Practice Question 1 Flashcards

Question 1

Q

Which one of the following statements is most accurate?
A. All legal behavior is ethical behavior
B. All ethical behavior is legal behavior
C. Some ethical behavior may be illegal

Answer

A

Answer: C
C is the correct answer. There are many examples in which legal and ethical behavior coincide, but that’s not always the case. Civil disobedience, for instance, is considered as ethical behavior, however, it is prohibited by law.

Question 2

Q

Trust is the very foundation of the investment profession, most likely because:
A. Investment professionals give advice related to products and services that are tangible in nature.
B. Investment professionals have specialized knowledge and skills, causing them to have less power in the client-advisor relationship.
C. Investment professionals manage clients’ financial wealth.

Answer

A

Answer: C
Financial advisors are professionals entrusted to manage their clients’ wealth. Thus, they would not survive if clients didn’t trust in their ability and willingness to provide best-in-class services. Answer A is incorrect as products and services offered by investment professionals are usually intangible in nature, in the form of advice or recommendations. Answer B is incorrect, too as investment professionals usually have more power in the client-advisor relationship due to their specialized knowledge and skills.

Question 3

Q

Ian is a financial advisor working for an investment management fund in the role of a team supervisor. Which one of the following statements is not a requirement that he should fulfill in order to be part of the investment profession?
A. He needs to have a specific number of years experience in a supervisory role
B. He needs to have specialized knowledge and skills in the industry
C. He needs to adhere to a common code of ethics

Answer

A

Answer: A.
Ian needs to make sure that he meets the three main requirements when it comes to belonging to a profession.
1. To have specialized knowledge and skills
2. To be dedicated to service to others
3. To adhere to a common code of ethics Solid experience in a supervisory role will surely benefit his personal development but this is not a requirement for belonging to a profession.

Question 4

Q

Which of the following is least likely a potential source of inquiries of the Professional
Conduct Program?
A. Annual Professional Conduct Statements completed by a CFA member
B. Exam Proctors’ reports from a June exam session
C. Exam results of candidates who failed in a June exam session

Answer

A

Answer: C
The Professional Conduct Program inquiries come from a number of sources, including:
- Reports by exam proctors regarding testing violations
- Evidence on disclosure of confidential exam information online
- Annual professional Conduct Statements completed by CFA members
- Written complaints by members and candidates
Exam results, whether pass or fail, do not trigger an investigation by the Professional Conduct
Program.

Question 5

Q

Which of the following statements is NOT true? If members and candidates are found guilty of violating the Code of Ethics and Standards of Professional Conduct, a Professional Conduct Program investigation may result in:
A. A prohibition from further participation in the program
B. A monetary sanction, depending on the seriousness of the violation
C. Suspension of the right to use the CFA designation

Answer

A

Answer: B
Sanctions imposed by the CFA Institute may include public censure, suspension of membership and
the right to use the CFA designation, and, in extreme cases, revocation of an existing CFA Charter.
CFA Candidates may be prohibited from further participation in the program if they are found guilty
of violating the Code and Standards. However, fines will never be imposed as sanctions for ethical
violations.

Question 6

Q

Understanding the strengths and weaknesses of your decisions is reflected in one of the steps described in the CFA Institute Ethical Decision-Making Framework. Which one is that?
A. Identify
B. Consider
C. Reflect

Answer

A

Answer: C
The last step of the Framework described is to reflect on what you have learned from the positive or negative consequences of your decisions. Understanding your strengths and weaknesses is of crucial importance for improving your ethical decision-making process in the future.

Question 7

Q

Which of the following is NOT a component of the CFA Institute Code of Ethics?
A. Members and candidates should maintain and improve their professional competence
B. Members and candidates should submit their annual Professional Conduct Statement
C. Members and candidates uphold the reputation and integrity of the investment profession

Answer

A

Answer: B
Although members and candidates are required to submit their Annual Professional Conduct Statements on a regular basis, this is not an explicit component of the Code of Ethics.
The six components of the Code of Ethics are:
1. Act in an ethical way
2. Place the integrity of the investment profession and clients’ interests above personal interests
3. Use reasonable care and be independent
4. Be a credit to the investment profession
5. Promote the integrity of global capital markets for the ultimate benefit of society
6. Be competent and constantly improve professional competence

Question 8

Q

Priority of Transactions is a sub-section of which Standard of Professional Conduct?
A. VI: Conflicts of Interest
B. V: Investment Analysis, Recommendations, and Actions
C. III: Duties to Clients

Answer

A

Answer: A
Standard VI: Conflicts of Interest is structured in three sections:
VI (A): Disclosure of Conflicts
VI (B): Priority of Transactions
VI (C): Referral Fees

Question 9

Q

Which of the following is NOT a sub-section of Standard (III): Duties to Clients?
A. Suitability
B. Performance Presentation
C. Communication with Clients and Prospective Clients

Answer

A

Answer: C
Standard III: Duties to Clients is structured in five sections:
III (A): Loyalty, Prudence, and Care
III (B): Fair Dealing
III (C): Suitability
III (D): Performance Presentation
III (E): Preservation of Confidentiality
Please pay attention that the ethical aspects of communication with clients and prospective clients are treated in Standard V: Investment Analysis, Recommendations, and Actions.

Question 10

Q

Which of the following statements is most accurate concerning NPV and IRR methods?
A. The internal rate of return (IRR) is best described as the opportunity cost of capital, while the NPV method assumes that a project’s cash flows will be reinvested at the cost of capital.
B. An investment’s IRR is the discount rate that makes NPV equal to 0.
C. When IRR and NPV give conflicting decisions for two mutually exclusive projects, the IRR should be the leading factor for selecting.

Answer

A

Answer B:
IRR is an internal measure that depends only on the cash flows related to the project. Therefore, we do not need to use any opportunity cost of capital like we do when calculating the NPV. Investments that have positive NPV increase our wealth and are worthwhile to be taken. When two projects are mutually exclusive, we should rely on the NPV method as our ultimate goal is to maximize our wealth.

