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

• Question 511:

  In a changing economy, a firm has experienced a fall in profit margin by 25%, a fall in asset turnover of 15% and an increase in financial leverage of 20%. If the firm increases its payout ratio from 30% to 40%, what's the change in its dividend growth rate?

  A. +12.14%

  B. + 18.98%

  C. -34.43%

  D. -23.5%

  Correct Answer: C

  Use g = ROE * retention ratio

  ROE = profit margin * asset turnover * financial leverage.

  The change in ROE equals (1-25%)*(1-15%)*(1+20%) - 1 = -23.5%. The retention ratio decreases from 70% to 60%. Therefore, the change in the growth rate equals (1-23.5%)*60/70 - 1 = -34.43%. Thus, the growth rate falls by 34.43%.

• Question 512:

  Point-and-figure charts include

  A. high, low, and ending prices for a given period.

  B. all ending prices.

  C. all daily volumes and ending prices.

  D. only significant price changes.

  Correct Answer: D

  With a point-and-figure chart, a technical analyst determines which price interval to record as significant (two points, for example) and records price changes equal to or larger than this, regardless of time interval. Given a graph, an analyst would try to discern price trends.

• Question 513:

  Which of the following correctly lists the two techniques for estimating the earnings multiplier for an industry? Choose the best answer.

  A. Residual earnings method and the arbitrage pricing theory

  B. None of these answers is completely correct

  C. Macroanalysis and microanalysis

  D. The time series method and regression analysis

  E. The industry life cycle method and the free-cash flow method

  F. The top-down approach and the bottom-up approach

  Correct Answer: C

  There is two common methods for estimating the earnings multiplier for an industry - macroanalysis and microanalysis. Macroanalysis involves an examination of the relationship between the earnings multiplier for an industry and the earnings multiplier for the market. Microanalysis involves an estimation of the specific variables that influence the earnings multiplier, including the required rate of return, the estimated growth rate, and the dividend payout ratio. While the top down and bottom up method are similar to macroanalysis and microanalysis, respectively, they do not represent the best possible answer. Specifically, the top-down and bottom up approaches are typically used to identify investment opportunities, not for the estimation of an industry earnings multiplier.

• Question 514:

  An independent investment advisor is examining shares of Claypool Manufacturing, Inc. for possible investment. In her examination, this investment advisor has gathered the following information:

  Market discount rate: 12.5% per year Observed Price/Earnings ratio: 14.25

  Given this information, what is the Franchise Price/Earnings ratio for Claypool Manufacturing?

  A. None of these answers is correct.

  B. 6.25

  C. 24.25

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

  E. 12.67

  F. 16.28

  Correct Answer: B

  The Franchise Factor method of value measurement is in many respects similar to EVA and MVA calculations. When examining a company using the franchise value approach, the observed price-toearnings ratio is broken down into its two components - (1) the "base P/E," which is based on the Company's ongoing performance, and (2) a "franchise P/E" that is based on the expected value of new and profitable business opportunities. This relationship is illustrated as follows:

  Franchise P/E = Observed P/E - Base P/E

  Where the Base P/E equals the reciprocal of the market discount rate. For example, if the market discount rate is 12.5%, the base P/E would be equal to (1 / 12.5%) = 8.

  In this example, all the necessary information has been provided, and the calculation of the Franchise P/E is as follows:

  Franchise P/E = (14.25 - 8) = 6.25

• Question 515:

  An analyst with Churn Brothers Brokerage is attempting to value shares of Intelligent Semiconductor using the Multi-stage Dividend Discount Model. Intelligent Semiconductor is expected to grow at a rate of 35% per year for the next two years, grow at to 25% per year in years 3 and 4, and then grows at 12% per year forever. Similar investments have warranted a 14.50% per year rate of return, and Intelligent Semiconductor paid a dividend of $0.70 at t0.

  Using the information provided, determine the value of Intelligent Semiconductor shares according to the Multi-stage Dividend Discount Model.

  A. $55.98

  B. None of these answers is correct.

  C. $88.23

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

  E. $87.83

  F. $91.87

  Correct Answer: A

  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 ofgrowth, as well as the long-term rate of growth. Once these growth rates have been determined, they are used to calculate the dividends at various points in the future. In this example, you are provided with two supernormal growth rates, in addition to the long-term rate of growth. Since two supernormal growth rates exist for Intelligent Semiconductor, the calculation is somewhat more complex than a situation characterized by a single supernormal growth rate. Nonetheless, the multi-stage dividend discount model can be applied.

