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

• Question 321:

  A firm has a dividend payout ratio of 70% and it earns a 10% per year return on its equity. Calculate the expected annual growth rate of the firm's dividends?

  A. Not able to compute with the above data.

  B. 7%

  C. 8%

  D. 3%

  Correct Answer: D

  g=(RR)(ROE)=0.3*0.10=3%.

• Question 322:

  Jones Rutherford, a portfolio manager with Churn Brothers Brokerage, has been examining a stock market

  series and is trying to determine an appropriate earnings multiplier for the series. In this analysis, Jones

  has amassed the following information:

  The estimated annual dividend at t1 = $2.30

  The estimated EPS at t1 = $4.85

  The anticipated growth rate of dividends is 10%

  The anticipated growth rate of earnings is 9%

  The required rate of return is 14%

  Given this information, what is the appropriate earnings multiplier for this stock market series?

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

  B. 9.48

  C. 13.04

  D. 10.51

  E. 13.14

  F. None of these answers is correct.

  Correct Answer: F

  The appropriate earnings multiplier for this stock market series is found as 11.86, therefore none of these answers is correct.

  Estimating the earnings multiplier for a stock market series requires the estimation of each of the following components:

  1.

  The dividend payout ratio.

  2.

  The required rate of return on common stock in the country/region/industry/sector being analyzed.

  3.

  The expected growth rate of dividends for the stocks in the country/region/industry/sector being analyzed.

  Once values for each of these components have been determined, they are imputed into the following formula: {P/E = [D/E / (k - g)]}. Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = thedividend payout ratio at t1, k = the required rate of return, and g = the anticipated growth rate of dividends. In this example all of the necessary information has been provided. However, the dividend payout ratio must be calculated based on the anticipated dividend at t1 and the projected EPS figure for t1. The calculation of the dividend payout ratio is as follows: {D/E = [$2.30 / $4.85] = 0.474227}. Now that the dividend payout ratio has been determined, the appropriate earnings multiplier is found as follows: {P/E = [0.474227/ (0.14 - 0.10)] = 11.86. Notice that it is the anticipated growth rate of dividends, not the anticipated growth rate of earnings, which is used in the determination of the earnings multiplier.

• Question 323:

  Ryan Williams, a professional money manager with Smith, Kleen and Associates, purchased 200 shares of Invertran Semiconductor at t0 for $42. At time t1, Invertran paid a $0.90 per-share dividend on the 200 shares owned and Mr. Williams purchased an additional 100 shares for $56.87 per share. At t2, Invertran paid a dividend of $1.00 per share on the 300 shares and then Mr. Williams sold all 300 shares for $63.15 per share. Similar investments have merited a 12.25% discount rate. Calculate the dollar-weighted rate of return for this investment.

  A. None of these answers is correct.

  B. 22.19%

  C. 14.34%

  D. 9.64%

  E. 16.96%

  F. 22.10%

  Correct Answer: F

  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. So said,

  the discount rate is not incorporated in the determination of the dollar-weighted rate of return, and has

  been included within this example largely as a distraction. 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: {-[200 shares purchased * $42 per share] = ($8,400)

  t1: {-[100 shares purchased * $56.87 per share] + [$0.90 per share dividend * 200 shares] = ($5,507)

  t2: {[300 shares sold * $63.15 per share] + [$1.00 per share dividend * 300 shares]} = $19,245

  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 22.10% for this investment.

• Question 324:

  Of the choices listed, which is an important difference between the assumptions underlying technical and fundamental analysis? Choose the best answer.

  A. Technical analysis is reliant on financial statements, whereas fundamental analysis is not heavily reliant on financial statements.

  B. All of these answers represent important differences between fundamental and technical analysis.

  C. None of these answers is correct.

  D. Technical analysis can be applied to any financial market or security, whereas fundamental analysis is limited primarily to the equity markets.

  E. Technical analysis assumes that securities prices move in identifiable patterns, whereas fundamental analysts believe that past price data cannot be used to predict future price movements.

  Correct Answer: E

  Of all the differences between technical analysis and fundamental analysis, perhaps the most important is the fact that technical analysis assumes that securities markets are not weak form efficient, whereas fundamental analysis assumes that the Weak Form of the EMH is correct. Technical analysts assume that securities markets will "price-in" relevant information gradually, and that securities prices follow observable trends and patterns. Fundamental analysts, on the other hand, generally assume that past price information cannot be used to predict movements in securities prices.