Question 11

Q

Question 2
Calculate the NPV of an investment with the following cash flow stream. Assume that the opportunity cost of capital is equal to 5%. The NPV is most likely equal to:
Year Year-end Cash flows
0 ($20,000.00)
1 $5,600.00
2 $4,500.00
3 $12,600.00
A. $199.32
B. $299.32
C. $399.32

Answer

A

Answer: B
Applying the NPV formula give us the following: 𝑁𝑃𝑉 = −$20,000 +
$5,6001
(1+0.05)
1
+
$4,5002
(1+0.05)
2 +
$12,6003
(1+0.05)
3 =
−$20,000.00 + $5,333.33 + $4,081.63 + $10,884.35 = $299.32
When using a financial calculator the procedure is as follows:

Question 12

Q

Question 3
Given the following information about two independent projects- A and B, what should an analyst decide? Assume the opportunity cost of capital for both projects is equal to 7%:
A. Accept both Project A and B
B. Accept Project A
C. Accept Project B

Answer

A

Answer A:
When we face two independent projects, we do not have any limitations and could invest in both. Our decision comes down to the following rule:
If NPV>0, we invest in the project
If NPV<0, we do not invest in the project
Applying the NPV formula for both projects give us the following: 𝑁𝑃𝑉𝑃𝑟𝑜𝑗𝑒𝑐𝑡 𝐴 = −$5,000.00 +
$2,5001
(1+0.07)
1
+
$3,5002
(1+0.07)
2 = −$5,000.00 + $2,336.45 + $3,057.04 = $393.48
3
𝑁𝑃𝑉𝑃𝑟𝑜𝑗𝑒𝑐𝑡 𝐵 = −$3,000.00 +
$1,5001
(1+0.07)
1
+
$2,5002
(1+0.07)
2 = −$3,000.00 + $1,401.87 + $2,183.60 =
$585.47
Both project A and project B have positive NPVs. Therefore, we should accept both.

Question 13

Q

Which of the following statements is least likely accurate?
A. A project which has an internal rate of return, which is less than the opportunity cost of capital will have a negative NPV
B. The net present value is equal to the sum of future cash flows discounted at the opportunity cost of capital
C. Internal rate of return less than the opportunity cost of capital means the project is profitable and should be accepted

Answer

A

Answer: C
If we find that the IRR for a project is higher than the opportunity cost of capital, we should accept it. On the contrary, if the opportunity cost of capital is higher than the IRR, we should reject the project. When the IRR is less than the cost of capital, the NPV will be negative, and effectively we will decrease our wealth.

Question 14

Q

Question 5
Calculate the internal rate of return (IRR) for Project C using a financial calculator. The cash flows are as
follows:
Year Year-end Cash flows
0 ($22,000.00)
1 $5,600.00
2 $9,500.00
3 $15,200.00
A. 14.11%
B. 15.11%
C. 16.11%

Answer

A

Answer B:

Question 15

Q

John buys a stock for $30. At the end of Year 1, it pays a dividend of $3 and John sells the stock for $40.The holding period return is equal to:
A. 25,6%
B. 43.33%
C. 56%

Question 16

Q

John buys a stock for $30. At the end of Year 1, it pays a dividend of $3 and John sells the stock for
$40.The holding period return is equal to:
A. 25,6%
B. 43.33%
C. 56%

Answer

A

Answer: B

Question 17

Q

Question 7
Melissa buys a share of stock for $55 at Year=0 and later another share at $60 at Year=1. The stock pays $5 dividend per share at the end of Year 1 and Year 2. The stocks are sold for $140 at the end of Year 2.
What is the money-weighted rate of return of the portfolio?
A. 22.55%
B. 23.55%
C. 24.55%

Answer

A

Finding the money-weighted rate of return for an investment essentially means solving for its IRR. We
need to find the rate that makes the present value of Outflows equal to the present value of Inflows.
The fastest way is to use a financial calculator or any spreadsheet software. Pay attention to the timing
of the cash flows. At Year=0 we have an investment outlay of -$55. At Year=1 we have another outlay of
money equal to -$60 plus the dividend paid ($5) which equals -$55. At Year=2 we have a positive inflow
of $140 plus the dividends of $10, which equals $150. Entering everything in the financial calculator
gives us IRR equal to 22.55%.

Question 18

Q

Question 8
Which of the following statements is most accurate about money-weighted rate of return?
A. Money-weighted rate of return accounts for the timing of cash flows but not for their amount
B. Investment managers prefer to use money-weighted rate of return because it allows them to be judged upon their own money-generating skills and not any external factors
C. Calculating the money-weighted rate of on investment is equal to finding its Internal rate of
return

Answer

A

Answer C:
The money-weighted rate of return accounts for the amount of cash flows. Hence, its name. But the measure is a poor estimate with regards to cash flow timing. In investment management, clients are those who determine how much money should be given to portfolio managers, not the other way around. The amount of money invested in a portfolio can significantly influence the way IRR is calculated. Therefore, most managers prefer to be judged against other measures such as timeweighted rate of return, unless they have discretion over the cash flows.

Question 19

Q

Melissa buys a share of stock for $55 at Year=0 and later another share at $60 at Year=1. The stock pays $5 dividend per share at the end of Year 1 and Year 2. The stocks are sold for $140 at the end of Year 2.
What is the time-weighted rate of return of the portfolio?
A. 20.6%
B. 21.6%
C. 22.6%

Answer

A

Answer: B
We first break the investment horizon of two years into smaller evaluation periods. For Year 1 the holding period return is $60 + the dividend of $5 minus the beginning value of $55. This is divided by $55 to find a return of 18.2%. For year 2 we have an ending value of $140 plus $10 in dividends minus the beginning value of $120 divided by $120. Pay attention that the beginning value is equal to the price of the second stock multiplied by 2. That’s how we calculate a holding period return equal to 25%. Now we only have to link both returns and find the time-weighted rate of return. Since we have two years of 6 investment horizon, we take the geomatic mean of the two holding periods. The time-weighted rate of return is equal to √(1.182)(1.25) − 1 = 21.6%

Question 20

Q

Question 10
Calculate the bank discount yield of a T-bill which is priced at $990 and has a face value of $1000 and
140 days until maturity.
A. 2.4%
B. 2.5%
C. 2.6%
Answer: C

