Block 2: Question block created by wizard

Question
1 of 30

Which of the following situations is the least likely reason why the marginal cost of capital schedule for a
company rises as additional funds are raised?
The company deviates from its target capital structure because of the economies of scale
associated with flotation costs and market conditions.
The cost of additional funds from various sources rises as higher levels of financing are achieved.
The company seeks to issue less senior debt because it violates the debt incurrence test of an
existing debt covenant.

Incorrect.
The WACC does not necessarily increase as more funds are being raised. Higher amounts of funding
would not change the WACC if everything were in proportion to the old target capital structure - it is the
changes in relative proportions of sources of funding that could make a difference because of interest
deductibility and financial risk. (B is the correct answer here, i.e., the least reason why the MCC slopes
upward. Study session 10, paragraph 4.3)

CFA Level I
"Cost of Capital," by Yves Courtois, Gene C. Lai, and Pamela Peterson Drake
Section 4.3

Question
2 of 30

The market price of a company's share is $22 per share with a price-to-book value of 0.80. It has 40
million shares outstanding and announces a buyback of 10% of its shares. If the buyback is done at $22
per share, the post-buyback book value per share isclosest to:
$24.80.
$30.60.
$28.10.

Correct.

The pre-buyback book value per share (BVPS) is $22/0.80 = $27.50.

Because the market price per share is less than BVPS, its BVPS should increase after the share
buyback.

Pre-buyback book value of equity 40 million $27.50 = $1,100 million

Post-buyback book value of equity $1,100 million (4 million $22) = $1,012 million
Post-buyback shares outstanding: 36 million shares outstanding (10% less)
Post-buyback BVPS = $1,012 million/36 million shares = $28.11

As per the calculation, the post-buyback BVPS is $28.11.

CFA Level I
"Dividends and Share Repurchases: Basics," by George H. Troughton and Gregory Noronha
Section 4.2.2

Question
3 of 30

According to good corporate governance practices, which of the following committees is most likely to
have members from executive management?
Audit

Environmental health and safety

Nominations

Correct.

In good corporate governance practices the audit and remuneration/compensation committees should be
composed entirely of independent board members. Other committees such as environmental health and
safety may have members from executive management.

CFA Level I
Corporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna F. Anderson,
and Deborah Kidd
Section 5.3
Question
4 of 30

The following data apply to two companies producing similar products.

Company A Company B
Number of units produced and sold 1 million 1 million
Sale price per unit $100 $100
Variable cost per unit $60 $50
Fixed operating costs $20 million $40 million
Fixed financing expenses $10 million $5 million
Degree of operating leverage (DOL) ? 5.0
Degree of financial leverage (DFL) 2.0 2.0
Compared with Company B, Company A has:
the same sensitivity of operating income to changes in net income.
a lower sensitivity of operating income to changes in units sold.
a higher degree of total leverage.

Correct.
 Company A Company
B
Degree of operating
leverage (DOL)

=5.0 (as
given)

Degree of financial
leverage (DFL)
= 2.0 (as given)
=2.0 (as
given)

Degree of total leverage

(DTL) DTL = 2.0 2.0 = 4.0 DTL = 5.0
DTL = DOL DFL 2.0
= 10.0

The DOL is lower for Company A than Company B (as per the table), meaning Company As operating
income is less sensitive to a change in the units sold relative to Company B.

CFA Level I
Measures of Leverage, by Pamela Peterson Drake, Raj Aggarwal, Cynthia Harrington, and Adam Kobor
Sections 3.33.5

Question
5 of 30
Which of the following is most likely a secondary source of liquidity?
Inventory liquidation
Trade credit
Bank line of credit

Correct.

Trade credit and a bank line of credit are considered primary sources of liquidity. Liquidating inventory is a
secondary source of liquidity.

CFA Level I
Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
Section 2.1.1, 2.1.2

Question
6 of 30

Under the stakeholder theory corporate governance is most consistent with a system of:
 internal controls and procedures by which individual companies are managed.
checks and balances to minimize the conflicting interests among shareowners.
defined roles for management and the majority shareowner(s).

