CFA Exam Question of the Day

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2022-10-05

Question:
Company X has shareholder's equity of $5 million at the beginning of 20x3 and net income during 20x3 of $1 million, of which $350,000 was paid out as dividends.

Find the sustainable annual growth rate.

Select an Answer:
11.22%
13.00%
13.45%
12.38%
Rationale:
The sustainable growth rate is given by the equation:

g = b × ROE

where b is the earnings retention ratio (which is the complement of the payout ratio).

Here we get (1 − 35%)($1 million/$5 million) = 13%.

2022-10-04

Question:
An economic researcher estimates the following regression between the annual income, I, of a family and the amount it spends on consumption goods, C:

C = 2,000 + 0.65 I + et

If the R2 of the regression is just 0.3, estimate the amount that a family with an income of 50,000 will spend on consumption.

Select an Answer:
35,400
34,500
32,500
2,000
Rationale:
With the given regression, the amount that a family with an income of 50,000 will spend on consumption equals:

2,000 + 0.65 × 50,000 = 34,500

2022-10-03

Question:
You are analyzing XYZPDQ Corporation.

XYZPDQ has the following financial characteristics for the most recently completed year (all figures in $millions):

Net income0
Net non-cash charges25
Interest expense18
Tax rate35%
Fixed capital investments8
Working capital investments3

If the FCFF growth rate is constant at 6%, the WACC is 20%, and the market value of debt is $150 million, find the fair market value of equity.

Select an Answer:
$194.6 million
$144.6 million
$44.6 million
$94.6 million
Rationale:
To answer this question, we must first determine the FCFF:

FCFF = NI + NCC + IE(1 − Tax rate) − FCI − WCI

Thus, we get:

0 + 25 + 18(1 − 35%) − 8 − 3 = 25.7

Next, we find the total market value of the firm using the equation:



Substituting, we obtain ($25.7) × (1.06) million / 0.14 = $194.6 million.

Finally, to get the value of equity we subtract the market value of debt, given as $150 million.

Thus, the market value of equity will be $44.6 million.

2022-10-02

Question:
You are estimating the required return on equity for Company Z. You are given that the risk-free rate is 0.83% per year. You also have as annual risk premia: competition risk, 3.24%; business cycle risk, 1.46%; and management risk, 2.39%. Find the annual required return on equity.

Select an Answer:
8.62%
7.92%
8.92%
8.02%
8.42%
Rationale:
For the build-up approach to estimating the required return on equity,



Therefore, 0.83% + 3.24% + 1.46% + 2.39% = 7.92%.

2022-10-01

Question:
Acme Corporation paid a dividend of $4.00 last year. Earnings and dividends are expected to grow at 5% forever.

What is the value of the stock if investors require an 18% return?

Select an Answer:
$30.77
$23.33
$32.31
$22.22
Rationale:
Acme exhibits a constant growth, thus the value of the stock may be calculated as follows:



or, in this case:



This variation of the dividend discount model (DDM) is known as the Gordon growth model and is appropriate for valuations where the growth is assumed to be perpetual and constant. The underlying formula is: