69. Which of the following is least likely classified as an opportunity cost?
A. The cash savings related to adopting a new production process.
B. The cash flows generated by an old machine that is to be replaced.
C. The market value of vacant land to be used for a distribution center.
Answer: A
“Capital Budgeting,” John D. Stowe, CFA, and Jacques R. Gagné, CFA
2009 Modular Level I, Volume 4, pp. 8-10
Study Session 11-44-b
Discuss the basic principles of capital budgeting, including the choice of the proper cash flows and determining the proper discount rate.
The cash savings related to adopting a new production process is an incremental cash flow, not an opportunity cost.
70. A capital project with a net present value (NPV) of $23.29 has the following cash flows:
|
Year |
0 |
1 |
2 |
3 |
4 |
5 |
|
Cash flow (€) |
-100 |
30 |
40 |
40 |
30 |
20 |
72. An analyst gathers the following information about the cost and availability of raising various amounts of new debt and equity capital for a company:
|
Amount of new debt |
Cost of debt |
Amount of new equity |
Cost of |
|
≤ €4.0 |
4% |
≤ €5.0 |
13% |
The company’s target capital structure is 60 percent equity and 40 percent debt. If the company raises €9.5 million in new financing, the marginal cost of capital is closest to:
A. 9.8%.
B. 10.6%.
C. 11.0%.
Answer: B
“Cost of Capital,” Yves Courtois, CFA, Gene C. Lai, and Pamela P. Peterson, CFA
2009 Modular Level I, Volume 4, pp. 62-65
Study Session 11-45-k
Describe the marginal cost of capital schedule, explain why it may be upward-sloping with respect to additional capital, and calculate and interpret its break-points.
The break-points for debt and equity are €10 million (€4.0 million / 0.40) and €8.33 million (€5.0 million / 0.60), respectively. The cost of debt and equity if the firm raises €9.5 million in new financing will be 4% and 15%, respectively, because €9.5 million is below the debt breakpoint and above the equity breakpoint. The marginal cost of capital = 0.40 × 4% + 0.60 × 15% = 10.6%.
73. An analyst gathers the following information for a company:
|
Liquidity measure |
Company |
|
Inventory turnover |
20.7 |
The company’s operating cycle is closest to:
A. 20.9 days.
B. 33.2 days.
C. 46.8 days.
Answer: C
“Financial Analysis Techniques,” Thomas R. Robinson, CFA, Jan Hendrik van Greuning, CFA, R. Elaine Henry, CFA and Michael A. Broihahn
2009 Modular Level I, Volume 3, pp. 506-509
“Working Capital Management,” Edgar A. Norton, Jr., CFA, Kenneth L. Parkinson, and Pamela P. Peterson, CFA
2009 Modular Level I, Volume 4, pp. 87-93
Study Session 11-46-a, b
Calculate, classify and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Calculate and interpret liquidity measures using selected financial ratios for a company and compare it with peer companies.
Evaluate overall working capital effectiveness of a company, using the operating and
cash conversion cycles, and compare its effectiveness with other peer companies.
Operating cycle = days inventory outstanding + days receivables outstanding
Days inventory outstanding = 365 / inventory turnover = 17.63 days
Days receivables outstanding = 365 / accounts receivable turnover = 29.2 days
Operating cycle = 17.63 days + 29.2 days = 46.8 days
74. A company is offered trade credit terms of 2/10, net 45. The implicit cost of failing to take the discount and instead paying the account in 45 days is closest to:
A. 21.28%.
B. 23.10%.
C. 23.45%.
Answer: C
“Working Capital Management,” Edgar A. Norton, Jr., CFA, Kenneth L. Parkinson, and Pamela P. Peterson, CFA
2009 Modular Level I, Volume 4, pp. 118-119
Study Session 11-46-f
Assess the performance of a company’s accounts receivable, inventory management, and accounts payable functions against historical figures and comparable peer company values.
The cost of trade credit if paid on day 45 = (1 + 2 / 98)365/35 – 1 = 23.45%.
ITEM COMMENTS:
PJY 27Sep08 Review group wanted to replace this Q because compounded rate is unfair to candidates. Upon further discussion with Dot Kelly & CFA staff, the question stays because eliminating would miss an opportunity to educate candidates about the proper method to calculate the cost of failing to take a discount offered.
This question could easily appear on the live exam and candidates need this opportunity to learn the correct calculation.
75. A company plans to issue €2,500,000 (face value) of commercial paper for one month. The company is quoted a rate of 5.88 percent with a dealer’s commission of 1/8 percent and a backup line cost of 1/4 percent, both of which will be assessed on the face value. The effective cost of the financing is closest to:
A. 6.03%.
B. 6.16%.
C. 6.29%.
Answer: C
“Working Capital Management,” Edgar A. Norton, Jr., CFA, Kenneth L. Parkinson, and Pamela P. Peterson, CFA
2009 Modular Level I, Volume 4, pp. 124-126, Example 7
Study Session 11-46-g
Evaluate the choices of short-term funding available to a company and recommend am financing method.
CP cost = [(interest + dealer’s commissions + back-up costs) / net proceeds] × 12
Net proceeds = €2,500,000 – (0.0588 × €2,500,000 × 1/12) = €2,487,750
Interest + dealer’s commissions + back-up costs = (0.0588 + 0.00125 + 0.0025) × €2,500,000 × 1/12 = 0.6255 × €2,500,000 × 1/12 = €13,031 CP cost = (13,031 / 2,487,750) × 12 = 6.29%
76. Regarding corporate governance, which of the following most likely would be a reason for concern when evaluating an independent board member’s qualifications?
The board member:
A. has served on the board for 14 years.
B. owns 1,000 shares of the corporation’s equity.
C. has formerly served on the boards of several successful companies.
Answer: A
“The Corporate Governance of Listed Companies: A Manual for Investors”
2009 Modular Level I, Volume 4, pp. 162-163
Study Session 11-48-d
Identify factors that indicate a board and its members possess the experience required to govern the company for the benefit of its shareowners.
Such long-term participation may enhance the individual board member’s knowledge of the company, but it also may cause the board member to develop a cooperative relationship with management that could impair his/her willingness to act in the best interests of shareowners.
77. Which of the following is least likely to concern an investor evaluating a corporation’s shareowner rights provisions?
A. Shareowners may nominate board members.
B. Shares held by the founding family have supernormal voting rights.
C. To ensure accuracy, company executives tabulate and verify shareowner voting.
Answer: A
“The Corporate Governance of Listed Companies: A Manual for Investors”
2009 Modular Level I, Volume 4, pp. 178-183
Study Session 11-48-g
Evaluate, from a shareowner’s perspective, company policies related to voting rules, shareowner sponsored proposals, common stock classes, and takeover defenses.
The ability to nominate one or more individuals to the board can prevent erosion of shareowner value. Shareowners may be able to force the board or management to take steps to address shareowner concerns.
78. A company’s optimal capital budget is best described as the amount of new capital required to undertake all projects with an internal rate of return greater than the:
A. marginal cost of capital.
B. cost of new debt capital.
C. weighted average cost of capital.
Answer: A
“Cost of Capital,” Yves Courtois, CFA, Gene C. Lai, and Pamela P. Peterson, CFA
2009 Modular Level I, Volume 4, pp. 41-43
Study Session 11-45-d
Explain how the marginal cost of capital and the investment opportunity schedule are used to determine the optimal capital budget.
The optimal capital budget is the amount of new capital required to undertake all investment projects with an IRR greater than the marginal cost of capital. 1
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