Incorrect.
Corporate governance is the system of internal controls and procedures by which individual companies
are managed.

CFA Level I
"The Corporate Governance of Listed Companies: A Manual for Investors," by Kurt Schacht, James C.
Allen, and Matthew Orsagh
Section Definitions: Corporate Governance

Question
7 of 30

A firm is considering a project that would require an initial investment of THB270 million (Thai baht). The
project will help increase the firm's after-tax net cash flows by THB30 million per year in perpetuity, and it
is found to have a negative NPV of THB20 million. The IRR (%) of the project is closest to:
12.0%.
11.1%.
10.3%.

Correct.
The IRR is the discount rate that makes the NPV = 0. Because the cash flow stream is in perpetuity, it can
be solved as follows:

IRR = 11.1%

CFA Level I
"Capital Budgeting," by John D. Stowe and Jacques R. Gagn
Section 4.2

Question
8 of 30
The effective annualized cost (%) of a bankers acceptance that has an all-inclusive annual rate of 5.25%
for a one-month loan of $2,000,000 is closest to:
5.54%.
5.38%.
5.27%.

Correct.
Calculate the effective annualized cost:

CFA Level I
Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
Section 8.4, Example 7

Question
9 of 30
A project has the following annual cash flows:

Year 0 Year 1 Year 2 Year 3

$606,061 $2,151,515 $2,542,424 $1,000,000
Which discount rate most likely provides a positive net present value (NPV)?
15%
21%
18%

Correct.
Year Cash Flow K = 15% K = 18% K = 21% Calculation
0 $606,061 $606,061.00 606,061
$606,061.00 $606,061.00
1 2,151,515 1,870,882.60 1,823,317.80 1,778,111.60 +2,151,515/(1 + K)
2 2,542,424 1,736,509.80 2,542,424/(1 + K)2
1,922,437.80 1,825,929.30
3 1,000,000 657,516.20 608,630.90 564,473.90 +1,000,000/(1 + K)3

NPV $100.00 $41.60 +$14.70 K = Discount rate

The NPV at 21% is $14.7, whereas the other two NPVs are negative
CFA Level I
Capital Budgeting, John D. Stowe and Jacques R. Gagn
Sections 4.1, 4.9
Question
10 of 30

A company recently issued a 10-year, 6% semiannual coupon bond for $864. The bond has a maturity
value of $1,000. If the marginal tax rate is 35%, the after-tax cost of debt (%) is closest to:
2.6%.
5.2%.
3.9%.

Correct.
The pre-tax cost of debt is the yield to maturity (YTM) of the bond. The bond's YTM can be calculated by
solving the following equation for i:

Using a financial calculator, enter N = 20 (semiannual periods), w = 864, PMT = 30, and FV = 1,000.
Compute I/YR.
The six-month yield (or calculated I/YR) is 4%. The YTM is obtained by doubling the six-month yield to get
8%. Multiplying the pretax cost of debt by (1 Tax rate) gives the result of 5.2%
[8 (1 0.35) = 5.2].

CFA Level I
"Cost of Capital," by Yves Courtois, Gene C. Lai, and Pamela Peterson Drake
Section 3.1

Question
11 of 30

Based on good corporate governance practices, it is most appropriate for a companys compensation
committee to:

recommend remuneration for the external auditors.

include some external directors.

develop director remuneration policies.

Correct.

Under good corporate governance practices the compensation committee develops remuneration policies
for directors as well as key executives. The audit committee, not the compensation committee, would be
involved in the remuneration of the external auditors.

CFA Level I
Corporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna F. Anderson,
and Deborah Kidd
Section 5.3.3

Question
12 of 30
If a 90-day $10,000 US Treasury security is selling for $9,870, the discount-basis yield is closest to:
5.27%.
5.34%.

5.20%.

Correct.
CFA Level I
Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
Section 4.1.1

Question
13 of 30

In order to maintain an adequate net daily cash position, a company is least likely to:
monitor access to borrowing facilities.
predict the business cycles and seasonal effects.
forecast depreciation and accruals.