  The multi-stage dividend discount model is often referred to as the "two-stage dividend discount model," and these two titles should be considered interchangeable for all intents and purposes, i.e. the "two stage" dividend discount model can be used to determine the value of a company that has multiple growth rate changes.

  Incorporating the given information into the multi-stage dividend discount model will yield the following:

  P = {[$0.70 * 1.35) / 1.145] + [($0.945 * 1.35) / 1.31103] + [($1.276 * 1.25) / 1.50112] + [($1.595 * 1.25) / 1.71879] + [($1.994 * 1.12) / (.145 - .12]/1.71879} Which can further be developed into:

  P = {$0.82533 + $0.97309 + $1.06254 + $1.15998 + $51.96} = $55.98

• Question 516:

  Assume the following information about the common stock of a mid-sized regional bank.

  Required rate of return on equity: 13.75% per year Expected growth rate: 10.20% per year Dividend at t0: $0.35

  Assuming that the growth rate will remain stable, what is the value of this regional bank's common stock?

  A. $13.93

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

  C. $15.23

  D. $10.86

  E. $10.02

  F. None of these answers is correct.

  Correct Answer: D

  In this example, the growth rate of dividends is assumed to remain stable, allowing the use of the Gordon Model. The Gordon Model is also known as the "constant growth dividend discount model" and takes the following form:

  P0 = [D1 / (r - g)]

  Where P0 = the price of common stock X at time 0 D1 = the expected dividend at t1 r = the required rate of return on equity investments and g = the expected growth rate of dividends.

  Since the dividend at t1 is not provided, we must calculate it manually by multiplying the dividend at t0 by (1 + g). This will produce an answer of $0.3857 at t1.

  Now that the dividend at t1 has been determined, the given information can be put into the equation provided, leading to the following series of calculations:

  P0 = [$0.3857 / (.1375 - .1020)] = $10.86.

  When using the Gordon model, remember that the required rate of return "r" must be greater than the expected growth rate "g." Otherwise, the equation will produce a nonsensical answer.

• Question 517:

  The upside-downside volume ratio is equal to

  A. the total number of share prices on an exchange increasing divided by the number of share prices decreasing. Technical analysts consider ratio values of 2.00 or greater to be indicative of an oversold market.

  B. the total volume of shares increasing on an exchange divided by the total volume of shares decreasing. Technical analysts consider ratio values of 1.25 or greater to be bullish.

  C. the total volume of shares increasing on an exchange divided by the total volume of shares decreasing. Technical analysts consider ratio values of 0.70 or less to be indicative of an oversold market.

  D. the total number of share prices on an exchange increasing divided by the number of share prices decreasing. Technical analysts consider ratio values of 1.25 or greater to be indicative of excessive market speculation.

  E. the total number of share prices on an exchange increasing divided by the number of share prices decreasing. Technical analysts consider ratio values of 2.00 or greater to be indicative of excessive market speculation.

  Correct Answer: C

  Technicians use the upside-downside volume ratio as an indicator of short-term momentum for the market. The ratio typically ranges between 0.50 and 2.00. Ratio values of 1.25 or greater are viewed as bearish, while values of 0.70 or less are viewed as bullish.

• Question 518:

  Assume the following information about a common stock:

  Last annual dividend per share: $0.25 Price per share: $18.90 Required return: 15% per year Expected growth rate: 11% per year

  What is the value of this common stock?

  A. $16.43

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

  C. $6.25

  D. $17.03

  E. $6.94

  Correct Answer: E

  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 will lead to the following:

  {V = [($0.25 * 1.11) / (0.15 - 0.11)] = $6.94

  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 519:

  A firm has an expected dividend payout ratio of 50%, and an expected dividend growth rate of 6% per year. What is the firm's Price/Earnings ratio if the appropriate discount rate is 10% per year?

  A. 50

  B. Not able to compute with the above data.

  C. 12.5

  D. 125

  Correct Answer: C

  Value = 0.50/(0.10-0.06) = 12.5.

• Question 520:

  The T-bill - Eurodollar yield spread should increase during periods of

  A. high inflation.

  B. low inflation.

  C. international stability.

  D. high consumption levels.

  E. international crisis.

  Correct Answer: E

  The T-bill - Eurodollar yield spread can be used as a measure of global investor confidence. During periods of international crisis, it is believed that the spread will widen as money flows back into safe U.S. T-bills.