Question 21

Q

Question 11
Calculate the holding period yield of T-bill priced at $96,000 with a face value of $100,000 and 180 days
to maturity.
A. 4.1%
B. 4.2%
C. 4.5%

Question 22

Q

Question 12
Imagine Jessica purchased a T-bill at $980 which matures at $1000 in 120 days. Which of the following
yields is closest to 6.3%?
A. Holding period yield (HPY)
B. Effective annual yield (EAY)
C. Money market yield (CD yield)

Question 23

Q

Question 13
Imagine that Jana purchased a $1000 T-bill which matures in 170 days for a price of $940. What is the
money market yield given that the bank discount yield is equal to 12.7%?
A. 13.5%
B. 14.2%
C. 16.7%

Question 24

Q

What is the bond equivalent rate of a 3-month loan which has a holding period rate of 4%?
A. 7.4%
B. 7.9%
C. 16.3%

Answer

A

Answer: C
First, we need to convert the 3-month yield into a semiannual yield. So, we have 1.042 − 1 = ~8.2%.
Then, we multiply by 2 to find the bond equivalent rate, which is 16.3%

Question 25

Q

Question 1
Which of the following is most likely true about corporate governance?
A. It seeks to mitigate conflicting interests between insiders and external shareholders.
B. It is similar across most countries.
C. It considers neither the shareholder theory nor the stakeholder theory.

Answer

A

Answer: A
Corporate governance is a set of rules and regulations which define the way companies are managed. It
determines the roles and responsibilities of the various stakeholders related to a company. Company
governance tends to differ in different parts of the world.

Question 26

Q

Question 2
Which of the following statements is most accurate about residual interest during bankruptcy?
A. Shareholders are paid before creditors under all circumstances.
B. Creditors have seniority over shareholders.
C. Both parties have equal rights.

Answer

A

Answer: B
Creditors have seniority over equity providers and in case of bankruptcy are paid before most equity
owners.

Question 27

Q

Question 3
Which stakeholder group benefits the most when market value increases?
A. Shareholders.
B. Suppliers.
C. Creditors.

Answer

A

Answer: A
Shareholders are the actual owners of a company and therefore benefit from higher market value.
Creditors have predetermined cash flows and their payments are unrelated to higher market valuation.
Suppliers are, in a sense, short-term loan providers and therefore are no different from creditors.

Question 28

Q

Question 4
Which is most likely true about shareholders and management?
A. Both stakeholder groups have similar levels of risk tolerance.
B. Shareholders have higher risk tolerance than managers.
C. Managers are more likely to take on risky projects when their salary is at stake.

Answer

A

Answer: B
Shareholders have access to more diversified portfolios and therefore have higher risk tolerance
compared to managers.

Question 29

Q

Question 5
What is most likely to happen if a company is subject to a takeover?
A. Shareholders with majority ownership would be in a better position compared to minority shareholders.
B. Both minority and majority shareholders have similar chances of receiving a good offer for their shares.
C. Minority shareholders would be in a better position to receive a good price for their shares.

Answer

A

Answer: A
Majority shareholders frequently get a premium offer at the expense of minority investors as any
acquirer would prefer to buy a company as quickly as possible by obtaining large blocks of stocks.

Question 30

Q

Question 6
An agreement between a company and one of their suppliers would most likely be considered part of a
company’s:
A. Organizational infrastructure.
B. Legal infrastructure.
C. Contractual infrastructure.

Answer

A

Answer: C
Contractual infrastructure manages different relationships between the company and its stakeholders.
Legal and government infrastructures are usually outside-driven and established by different
government agencies or regulators. Organizational infrastructure deals with internal systems controls
designed to manage all different stakeholders.

Question 31

Q

Question 7
Which is most accurate about the legal and contractual infrastructure of a company?
A. Both are company-driven infrastructures.
B. Contractual infrastructure is more company-driven while legal infrastructure is driven by
different governmental agencies and regulators.
C. Legal infrastructure is company-driven.

Answer

A

Answer: B
Legal and government infrastructures are usually externally-driven and established by different
government agencies or regulators. A contractual infrastructure, on the other hand, is typically
company-driven as it manages the relationships between the firm and its own stakeholders. A good
example of the latter is an agreement between a company and one of its supplier firms.

Question 32

Q

Question 8
Which statement reflects most correctly what effective Stakeholder management is?
A. It should prioritize the interests of certain stakeholders over others.
B. The interests of all stakeholders are identified and managed accordingly.
C. Creditors should have more rights than other stakeholder groups.

Answer

A

Answer: B
Effective Stakeholder management identifies the interests of all stakeholders and manages their
relationship with the company for better corporate governance. The cornerstone of effective
Stakeholder management is communication and engagement with all parties.

Question 33

Q

Question 9
Which is most likely to happen during an Annual General Meeting?
A. Shareholders are presented with the annual audited financial statements of the company.
B. The company’s bylaws are usually changed.
C. Shareholders vote for a significant sale of a company’s assets.

Answer

A

Answer: A
During Annual General Meetings, management presents the audited financial statements of the company to shareholders. The company’s performance and activities are discussed, and shareholders are given the opportunity to ask questions. Moreover, shareholders can cast their votes and elect directors. In rare cases, companies need to change their bylaws, sell a significant part of the business, or vote for a merger and acquisition. On such occasions, extraordinary general meetings are held.

Question 34

Q

Question 10
The Board of Directors is least likely accountable for which of the following?
A. Appointing top management.
B. Supervision of audit, control and risk management functions.
C. Procurement of supplies.

Answer

A

Answer: C
The Board of Directors is elected by the shareholders of a given company and its purpose is to have a broader view of the strategy and direction the firm is heading to. In addition, it elects senior 4 management and supervises the company’s audit, risk management, and corporate governance system.
Procurement is more of a day-to-day function and requires a narrower approach.

Question 35

Q

Question 11
Which Board composition will most likely be independent?
A. When most directors on the board are also executives.
B. When the CEO and the Board chair are the same people.
C. When the Board consists of many independent directors with expertise in the company’s business areas.

