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

• Question 461:

  Given that the expected dividend payout ratio on a common stock is 0.77, the required rate of return is 23%, the dividend growth rate is 18%, using the earnings multiplier model, what is the estimated value of the stock?

  A. $28.51

  B. $23.94

  C. $34.91

  D. $41.84

  E. Not enough information

  Correct Answer: E

  In order to estimate the value of the stock using the earnings multiplier model, one will eventually have to multiply the P/E ratio by next year's earnings (E). The P/E ratio can be determined with the information presented in this problem, but E cannot be.

• Question 462:

  The earnings multiplier is also known as

  A. the operating leverage ratio.

  B. the profit margin multiplied by the total asset turnover.

  C. the P/E ratio.

  D. the ROE ratio.

  Correct Answer: C

  The earnings multiplier, which is the basis for a method of valuing stocks, is also known as the price / earnings (P/E) ratio. It is usually set equal to the current market price divided by expected 12-month earnings.

• Question 463:

  The situation of monopoly is most closely affiliated with which of Porter's Five Forces of industry competition? Choose the best answer.

  A. Threat of substitute products

  B. None of these answers is correct.

  C. Rivalry among existing firms

  D. Bargaining power of buyers

  E. Threat of new entrants

  Correct Answer: B

  None of these answers is correct. The situation of monopoly is most closely associated with the bargaining power of suppliers. When there exists only one supplier of a product, that supplier possesses a great deal of influence over prices and delivery terms.

  Monopolies are thus discouraged and regulated in many instances.

  The bargaining power of buyers refers to the influence that customer's have on suppliers. This bargaining power is greatest in the situation of monopsony, which is characterized by only one buyer.

  While "rivalry among existing firms" is an appealing choice, it does not represent the best possible answer.

• Question 464:

  An increase in margin debt would by viewed by technical analysts as

  A. signaling a market peak.

  B. neither particularly bullish nor bearish.

  C. a bearish sign.

  D. a bullish sign.

  E. irrelevant.

  Correct Answer: D

  Those who purchase securities on margin tend to be relatively sophisticated investors. Technical analysts trying to follow the "smart money" would view an increase in margin debt (debit balances in brokerage accounts) as indicating that those sophisticated investors are bullish on the market, which would lead the analysts to also be bullish.

• Question 465:

  Estimate the dividend growth for a company that exhibits the following characteristics:

  Retention rate 75%

  Payout rate 25%

  Return on Equity (ROE) 20%

  A. 15%

  B. 12%

  C. 10.0%

  D. 9.6%

  E. 6.4%

  F. 25%

  Correct Answer: A

  The estimated growth rate of dividends = (Retention Rate) x (Return on Equity). In this case the estimated growth rate of dividends = 75% x 20% = 15%.

• Question 466:

  The ________ is responsible for differences in the required rates of return among alternative investments.

  A. real premium

  B. risk rate

  C. bond rate

  D. risk premium

  Correct Answer: D

  Investors demand higher return for riskier investments and thus require a higher rate of return on them.

• Question 467:

  Firms in which of the following industries would likely have the highest earnings retention rate? Further, are firms in this industry are likely to be financed primarily through debt or equity?

  A. Fiber optics networking; equity

  B. Computer manufacturing; debt

  C. Media; equity

  D. Media; debt

  E. Computer manufacturing; equity

  F. Fiber optics networking; debt

  Correct Answer: A

  Of the industries listed, fiber optics networking would be expected to have the highest earnings retention rate. The fiber optics networking industry is characterized by a high degree of investment in research and development, along with a high growth rate and level of uncertainty. All of these factors are conducive to a high retention rate, i.e. a low dividend payout ratio. Further, firms within industries associated with high growth rates and high levels of uncertainty are likely to be financed primarily with equity. This is reasoned by several factors, some of which include the following:

  Firms in new industries typically have a balance sheet weighted heavily toward intangible assets, which can neither be easily liquidated nor pledged as collateral for a loan.

  Firms in new industries are characterized by a high degree of research and development expenses.

  Equity provides firms in emerging industries with a higher degree of agility than debt financing.

  The cash flows of firms in developing industries are characterized by a high degree of uncertainty, which often prevents the reliable payment of debt obligations.

• Question 468:

  In general, the earnings multiplier for a stock market series is a more volatile figure than the earnings-pershare for the same series. The greater relative volatility of the earnings multiplier is mostly attributable to which of the following?

  A. The earnings multiplier is more sensitive to changes in the spread between the required return and growth.

  B. The earnings per share (EPS) figure is subject to cash flow adjustments, which "normalize" the EPS figure over time.

  C. The earnings multiplier is more sensitive to changes in the payout ratio.

  D. The earnings multiplier is subject to a tax-deleveraging effect.

  E. None of these answers is correct.

  Correct Answer: A

  The greater relative volatility of the earnings multiplier versus the EPS figure is primarily attributable to an increased sensitivity to changes in the spread between the required rate of return "k" and the anticipated growth rate "g." Remember that the equation used to determine the appropriate earnings multiplier for a stock market series is the following:

  P/E = [D/E / (k - g)]

  Where: P/E = the earnings multiplier, or Price-to-Earnings ratio, D/E = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated growth rate of dividends.

  As you can see, changes in the spread between the required rate of return and the anticipated growth rate can have a dramatic effect on the earnings multiplier for a stock market series. While the earnings multiplier is sensitive to changes in the dividend payout ratio, volatility in this figure is not cause for the increased volatility of the earnings multiplier versus the EPS figure.

• Question 469:

  Which of the following factors is not an underlying assumption of technical analysis?

  A. Supply and demand is driven by rational and irrational behavior.

  B. Prices move in trends that persist for long periods of time.

  C. The actual shifts in supply and demand cannot be observed in market behavior.

  D. Prices are determined by supply and demand.

  Correct Answer: C

  Shifts in supply and demand CAN be observed in market behavior.

• Question 470:

  The two most important variables affecting aggregate profit margin are

  A. the capacity utilization rate and rate of inflation.

  B. foreign competition and unit labor costs.

  C. the capacity utilization rate and foreign competition.

  D. the rate of inflation and unit labor costs.

  E. the capacity utilization rate and unit labor costs.

  Correct Answer: E

  Analysis of annual data for the period of 1977 to 1994 has shown that there is a significant positive relationship between the capacity utilization rate and operating profit, and a significant negative relationship between unit labor costs and operating profit. The rate of inflation and foreign competition variables were not found to be significant in a multiple regression on operating profit.