: $6,500,000 Total Assets: $68,000,000 Total Liabilities: $53,000,000 Number of common shares outstanding: 2,000,000 Current stock price: $16.75 per share

  Using this information, what are the price-to-sales, price-to-book, and price-to-cash flow ratios, respectively?

  A. 0.75, 2.23, 5.15

  B. None of these answers is correct.

  C. 1.34, 0.45, 5.15

  D. 1.34, 2.23, 0.19

  E. 0.75, 0.45, 5.15

  Correct Answer: B

  To calculate the price-to-sales ratio, divide the market price of a common stock by its sales-per share

  figure. The equation for the price-to-sales ratio is as follows:

  Price-to-sales ratio = [P0 / sales per share].

  Incorporating the given information into this equation will yield the following: Price-to-sales ratio = [$16.75 /

  ($25,000,000 / 2,000,000)] = 1.34 The calculation of the price-to-book ratio involves dividing the market

  price of a common stock by its net worth per share. The equation for the price-to-book ratio is as follows:

  Price-to-book ratio = [P0 / net worth per share].

  Where: net worth per share = (total assets - total liabilities) / number of common shares outstanding.

  In this example, the net-worth-per-share figure must be calculated manually. This process is illustrated as

  follows:

  Net worth per-share = [($68,000,000 - $53,000,000) / 2,000,000} = 7.5

  Now that the net-worth-per-share figure has been determined, the price-to-book ratio can be calculated.

  This process is shown below:

  Price-to-book ratio = ($16.75 / $7.5) = 2.23

  The calculation of the price-to-cash flow ratio involves dividing the market price of a common stock by the

  cash-flow-per-share figure. The calculation of the price-to-cash flow ratio is as follows:

  Price-to-cash flow = (P0 / cash flow per share)

  Incorporating the given information into this equation will yield the following: Price-to-cash flow = [$16.75 /

  ($6,500,000 / 2,000,000)] = 5.15385

• Question 316:

  Assume the following series of transactions: t0: Purchase 150 Intelligent Semiconductor common stock at $90.60 per share t1: Receive a $4.45 per share dividend on 150 shares t1: Purchase an additional 100 shares at $100 per share t2: Receive $4.50 per share dividend on 250 shares t2: Purchase an additional 50 shares at $105 per share t3: Receive a $4.55 per share dividend on 300 shares t3: Sell 300 shares for $107.84 per share Assuming no taxes or commissions and that each dividend was not reinvested, what is the dollar-weighted rate of return for this series of transactions?

  A. None of these answers is correct.

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

  C. 9.73%

  D. 11.18%

  E. 8.18%

  F. 9.96%

  Correct Answer: C

  Remember that the dollar-weighted rate of return uses the IRR equation in the determination of the answer. Further, the dollar-weighted rate of return is simply another name for the IRR equation, and this nomenclature is commonly used within the field of investment management. The reason behind this classification is the fact that the IRR equation takes into account both the timing and scope of all project cash flows. In the determination of the dollar-weighted rate of return calculation, the first step should be to identify the cash flows for each period. This process is illustrated as follows: t0: -[150 shares purchased * $90.60 per share] = [$13,590] t1: -[100 shares purchased * $100 per share] + [$4.45 per share dividend * 150 shares] = [$9,332.50] t2: [50 shares purchased * $105 per share] + [$4.50 per share dividend * 250 shares]} = [$4,125] t3: [300 shares sold * $107.84 per share] + [$4.55 per dividend * 300 shares] = $33,717 Now that the cash flows have been determined, incorporating this information into your calculator's cash flow worksheet and solving for IRR will yield a dollar-weighted rate of return of 9.73% for this investment.

• Question 317:

  An analyst with Smith, Kleen and Beetchnutty Securities has been working on a determination of EPS for a fiber optics index. In his research, this analyst has determined the following:

  1.

  Regressing sales for the series against Nominal GDP, the sales figure for the index has been estimated at: $16.50 per share.

  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 21.00%.

  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: $2.45.

  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: $0.45 per share.

  5.

  Coordinating his research with a legislative consultant, the corporate tax rate for this series has been estimated at: 36%.

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

  A. $3.50

  B. $2.81

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

  D. $0.20

  E. None of these answers is correct.

  F. $0.36

  Correct Answer: F

  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 = [($16.50 * 0.21) - $2.45 - $0.45] * (1 - 0.36) = $0.3616

• Question 318:

  Which is not a correct stage in a 5-stage industry life cycle?

  A. pioneering development

  B. rapid accelerating growth

  C. rapid decline and market exit

  D. mature growth E. deceleration of growth and decline

  Correct Answer: C

  Stabilization and market maturity would be the other correct stage.

• Question 319:

  Based on the P/E equation, there is ________ relationship between the payout ratio and the P/E ratio.

  A. no

  B. a negative

  C. a positive

  Correct Answer: C

  P/E ratio = (Payout ratio)/(k - g); i.e. the relationship is positive.

• Question 320:

  Freelancers.com, a publishing agency, has an issue of preferred stock outstanding. The preferred stock of Freelancers pays a semiannual dividend of $0.40, and this dividend is not expected to grow in the foreseeable future. Similar investments are currently warranting a 12.5% per year required rate of return.

  What is the value of Freelancers' preferred stock? Further, is this preferred stock valued as a perpetuity or as a finite series of cash flows?

  A. $6.40; finite series of cash flows

  B. $3.20; perpetuity

  C. None of these answers is completely correct.

  D. $6.40; perpetuity

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

  F. $3.20; finite series of cash flows

  Correct Answer: D

  Preferred stock is commonly valued as a perpetuity using the following equation: {P0 = [d1 / k]}

  Where: P0 = the price of the preferred stock at time 0, d1 = the annual dividend at t1, and k = the required rate of return.

  In this example, the dividend is provided as a semiannual figure, which must be doubled to show the annual dividend. After this adjustment has been made, the value of the preferred stock can be found as follows:

  {P0 = [$0.80 / 0.125] = $6.40}

  Preferred stock is commonly valued as a perpetuity because there is no finite conclusion to the projected series of cash flows for a preferred stock. Unlike a bond, whose cash flows are characterized by a finite lifespan (i.e. the cash flows of a bond cease at maturity), the cash flows (dividends) produced by a preferred stock could theoretically last forever.