Answer

A

Answer: C
Internal directors are less likely to be independent. In companies with CEO “duality” the Board Chair is
to oversee him- or herself, which creates a risk in terms of independence.

Question 36

Q

Question 12
Which of the flowing is a market factor affecting corporate governance?
A. The legal environment of the company.
B. The media effect.
C. Shareholder activism.

Answer

A

Answer: C Shareholder activism is the correct answer. Both legal environment and media are nonmarket factors affecting corporate governance.

Question 37

Q

Question 13
Which of the following is not an example of the benefits associated with effective corporate governance?
A. Improved operational performance.
B. Reduced risk of default.
C. Avoiding risky projects with a potential for high revenue.

Answer

A

Answer: C
Both improved operational performance and reduced risk of default are among the most important benefits of effective corporate governance. Managers with superior information about their firms frequently choose sub-optimal decisions that are more in line with their risk-averse profiles. This leads to avoiding beneficial investment projects which are more suitable for a firm’s shareholders and their higher risk tolerance.

Question 38

Q

Question 14
Which of the following is not considered a takeover defense mechanism?
5
A. The existence of cross-shareholdings.
B. Staggered boards.
C. Strong activist shareholders.

Answer

A

Answer: C
Staggered boards and cross-shareholdings make change of management and board of directors more difficult and therefore are considered anti-takeover defense. On the contrary, strong activist shareholders serve as a catalyst for a radical change in corporate governance and investment management

Question 39

Q

Question 15
Which of the following is most accurate regarding executive compensation?
A. Managers should be compensated primarily with cash to avoid misalignment of interest with shareholders.
B. Performance targets should be easy to reach in order to avoid unrealistic expectations.
C. Compensation should align management incentives with company strategy.

Answer

A

Answer: C
Both A and B are examples of poor management compensation. Managers should have a combination of salary, bonuses and long-term incentive plans that align their interests to those of shareholders. In addition, their salary levels should be in line with their peers in similar industries.

Question 40

Q

Question 16
Which of the following statements regarding environmental, social and governance (ESG) in investment analysis is most accurate?
A. Thematic investing refers to investing in companies within a specific sector or those focused on a certain theme.
B. Green finance is rarely realized through the issuance of green bonds.
C. Negative screening refers to including companies with negative ESG practices in portfolio construction.

Answer

A

Answer: A
Negative screening refers to excluding companies from specific sectors such as fossil fuel or tobacco. Companies with sub-par practices in human rights, corruption, and environmental concerns are also examples of negative screening. Green finance is frequently realized through issuance of so-called green bonds.

Question 41

Q

Which of the following statements is most likely a requirement of the GIPS standards? Firms
should:
A. have their performance records verified by an independent third party
B. include all discretionary, non-discretionary, fee-paying, and non-fee paying portfolios in at least one composite
C. present a minimum of five years of annual investment performance results compliant with the GIPS standards

Answer

A

Answer: C
Once compliant with GIPS, firms may obtain third-party verification to their claim of compliance.
However, this practice is recommended, rather than required, so answer A is incorrect.
Answer B is incorrect, too. Only discretionary, fee-paying portfolios are to be included when constructing composites. Non-fee paying portfolios cannot be part of any composites.
The correct answer is C. Investment management firms must present at least five years of annual investment performance results compliant with the standards. After that they must add performance records each year, building up to a minimum of 10 years history of GIPS-compliant performance.

Question 42

Q

In cases when applicable local laws and regulations conflict with the GIPS Standards, to claim compliance, firms are required to:
A. adhere to the Global Investment Performance Standards
B. calculate and maintain two sets of performance data
C. comply with the local regulations and make full disclosure of the particular conflict

Answer

A

Answer: C
In cases when applicable local or country-specific laws and regulations conflict with GIPS, firms must comply with the local legal requirements and make full disclosure of the particular conflict.

Question 43

Q

Which of the following is not one of the 9 major sections of GIPS?
A. Derivatives
B. Private Equity
C. Real Estate

Answer

A

Answer: A
The nine sections of GIPS are the following:
0. Fundamentals of Compliance
1. Input Data
2. Calculation Methodology
3. Composite Construction
4. Disclosure
5. Presentation and Reporting
6. Real Estate
7. Private Equity
8. Wrap Fee/ Separately Managed Account (SMA) Portfolios
2
There is no section related to Derivatives in the Global Investment Performance Standards.

Question 44

Q

Which of the following is not one of the 9 major sections of GIPS?
A. Derivatives
B. Private Equity
C. Real Estate

Answer

A

Answer: A
The nine sections of GIPS are the following:
0. Fundamentals of Compliance
1. Input Data
2. Calculation Methodology
3. Composite Construction
4. Disclosure
5. Presentation and Reporting
6. Real Estate
7. Private Equity
8. Wrap Fee/ Separately Managed Account (SMA) Portfolios
2
There is no section related to Derivatives in the Global Investment Performance Standards.

Question 45

Q

Who can claim compliance with GIPS?
A. Pension funds
B. Investment management firms
C. Wealthy individuals

Answer

A

Answer: B
Only investment management firms can claim compliance with the GIPS Standards. They should do
that on a firm-wide basis.

Question 46

Q

Is the following compliance statement correct?
ABC Inc. claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. ABC Inc. has been independently verified for the periods January – December of the current year. The verification report(s) is/are available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite
presentation.”
A. Yes
B. No, because of the incorrect description of what is assessed by the verification process
C. No, because verification must ensure the accuracy of the presented composites

Answer

A

Answer: A
This is an example of a correct statement by a GIPS-compliant firm that has chosen to verify its
compliance. The verification process is focused on processes and procedures in the firm. It does not
ensure the accuracy of any specific composite performance.

Question 47

Q

Which of the following statements is most likely correct in regard to composites
construction?
A. Composites usually “suffer” from a survivorship bias
B. Composites must be defined on an ex-post basis
C. A composite’s return is calculated as the asset-weighted average return of all portfolios included in that composite

Answer

A

Answer: C
As per GIPS, a composite’s return is defined as the asset-weighted average of the performance results(return) of all portfolios included in the particular composite.
Answer A is incorrect because when presenting a composite’s return, we should take into account the return of all portfolios that are part of the particular composite, including portfolios of current and past customers. Thus, the survivorship bias is basically eliminated, and composites’ return is presented in a fair and accurate manner.
Answer B is incorrect because composites are defined in advance, on an ex-ante basis.