Correct.
Accruals are paid at a later date, and depreciation is a noncash expense.

CFA Level I
"Working Capital Management," by Edgar A. Norton, Jr., Kenneth L. Parkinson, and
Pamela Peterson Drake
Sections 3.1 3.2

Question
14 of 30

The following information is available for a company and the industry in which it competes:

Company Industry
Accounts receivable turnover 5.6 times 6.5 times
Inventory turnover 4.2 times 4.0 times
Number of days of payables 28 days 36 days
Operating cycle ? 147 days
Cash conversion cycle 124 days ?
Relative to the industry, the company's operating cycle:
is shorter, but its cash conversion cycle is longer.
and cash conversion cycle are both longer.
is longer, but its cash conversion cycle is shorter.

Correct.
Operating cycle = Number of days of inventory + Number of days of receivables.
Cash conversion cycle = Operating cycle Number of days of payables.

Company Industry
Number of days receivables 365/5.6 = 65 days 365/6.5 = 56 days
Number of days inventory 365/4.2 = 87 days 365/4.0 = 91 days
Operating cycle 65 + 87 = 152 days Longer 147 days (given)
Cash conversion cycle 124 days (given) Longer 147 36 = 111
Therefore, both the operating and cash conversion cycles are longer for the company.

CFA Level 1
"Financial Analysis Techniques," by Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
Sections 4.2 4.3

"Working Capital Management," by Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson
Drake
Section 2.2

Question
15 of 30
Which of the following is most likely associated with a strong corporate code of ethics? The code of ethics
is:
updated at least every 10 years.
signed by employees on a voluntary basis.
developed and its implementation overseen by the governance committee.

Correct.

The governance committee typically develops and oversees implementation of the companys code of
ethics.

CFA Level I
Corporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna F. Anderson,
and Deborah Kidd
Section 5.3.2, 4.2.9
Question
16 of 30
Which is most likely considered a pull on liquidity?
Obsolete inventory
Increased difficulty in collecting receivables
Reduction in a line of credit

Correct.
A pull on liquidity occurs when disbursements are made too quickly (e.g., current liabilities are paid
instead of being held or when credit availability is reduced or limited). A drag on liquidity occurs when
receipts lag (i.e., non-cash current assets do not convert to cash quickly). Consequently, a reduction in a
credit line is a pull on liquidity.

CFA Level I
Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
Section 2.1.3

Question
17 of 30
Based on a need to borrow $2 million for one month, which of the following alternatives has
the least expensive effective annual cost?
Commercial paper at 5.9% annually with a dealers annual commission of $3,000 and a backup line
annual cost of $4,000
A bankers acceptance with an all-inclusive annual rate of 6.1%
A credit line at 6.0% annually with a $4,000 annual commitment fee

Incorrect.
Method Formula Calculation
Bankers Interest 12 Interest 0.061/12 $2,000,000 = 10,167
Acceptance Net proceeds Net
(BA) 2,000,000 10,167 = 1,989,833
proceeds
BA cost (10,167 12)/1,989,833 0.0613
Line (Interest + Commitment fee) 12 Interest 0.06/12 $2,000,000 = 10,000
of Usable loan amount Commitment
credit $4,000/12 = 333
fee
(LOC) Usable loan $2,000,000
LOC cost (10,333 12)/2,000,000 0.0620
Commercia (Interest + Dealers commission + Interest 0.059/12 $2,000,000 = 9,833
l Paper Backup costs) 12 Dealer
(CP) Net proceeds $3,000/12 = 250
commission
Backup
$4,000/12 = 333
costs
Total costs 9,833 + 250 + 333 = 10,416
Net
2,000,000 9,833 = 1,990,167
proceeds
CP cost (10,416 12)/1,990,167 0.0628
Bankers acceptance has the lowest annual effective cost of 0.0613.
CFA Level I
Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
Section 8.4
Question
18 of 30
A firm's before-tax costs of debt, preferred stock, and equity are 12%, 17%, and 20% respectively.
Assuming equal funding from each source and a marginal tax rate of 40%, the weighted average cost of
capital (%) is closest to:
14.7%.
9.8%.
13.9%.