• Question 325:

  To estimate the expected earnings multiplier, it is necessary to estimate changes in the ________.

  A. unit labor cost

  B. required rate of return

  C. relative strength of foreign competition

  D. capacity utilization rate

  Correct Answer: B

  To estimate the expected earnings multiplier, it is necessary to estimate changes in the required rate of return, the expected growth rate of dividends (earnings) (g) and the spread between k and g.

• Question 326:

  Assume the following information about a common stock:

  Price per share: $90.35 Last dividend per share: $1.50 Required return: 15% per year Expected growth rate: 12% per year What is the value of this common stock?

  A. None of these answers is correct.

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

  C. $79

  D. $50

  E. $44

  F. $56

  Correct Answer: F

  To determine the value of a common stock using the Infinite Period Dividend Discount Model, use the following equation:

  {V = [d1 / (k - g)]}

  Where: V = the value of the common stock at t0, d1 = the annual dividend at t1 (which is found by multiplying d0 by (1 + g), k = the investor's required rate of return, and g = the anticipated annual growth rate.

  In this example, all of the necessary information has been provided, and incorporating this information into the Infinite Period DDM will lead to the following:

  {V = [($1.50 * 1.12) / (0.15 - 0.12] = $56}

  This value is significantly less than the price of the shares in the open market. While at first it may be appealing to assume that the common stock is overvalued, this may be a dangerous assumption. Equally likely is the possibility that the Infinite Period DDM is not the ideal valuation model for this common stock. Perhaps the price of this common stock is reflecting other sources of potential cash flows, ratherthan the summation of the present value of future dividends. This is an important point to consider, and one with which you should become familiar.

• Question 327:

  To estimate the risk-free rate for a country, estimate the country's expected ________ and adjust the real risk-free rate for this expectation.

  A. GDP

  B. growth rate of labor productivity

  C. average P/E ratio

  D. rate of inflation

  Correct Answer: D

  Inflation is risky and needs to be discounted to obtain a true risk-free rate.

• Question 328:

  A support level

  A. 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 support level is usually near the 12-week low.

  B. 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. A support level usually develops after the stock has had a meaningful price increase, and has begun to experience some profit taking.

  C. is the price range above the current price at which the technical analyst would expect the stock to get an added boost of demand, pushing it to even higher prices. The support level is usually near the 52week high. Investors tend to expect a stock that has broken through its 52-week high to continue increasing.

  D. 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.

  Correct Answer: B

  A support level is viewed as something of a safety net by technical analysts. They believe that at some price range there will be an increase in demand by investors who did not purchase the stock prior to its price increase and who have been waiting for a small reversal to invest. When the stock price falls within that range, there will be a surge in demand as they purchase the stock.

• Question 329:

  A company pays a dividend of $8 per share to the holders of its perpetual preferred stock. The appropriate discount rate is 7% per year. What is the value of the preferred stock?

  A. $114.28

  B. $11.73

  C. Not able to compute with the above data.

  D. $14.18

  Correct Answer: A

  Value = dividend/discount rate = 8/0.07= $114.28.

• Question 330:

  The scotch whiskey distilling industry is most likely in which stage of the industry life cycle? Further, what type of earnings multiple and payout ratio should be expected from firms in this industry?

  A. Accelerating growth, high multiple and low payout

  B. Mature growth, low multiple and high payout

  C. Mature growth, high multiple and high payout

  D. Sales decline, low multiple and high payout

  E. Development, high multiple and low payout

  F. Decelerating growth, low multiple and high payout

  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. During the mature growth stage, sales are still growing, albeit slowly. During the last stage of the industrial life cycle, however, is characterizes by a decline in annual sales.

  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. Finally, the industry will begin to decline, as it advances to the last stage in the industry life cycle.

  The market for scotch whiskey is mature, and very defined. Companies who are in the scotch whiskey distilling industry should be expected to have slow to mediocre annual sales growth, and thus should warrant a lower earnings multiple. In this same light, firms in the scotch whiskey industry are likely to have inferior investment opportunities, holding everything else equal. So said, shareholders of these firms will likely require high dividend payments to compensate for the slow anticipated earnings growth.