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

• Question 561:

  Given that the P/E ratio on a common stock is 15, the expected dividend payout ratio is 0.6, and the required rate of return is 19%, what is the dividend growth rate?

  A. 13.4%

  B. 9%

  C. 12.8%

  D. Not enough information

  E. 15%

  Correct Answer: E

  The infinite period Dividend Discount Model claims that the current price of a common stock is equal to D1 / (k - g), where D1 is next period's (most often next year's) dividend, k is the required rate of return, and g is the growth rate of dividends. The earnings multiplier model goes a step further by dividing both sides of the infinite period Dividend Discount Model equation by expected earnings during the next 12 months, yielding P/E = (D1/E) / (k - g). Rearranging this results in g = k - (D1/E) / (P/E). In this question, the dividend growth rate is equal to 0.19 - 0.6/15 = 0.15 = 15%

  Exam R

• Question 562:

  Which of the following best describes the primary reason for the greater volatility of the earnings multiplier of a stock market series compared to the earnings per share (EPS) for the same series? Choose the best answer.

  A. The price/earnings ratio is less insulated from accounting distortions than is the EPS figure.; i.e. it is harder to "normalize."

  B. None of these answers is correct.

  C. The EPS figure is subject to a deleveraging effect caused by changes in the capital structure.

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

  E. The earnings multiplier is more sensitive to fluctuations in the equity markets than is the EPS figure; i.e. the earnings multiplier is "forward looking."

  F. The price/earnings ratio is more sensitive to increases in a companies dividends.

  Correct Answer: D

  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 figure 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 563:

  Given the following information, what would the expected industry rate of return equal?

  Dividend payout= 30% Net earnings estimate= $12.62/share Multiple estimate= 19 Current earnings index= 225.50

  A. 8.5%

  B. 9.0%

  C. 8.0%

  D. 7.5%

  E. 10.0%

  Correct Answer: C

  Expected industry return = (Index estimate - Current index + Dividend) / Current index = (239.78 - 225.50 + $3.79) / 225.50 = 8.0%

  Index estimate = $12.62 x 19 = 239.78 Dividend = .30 x $12.62 = $3.79

• Question 564:

  Given that the risk-free rate of return is 6%, what is the value of a riskless zero-coupon bond with which the principal payment is $10,000 in 15 years?

  A. $5,733

  B. $4,173

  C. $5,929

  D. $6,841

  E. $7,126

  F. Not enough information

  Correct Answer: B

  The value of a zero-coupon bond is equal to the present value of its principal payment. The required rate of return on a riskless bond is the risk-free rate of return. Usingappendix C in the book by Reilly and Brown, the present value of the bond is $10,000 x0.4173 = $4,173, or $10,000/(1.06^15).

• Question 565:

  Given the following information, what would the expected industry rate of return equal?

  Retention rate= 80% Net earnings estimate= $15.00/share Multiple estimate= 22 Current earnings= $13.95/share Current multiple= 21

  A. 12.8%

  B. 12.2%

  C. 13.7%

  D. 14.0%

  E. 11.9%

  Correct Answer: C

  Expected industry return = (Index estimate - Current index + Dividend) / Current index = (330 - 292.95 + $3.00) / 292.95 = 13.7%

  Index estimate = $15.00 x 22 = 330 Current index = $13.95 x 21 = 292.95 Dividend = (1 - .80) x $15.00 = $3.00

• Question 566:

  When the relative strength of a stock with respect to an index is increasing, the stock is

  A. keeping pace with the chosen index.

  B. all of these answers are possible.

  C. doing better than the chosen index.

  D. worse than the chosen index.

  Correct Answer: C

  The Relative Strength of a stock relative to an index equals the ratio of the stock price to the index price. Hence, if the relative strength is increasing, it indicates that the stock is doing better in price appreciation than the index.

• Question 567:

  Given that the expected dividend payout ratio is 0.34, the expected net profit margin is 0.16, the expected total asset turnover is 0.94, the expected return on capital is 0.24, and the expected financial leverage multiplier is 1.13, what is the expected growth rate of the firm?

  A. 19%

  B. 11%

  C. 6%

  D. 4%

  E. Not enough information

  F. 13%

  Correct Answer: B

  The expected growth rate of the firm is equal to the expected retention rate multiplied by the expected return on equity. The return on equity is equal to the expected net profit margin multiplied by theexpected total asset turnover multiplied by the expected financial leverage multiplier (0.16 x 0.94 x 1.13 = 0.17). The expected retention rate is equal to 1 minus the expected dividend payout ratio (1 - 0.34 = 0.66). In this question, the expected growth rate is equal to 0.66 x 0.17 = 0.11 = 11%

• Question 568:

  Which of the following is a method of assessing country risk?

  A. Delphi technique

  B. Simulation analysis

  C. Monte Carlo simulation

  D. Scenario Analysis

  E. None of these answers is correct.

  F. Darden case method

  G. More than one of these answers is correct.

  Correct Answer: A

  The Delphi technique is a popular method of assessing country risk, and involves the collection of several independent opinions the appropriate countries risk premium to be applied to the country under examination. In the Delphi technique, a group of experts are asked to quantify the country risk of a particular nation, without any input from other experts. By limiting any group discussion, the Delphi technique seeks to provide a realistic quantification of the country risk premium.

  "Simulation analysis," "Monte Carlo simulation," and "scenario analysis," are techniques designed to measure stand-alone risk. The "Darden case method" is largely a fictitious term.

• Question 569:

  A large net advance on an advance-decline series in a rising market would be viewed by technicians as

  A. a bullish signal.

  B. a sign of caution.

  C. indicative of an uneven market.

  D. irrelevant.

  Correct Answer: A

  The large net advance means that considerably more stocks advanced than declined in the series, meaning that the general market rise is broadly based and extends to most of the stocks. This would be viewed as a bullish sign.

• Question 570:

  A fundamental analyst is examining the perpetual preferred stock of a large telecom company. The preferred stock is expected to pay a quarterly dividend of $0.55, and the required rate of return is 11.75% per year. At what price would this preferred stock be fairly valued?

  A. $16.44

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

  C. $18.20

  D. None of these answers is correct.

  E. $18.72

  F. $21.14

  Correct Answer: E

  Assuming that the quarterly dividend is to remain unchanged forever allows us to use the standard perpetuity model, which is illustrated as follows:

  Value of preferred stock = {Annual dividend / required rate of return}

  In this example, we are given the quarterly dividend, which must be multiplied be annualized in order to be

  imputed into the perpetuity valuation equation.

  So said, a quarterly dividend of $0.55 translates into a yearly dividend of $2.20. Incorporating this yearly

  dividend into the perpetuity valuation model will result in the following:

  Value of preferred stock = {$2.20 / 0.1175} = $18.72