Correct.
WACC = wdrd (1 - t) + wprp + were

CFA Level I
"Cost of Capital," by Yves Courtois, Gene C. Lai, and Pamela Peterson Drake
Section 2

Question
19 of 30
A 30-day $10,000 US Treasury bill sells for $9,932.40. The discount-basis yield (DBY) is closest to:
8.11%.
8.28%.
8.17%.

Correct.

CFA Level I
Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
Section 4.1.1

Question
20 of 30

Based on good corporate governance practices, independent board members most likely:

have a lead director when the board chair is not independent.

 are pre-approved by management before being nominated.
hold large equity positions but have never worked at the company.

Correct.

Under good corporate governance practices, independent board members should have a lead director
when the board chair is not independent.

CFA Level I
Corporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna F. Anderson,
and Deborah Kidd
Section 5.1

Question
21 of 30
Assume a 365-day year and the following information for a company:
Current Previous
Year Year
Sales $12,000 $10,000
Cost of goods sold $9,000 $7,500
Inventory $1,200 $1,000
Accounts payable $600 $600

The firms days of payables for the current year is closest to:
24.9.
23.8.
18.3.

Correct.

The number of days of payables =

CFA Level I
Financial Analysis Techniques, Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
Section 4.2.2

Working Capital Management, Edgar A. Norton, Jr., Kenneth L. Parkinson, and Pamela Peterson Drake
Section 7.3
Question
22 of 30

Which of the following is most consistent with good corporate governance practices?

An audit committee that benefits from the direct guidance of management.

Appropriate controls and procedures to effectively manage the firm should be in place.
All stakeholders should have the right to participate in the governance of the firm.

Correct.

Effective corporate governance requires a system of appropriate controls and procedures to protect
financial markets and investors.

CFA Level I
Corporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna F. Anderson,
and Deborah Kidd
Section 2

Question
23 of 30

A firm with a marginal tax rate of 40% has a weighted average cost of capital of 7.11%. The before-tax
cost of debt is 6%, and the cost of equity is 9%. The weight of equity in the firm's capital structure
is closest to:
65%.
79%.
37%.

Correct.
WACC = wd rd (1 t) + we re, where wd + we = 1
7.11 = (1 we) 6 (1 0.4) + we 9
we = 65%

CFA Level I
"Cost of Capital," by Yves Courtois, Gene C. Lai, and Pamela Peterson Drake
Section 2.1
Question
24 of 30

The post-audit performed as part of the capital budgeting process is least likely to include the:
rescheduling and prioritizing of projects.
provision of future investment ideas.
indication of systematic errors.

Incorrect.
Rescheduling and prioritizing projects is part of the planning stage of the capital budgeting process, not
the post-audit. The post-audit's purpose is to explain any differences between the actual and predicted
results of a capital budgeting project. This process can aid in indicating systematic errors, improve
business operations, and provide concrete ideas for future investment opportunities.

CFA Level I
"Capital Budgeting," by John D. Stowe and Jacques R. Gagn
Section 2

Question
25 of 30

A company that wants to determine its cost of equity gathers the following information:
Rate of return on 3-month Treasury bills 3.0%

Rate of return on 10-year Treasury bonds 3.5%

Market risk premium 6.0%

The companys equity beta 1.6

Dividend growth rate 8.0%

Corporate tax rate 35%

Using the capital asset pricing model (CAPM) approach, the cost of equity (%) for the company is closest
to:

13.1%.
12.6%.
7.5%.

Correct.

CAPM: Cost of equity = Risk free rate + Beta Market risk premium = 3.5% + 1.6 (6.0%) = 13.1%

The 10-year risk free rate is appropriate based on the long-term duration of the cash flows from the
project.
CFA Level I
"Cost of Capital," by Yves Courtois, Gene C. Lai, and Pamela Peterson Drake
Section 3.3.1

Question
26 of 30
When a new project reduces the cash flows of an existing project of the same firm, it is best described as
a(n):
sunk cost.
opportunity cost.
externality.