Question 48

Q

The Fundamentals of Compliance section of GIPS least likely:
A. requires that portfolios are valued at fair value.
B. prohibits partial compliance claims.
C. requires that firms establish and document adequate policies and procedures for GIPScompliance.

Answer

A

Answer: A
All statements given in the answers are true with respect to GIPS. However, the requirement that portfolios are valued at fair value is given in Section 1: Input Data, not in Section 0:
Fundamentals of Compliance

Question 49

Q

Who would least likely benefit from the development of the Global Investment Performance Standards?
A. Actual and prospective clients
B. Regulators
C. Investment management firms

Answer

A

Answer: B
Only investment management firms can claim compliance with GIPS. They, as well as their clients, benefit from GIPS compliance.
Regulators are not involved in money management activities and are not directly affected by the implementation of GIPS.

Question 50

Q

Which of the following distinct business entities can claim compliance with the Global
Investment Performance Standards (GIPS)?
A. A multinational financial services holding company
B. A local subsidiary of a multinational commercial bank
C. A subsidiary undertaking investment management services

Answer

A

Answer: C
The standards define a “firm” as an investment management firm, subsidiary, or division “held out to clients or prospective clients as a distinct business entity”. This means that its operations should be held independently and autonomously.
A multinational financial services holding company is unlikely to be operating solely as an investment firm. Moreover, the scope of its business could make it very difficult to claim compliance on a firmwide basis. Therefore, A is an incorrect answer.
A commercial bank subsidiary does not provide investment management services, so answer B is incorrect, too.
A subsidiary undertaking investment management services meets all the criteria for a firm definition stipulated in the standards. Hence, C is the correct answer.

Question 51

Q

Question 1
Which of the following statements is least likely correct?
A. Financing costs are not included in a project’s incremental cash flows
B. Cash flows are calculated on an after-tax basis
C. Accounting income is relevant for calculating the NPV of a project

Answer

A

Answer C:
In capital budgeting, the first principle that should guide us is that decisions are always based on cash
flows and not on accounting income. All intangible benefits and costs included in accounting statements
are not considered until they translate into cash flows and enter the capital budgeting cash stream.

Question 52

Q

Question 2
Which statement about two mutually exclusive projects is most accurate?
A. If projects are profitable, we should accept both
B. We should accept the project with the highest profitability according to NPV analysis
C. If they have a ranking conflict related to their respective values for IRR and NPV, we should
accept the one which has the higher IRR

Answer

A

Answer B:
Two or more projects are mutually exclusive when a company must choose only one of them. The IRR
method assumes that the reinvestment rate is the internal rate of return. In addition, the IRR technique
proves insufficient when it comes to comparing projects of different size. On the other hand, the NPV
method suggests reinvestment at the opportunity cost of capital. This is а much more realistic and
economically relevant assumption because it incorporates the market-determined opportunity cost of
capital as a discount rate. Therefore, the NPV is actually the net change in shareholders’ wealth after
choosing a particular investment. And this is what we need to know. At the end of the day, investors are
interested in the absolute amount of wealth generated by a given project. That’s why when we have a
ranking conflict, we should choose the project with the higher NPV.

Question 53

Q

Question 3
Under which circumstances the payback period and discounted payback period would end up being
equal?
A. Two projects will have equal payback and discounted payback periods when the required rate
of return is 0%
B. Under no circumstances can the two measures end up being equal
C. If we choose the same positive discount rate, the two measures will become equal

Answer

A

Answer: A
2
We know money today is more valuable than money tomorrow. The payback period measure simply
sums the cash flows without any consideration of their timing. On the other hand, the discounted
payback period overcomes this limitation. Still, if we choose 0% to be our required rate of return, both
measures would become equal because they ignore the time value of money.

Question 54

Q

Question 4
Calculate the payback period for the following project A:
Year 0 1 2 3 4
Cash
Flow
($75,000.00) $45,000.00 $20,000.00 $15,000.00 $10,000.00
A. 2.5 years
B. 2.67 years
C. 3 years

Answer

A

Answer B:
The payback period helps us figure out the number of years to recover our initial investment. For project
A, we recover $65,000 until the end of year 2 and we still need to gain $10,000 more from Year 3 in
order to repay our initial investment. So, we have $10,000/$15,000 which equals approximately 0.67. In
the end, the payback period is 2+0.67 which equals 2.67 years.

Question 55

Q

Question 5
Which of the following statements about the NPV and the IRR is most likely accurate?
A. When the cost of capital is equal to IRR, the NPV will be zero
B. IRR and NPV often give conflicting results for independent projects
C. When two projects are mutually exclusive, we should always put more emphasis on the IRR

Answer

A

Answer: A
The IRR method effectively answers the question: What is the discount rate that makes the NPV equal to
zero? Independent projects rarely produce conflicting results when we use NPV and IRR analysis.
Mutually exclusive projects should be evaluated based on an NPV analysis.

Question 56

Q

Question 6
Given the following information about two independent projects- A and B, what should an analyst
decide? Assume the opportunity cost of capital for both projects is equal to 7%:
Year Year-end Cash flows Project A Year-end Cash flows Project B
0 ($5,000.00) ($3,000.00)
1 $2,500.00 $1,500.00
2 $3,500.00 $2,500.00

A. Accept both Project A and B
B. Accept Project A
C. Accept Project B

Question 57

Q

Question 7
Which of the following statements is least likely accurate?
A. A project which has an internal rate of return, which is less than the opportunity cost of capital
will have a negative NPV
B. The net present value is equal to the sum of future cash flows discounted at the opportunity
cost of capital
C. Internal rate of return less than the opportunity cost of capital means the project is profitable
and should be accepted

Answer

A

Answer:
If we find that the IRR for a project is higher than the opportunity cost of capital, we should accept it. On
the contrary, if the opportunity cost of capital is higher than the IRR, we should reject the project. When
the IRR is less than the cost of capital, the NPV will be negative, and effectively we will decrease our
wealth.