Correct.

A new project reducing the cash flows of an existing project is an externality called cannibalization.

CFA Level I
Capital Budgeting, John D. Stowe and Jacques R. Gagn
Section 3

Question
27 of 30
Which of the following best allows a board of directors to act in the interest of the company and
shareholders?
Independent board members are selected from outside the industry
The board has the authority to select and terminate senior management.
Internal directors provide monitoring of the firms management.

Correct.

The board has a duty to make decisions in the best interest of the company and shareholders. It reviews
managements performance in executing the strategy set by the board. In order to ensure strong
execution of the strategy, the board must have the authority to select and terminate senior management.

CFA Level I
Corporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna F. Anderson,
and Deborah Kidd
Section 5.2
Question
28 of 30
A consultant sees the following information about a publicly listed company:
 The company has a 12-person board of directors.
The board is chaired by the chief executive officer (CEO) of the company.
All members of the audit committee are outside directors with relevant financial and accounting
experience.

Which of the following changes would provide the greatest improvement in the corporate governance of
this company?
The companys Vice-President of Finance should be a member of the audit committee.
The chairman of the board should be an independent director.

The board of directors should have an odd number of directors to preclude tied votes.

Correct.

In good corporate governance practices the chair of the board and CEO roles are independent. If the
chair of the board is a chief executive of the company, it may hamper efforts to undo the mistakes made
by him or her as chief executive. There is a general trend in governance toward reduced influence for
executive directors, as exemplified by the decreasing incidence of CEO duality.

CFA Level I
Corporate Governance and ESG: An Introduction, Assem Safieddine, Young Lee, Donna F. Anderson,
and Deborah Kidd
Section 5.1
Question
29 of 30

A company is deciding to repurchase 5 million shares of stock that has a current price of $49.50. Below is
the forecasted information of shares available for purchase. Which of the following repurchase methods
will most likely result in the average repurchased cost being $49.80?

Number of Shares
Available for Purchase
Price (in millions)
$50.00 9.00
$49.90 5.00
$49.80 3.00
$49.70 1.00
$49.60 0.50
$49.50 0.50

Dutch auction
Open market repurchase
Fixed-price tender offer
Incorrect.
A Dutch auction uncovers the minimum price at which the company can buy back the desired number of
shares with the company paying that price to all qualifying bids. Here the qualifying bids are from $49.50
to $49.80 to satisfy the required 5 million share requirement. Under a Dutch auction, 5 million shares can
be purchased for $49.80 because at that price point, sufficient volume is available in the shares.

The fixed-price tender offer cannot be completed at the $49.80 price because there is insufficient volume
available at that price.

Using an open market share repurchase process, shares are bought at prices that vary between $49.50
and $49.80. The open market share repurchase will result in the average cost per share of $49.73.

Price Volume Price Volume

$49.80 3,000,000 $149,400,000
$49.70 1,000,000 $49,700,000
$49.60 500,000 $24,800,000
$49.50 500,000 $24,750,000
Total Cost $248,650,000
Average repurchased cost per share $49.73
CFA Level I
"Dividends and Share Repurchases: Basics," by George H. Troughton and Gregory Noronha
Section 4.1

Question
30 of 30
A project has the following cash flows:
Year 0 Year 1 Year 2 Year 3 Year 4
$1,000 $100 $100 $100 $1,100

The internal rate of return (IRR) for the project is closest to:

8.8%.
10.0%.
9.1%.

Correct.

The IRR is the discount rate when the net present value (NPV) = 0. The NPV is zero when discounting at
10%: ($100/10%) [1 1/(1 +10%)3] + $1,100/(1 +10%)4 $1,000.00 = $0. Consequently, 10% is the
IRR. Using a financial calculator and recognizing that it is a bond: Present value (PV) = 1,000, Future
value (FV) = 1,000, Payment (PMT) = 100, N = 4, and solve for i, which will equal 10%.

CFA Level I
Capital Budgeting, John D. Stowe and Jacques R. Gagne
Section 4.2