Question 58

Q

Question 7
Which of the following statements is least likely accurate?
A. A project which has an internal rate of return, which is less than the opportunity cost of capital
will have a negative NPV
B. The net present value is equal to the sum of future cash flows discounted at the opportunity
cost of capital
C. Internal rate of return less than the opportunity cost of capital means the project is profitable
and should be accepted

Answer

A

Answer:
If we find that the IRR for a project is higher than the opportunity cost of capital, we should accept it. On
the contrary, if the opportunity cost of capital is higher than the IRR, we should reject the project. When
the IRR is less than the cost of capital, the NPV will be negative, and effectively we will decrease our
wealth.

Question 59

Q

Question 8
Calculate the NPV for Project B which has the following cash flow structure. Assume 10% required rate
of return.
Year 0 1 2 3 4 5
Cash Flow ($5,000.00) $3,500.00 $2,000.00 $1,500.00 $1,000.00 $500.00
A. $1,655
B. $1,955
C. $2,122

Question 60

Q

Question 10
Which of the following statements about the NPV profiles of two projects is most accurate?
A. The point where the two projects have equal NPVs is called crossover rate.
B. The NPV profiles of the projects will cross each other at their respective internal rates of return.
C. The NPV profiles of the projects will not cross unless they have the same discount rates

Answer

A

Answer: A
The crossover rate represents the point where two projects have equal NPVs. In such cases, we usually
stay indifferent regarding either of the investment opportunities, that is, we don’t choose any of them.
Statements B and C are not accurate. The IRR is the discount rate that makes the NPV equal to zero.
These are the points where the horizonal axes, representing the discount rate, are crossed. The NPV
6
profiles cross each other at the crossover rate not the IRRs. Statement C is wrong. There is not a
requirement for the profiles of the two projects to cross each other only when they have equal discount
rates

Question 61

Q

Question 11
Calculate the average accounting rate of return (AAR) for the following project. Assume that the initial
investment of $100 will be depreciated using straight-line over 2 years and the salvage value will be 0.
2018 2019
Sales $100 $105
Cash expenditure $35 $45
Depreciation $50 $50
EBT $15 $10
Taxes @ 40% $6 $4
Net income $9 $6
A. 14%
B. 15%
C. 17%
Answer: B

Answer

A

AAR is calculated using the following formula:
𝐴𝐴𝑅=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒
The average net income for the two years is equal to (9+6) divided by 2. This gives us 7.5. Next, we need
to calculate the average book value. It’s given that the starting value is 100 and the ending value is 0.
Therefore, we have an average book value equal to 50. 7.5 divided by 50 gives us 15% AAR.

Question 62

Q

Question 12
Calculate the profitability index (PI) for the following cash flow structure. Assume the required rate of
return is equal to 10%.
Year 0 1 2 3
Cash Flow ($5,000.00) $3,500.00 $2,000.00 $1,500.00
A. 1.17
B. 1.18
C. 1.19

Question 63

Q

Question 13
Which of the following projects is most likely to have a ‘problem’ when we calculate its IRR?
A. A project which has a conventional cash flow pattern.
B. A project which has two cash outflows at the beginning and at the end of the project life.
C. A project which has a small initial outflow of money as an initial investment followed by a series
of huge cash inflows later.

Answer

A

Unconventional cash flows which change sign more than once could cause issues when we calculate the
IRR. In this case, we could end up with having the so-called “multiple IRR problem”. Answers A and C
describe conventional cash flow patterns and do not cause a problem when we calculate the IRR.

Question 64

Q

Question 14
Examine the following information about two mutually exclusive projects A and B. Which of the two
projects is most likely to be selected?
0 1 2 3 4 NPV IRR
Project A (400) 160 160 160 160 118.36 21.86
Project B (400) 0 0 0 800 166.74 18.92

Answer

A

Answer: B
It is said that the projects are mutually exclusive. Therefore, we cannot select both of them even if we
wanted. Project A has a higher IRR, while Project B has a larger NPV. When we have two mutually
exclusive projects with conflicting rankings based on their IRR and NPV, we should always choose the
project with the higher NPV. In our case, this is Project B.

Answer 57

A

Answer:
To calculate the IRR, we need to solve for the following equation:
NPV = -$1,000,000
+
$1,000,000
+
$1,100,000
+
$1,300,000
+
$1,000,000
+
-$3,700,000
= 0
(1 + IRR)1
(1 + IRR)2
(1 + IRR)3
(1 + IRR)4
(1 + IRR)5
Using a financial calculator, we obtain that the relevant cash flow stream results in an error. In other
words, neither answer B nor C is accurate. Therefore, the only possible solution is A.

Answer 58

A

Answer: B
The after-tax cost of debt is calculated using 𝑟𝑑
(1 − 𝑡). Therefore, we have
𝑟𝑑
(1 − 𝑡)=(0.12)(1-0.4)=0.072 or 7.2%

Answer 59

A

Answer: C
Here we can apply the WACC formula directly. 𝑊𝐴𝐶𝐶 = 𝑤𝑑𝑟𝑑
(1 − 𝑡) + 𝑤𝑝𝑟𝑝 + 𝑤𝑒𝑟𝑒=(0.2)(0.05)(1-
0.4)+(0.2)(0.08)+(0.6)(0.10)=0.082 or 8.2%

Answer 60

A

The cost of equity is equal to
𝑟𝑒 =
𝐷1
𝑃0
+ 𝑔
= (3)/(25) + 0.07= 0.19 or 19%

Answer 61

A

Answer: A
Statement A is accurate. This is the point where the IRR equals the weighted average cost of capital, and
the shareholder value is optimized. Statement B is wrong. The optimal capital budget is determined by
the intersection of the marginal cost of capital and the investment opportunity schedule. It’s not the
point where NPV equals zero.

Answer 62

A

Answer: C
We use the WACC as a discount factor only when a project’s level of risk is consistent with the firm’s
existing projects. If the project’s riskiness is higher, we should adjust the WACC upward. On the
3
contrary, if the project has below-average riskiness, the cash flows should be discounted with a lower
WACC.

Answer 63

A

Answer: B
kps = Dps / Pps, Dps=50x0.06=$3, kps = 3/ 45 = 6.7%

Answer 64

A

Answer: B
To estimate the cost of equity using CAPM we need to know three things in advance:
* The risk-free rate
* The market risk premium, and
* The stock beta

Answer 65

A

Answer B:
Beta measures the sensitivity of a stock to any changes in the market return.

Answer 66

A

Answer: A
The formula for calculating the cost of equity, based on the CAPM is
𝐸(𝑅𝑖
) = 𝑅𝐹 + 𝛽𝑖
[𝐸(𝑅𝑀) − 𝑅𝐹
]
=5%+(1.5)(6)=14%

Answer 67

A

Answer: C
Both statements A and B are correct. Each company is exposed to both business and financial risks. They
affect companies in different ways, so every company has a unique beta.

Answer 68

A

Answer: A
The Asset beta is the beta of a company with no debt on its balance sheet. It is also called unlevered
beta because it includes the business risk only and ignores any financial risk.

Answer 69

A

Answer: B
Beta is basically used to show how a financial security behaves with respect to the rest of the market.
That is why we divide its Covariance with the rest of the market by the market variance. Using the
formula for calculating beta we have following:
𝛽𝑖 =
𝐶𝑜𝑣(𝑅𝑖,𝑅𝑀)
𝑉𝑎𝑟(𝑅𝑀)
𝛽𝐶𝑜𝑚𝑝𝑎𝑛𝑦 𝑥 =
0.040
0.020 = 2.00
In the end, we obtain that it’s equal to 2.00 which corresponds to answer B.

Answer 70

A

Answer: A
Statement A is accurate. Sales risk refers to the uncertainty of how much we will sell and at what price.
It is affected by a large number of factors such as the elasticity of product demand, industry
competition, and the cyclicality of revenues. Both statements B and C are wrong. Statement B describes
the operating risk of a company. It is affected by the relative mix of fixed and variable operating costs in
the production process of a company. Firms with high fixed costs and low variable costs are generally
said to have high operating leverage. Statement C is also not accurate. Many companies do very well in
the expansion phase of the business cycle and perform poorly in the contraction phase. Some examples
are high-tech firms, retailers, and automotive firms. Usually, their growth corresponds to fluctuations in
the business cycle. On the other hand, firms in industries such as utilities, healthcare, and food are less
6
dependent on business cycle shifts. Such companies are called “defensive” because their earnings
remain stable regardless of the state of the overall economy.

Answer 71

A

Answer: B
We apply our formula for sovereign yield spread to get:
7
𝐶𝑜𝑢𝑛𝑡𝑟𝑦 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 = 𝑠𝑜𝑣𝑒𝑟𝑒𝑖𝑔𝑛 𝑦𝑖𝑒𝑙𝑑 𝑠𝑝𝑟𝑒𝑎𝑑 × (
𝑎𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥
𝑜𝑓 𝑑𝑒𝑣𝑒𝑙𝑜𝑝𝑖𝑛𝑔 𝑐𝑜𝑢𝑛𝑡𝑟𝑦
𝑎𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑠𝑜𝑣𝑒𝑟𝑒𝑖𝑔𝑛
𝑏𝑜𝑛𝑑 𝑚𝑎𝑟𝑘𝑒𝑡 𝑖𝑛 𝑡𝑒𝑟𝑚𝑠 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑒𝑣𝑒𝑙𝑜𝑝𝑒𝑑 𝑚𝑎𝑟𝑘𝑒𝑡 𝑐𝑢𝑟𝑟𝑒𝑛𝑐𝑦)
=(0.10-0.05)x(0.30/0.25)=0.06 or 6%

Answer 72

A

Answer: B
Statement B is accurate. Each break point represents the amount of capital that causes a change in the
weighted average cost of capital. Statement C is wrong. The capital structure of a firm affects the
calculation of break points. To calculate the break points, we divide the amount of capital at which the
source’s cost of capital changes by the weight of the source in the capital structure. Statement A is also
not accurate. While NPV is affected by WACC it is not always equal to 0.

Answer 73

A

Answer: B
The cost of equity, 𝑟𝑒
is equal to:
𝑟𝑒 =
𝐷1
𝑃0
+ 𝑔
8
= 3*(1.05)/30+0.05=0.155 or 15.5%. 𝑟𝑑
(1 − 𝑡)= 8%(1-0.4)=4.8%.
The company has a debt to equity ratio of 0.67. This means that we have $0.67 debt for each dollar of
equity. V=debt +equity=$0,67+$1=$1,67. Therefore, we have a debt weight of 0,67/1,67 which is
approximately 0.4. Equity weight is equal to 1-0.4 or 0.6.
Applying the WACC formula, we get to 𝑊𝐴𝐶𝐶 = 𝑤𝑑𝑟𝑑
(1 − 𝑡) + 𝑤𝑒𝑟𝑒= 0.4(4.8%)+0.6(15.5%)=0.1122 or
11.22%

Answer 74

A

Answer: A
Statement B is wrong. Flotation costs are essentially cash outflows occurring at the beginning of a
project. We can think of them as initial investments decreasing the NPV. Incorporating flotation costs
into the formula of calculating the cost of equity implies that we also include them in the weighted
average cost of capital. However, as you remember, WACC is the discount rate we apply throughout the
entire life of a project. Thus, using this approach would mean that we treat flotation costs as an ongoing
expense which is a wrong assumption. Statement C is also not accurate. While these costs are only
marginal for obtaining debt financing, the issue costs for equity financing could close to 7%, which is
substantial. Statement A is accurate.

Answer 75

A

Answer: B
Business risk is the risk associated with a firm’s operating performance. It encompasses both sales andoperating risks. When we say sales risk, we refer to the uncertainty regarding how much of our production we will be able to sell and at what price. A large number of factors play a role here, such as the elasticity of product demand, industry competition, and revenues cyclicality. On the other hand, operating risk deals with additional uncertainty regarding a company’s earnings caused by fixed operating costs.

Answer 76

A

Answer: B
Statements A is wrong. Financial risk refers to the uncertainty of net income and net cash flows attributed to the use of external financing that has a fixed cost. Examples of external financing are bank loans and financial leases. Companies that finance their operations by borrowing capital are called leveraged. Statement C is also wrong. The higher the financial risk, the lower the price of a stock because such a company is more likely to default compared to a less leveraged firm. Statement B is accurate.

Answer 77

A

The interest expense does not affect the operating but the financial leverage of a company. Statement B is accurate. Every company has a mix of operating variable and fixed costs. Variable costs, such as expenses for purchased goods or materials and supplies, change constantly and depend on sale levels. Fixed costs, such as rent and wages, stay the generally same and aren’t affected by changes in the sale levels. The larger the fixed component, the more difficult it is to adjust the variable component to changes in sales. Therefore, operating risk becomes higher. Statement C is also accurate. The degree of operating leverage shows the sensitivity of operating income to changes in product demand, measured by unit sales.

Answer 78

A

In the end, we obtain that at 150,000 units the degree of operating leverage is 1.03 which is the lowest of the three options. Note that we could have also guessed the answer by noticing that the higher the number of units produced the lower the effect on fixed costs. This means that operating leverage decreases when unit production increases.

Answer 79

A

Answer: B
The degree of financial leverage is calculated using the following formula:
𝐷𝐹𝐿 =
𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
First, we calculate EBIT (Earnings Before Interests and Taxes) by subtracting the variable and fixed
operating costs from the revenues: ($20-$5-$3)=$12. Then, we substitute into the formula:
𝐷𝐹𝐿 =
$12
$12 − $1 = 1.091
The degree of financial leverage is equal to 1.091.

Answer 80

A

Answer: B
The degree of financial leverage is calculated using the following formula:
𝐷𝐹𝐿 =
𝐸𝐵𝐼𝑇
𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
First, we calculate EBIT (Earnings Before Interests and Taxes) by subtracting the variable and fixed
operating costs from the revenues: ($20-$5-$3)=$12. Then, we substitute into the formula:
𝐷𝐹𝐿 =
$12
$12 − $1 = 1.091
The degree of financial leverage is equal to 1.091.

Answer 81

A

Answer: C
The formula for calculating the degree of total leverage is as follows:
𝐷𝑇𝐿 =
𝑄(𝑃 − 𝑉)
𝑄(𝑃 − 𝑉) − 𝐹 − 𝐼
Substituting the parameters we know results in the following value:
𝐷𝑇𝐿 =
100,000($5 − $4)
100,000($5 − $4) − $30,000 − $2,000 = 1.47
The degree of total leverage is equal to 1.47

Answer 82

A

Answer: B
Statements A and C are correct. The financial leverage has a magnifying effect on the Net income and
returns on equity. It increases not only the level of ROE but also the rate of change. Statement B is
wrong. The higher the proportion of debt in the capital structure, the higher the risk of default.

Answer 83

A

Answer: C
We use the following equation to calculate the breakeven quantity of sales:
𝑄𝐵𝑟𝑒𝑎𝑘 𝐸𝑣𝑒𝑛 =
𝐹 + 𝐶
𝑃 − 𝑉
Substituting the known parameters results in 14,000 units.
6
𝑄𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝐵𝑒𝑡𝑎 𝑐𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑖𝑜𝑛 =
$40,000 + $2,000
$7 − $4 = 14,000 (𝑈𝑛𝑖𝑡𝑠)

Answer 84

A

Answer: A
The formula for calculating the operating breakeven quantity of sales is:
𝑄𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐵𝑟𝑒𝑎𝑘 𝐸𝑣𝑒𝑛 =
𝐹
𝑃 − 𝑉
We substitute the known parameters to obtain the following:
𝑄𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐵𝑟𝑒𝑎𝑘 𝐸𝑣𝑒𝑛 𝐶𝑜𝑚𝑝𝑎𝑛𝑦 𝑍 =
$300,000
$50 − $40 = 30,000 𝑈𝑛𝑖𝑡𝑠
In the end, we obtain that the operating breakeven quantity of sales is 30,000 units

Answer 85

A

Answer: B
The primary sources of liquidity are the sources that a firm uses for its regular daily operations. These
represent the most readily available funds which are held as cash or near-cash securities. More
precisely, primary sources of liquidity are cash balances from selling goods or services, collecting
receivables, and holding short-term instruments. Or trade credits from vendors and bank lines of credit.
An effective cash flow management of collections and payments could also be a source of liquidity. A
more centralized cash flow system would imply that cash is not tied up in subsidiaries and ensures it is
used more efficiently. Statements A and C are examples of secondary sources of liquidity.

Answer 86

A

Answer: B
Pulls on liquidity accelerate cash outflows. Statement A indicates that the vendor will be paid 20 days
later than the previous time. In other words, Alpha will be able to hold cash for longer. Thus, it can use
the money for other activities such as investing in money-generating securities. Drags on liquidity delay
or reduce cash inflows. Higher inventory turnover means that the company would be able to produce
more goods and that cash inflows will increase. The weighted average collection period in statement B is
increased from 35 to 45 days. The metric indicates the average days outstanding per dollar of receivable
or in other words, how long it takes to collect payments from customers. An increase in this ratio shows
that the company has difficulties collecting money from clients.

Answer 87

A

Answer: B
The current ratio is calculated by dividing the current assets by the current liabilities. For company X we
have:
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
$200,000,000 = 3.5
Therefore, the current assets are equal to 3.5x$200,000,000 or $700,000,000. The quick ratio includes
only assets that can be converted to cash. We subtract the Inventory of the current assets and solve the
equation.
𝑄𝑢𝑖𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 =
($700,000,000 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦)
$200,000,000 = 2.5
That’s how we find that the amount of inventory is equal to $200,000,000

Answer 88

A

The operating cycle is equal to the number of days of inventory plus the number of days of receivables.
We calculate each of the two terms. First, we determine the turnover ratio and then multiply its inverse
by 365 to find the days of inventory.

Answer 89

A

First, we calculate the payables turnover ratio by dividing the purchases by the average accounts
payables. As we already know, purchases are calculated by summing the costs of goods sold with the
ending inventory and then subtracting the beginning inventory.

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