When barriers to exit are high, companies may not be able to exit the industry without incurring significant capital costs by redeploying capital, for example. Therefore, these companies may continue to operate their loss-making plants prolonging conditions of overcapacity. When price is a large component of the purchase decision, companies will have a limited ability to influence price at a level necessary to generate healthy profits.
CFA Level I Mock Exam 5 – Solutions (PM) FinQuiz.com © 2016 - All rights reserved. 61 85. Jones Davenport submits a sell order for 12 contracts with a limit price of $25.7. The market’s limit order book immediately prior to Davenport’s order is as follows: Buyer Bid size Limit Price ( € ) Offer Size Seller Martin 4 25.6 Smith 2 25.7 Peterson 7 25.8 25.9 6 Hill 26.0 8 Ali 26.1 10 Khan Davenport’s average trade price is closest to: A. € 25.73. B. € 25.78. C. € 25.95. Correct Answer: B Reference: CFA Level 1, Volume 4, Study Session 13, Reading 46, LOS i Daveport’s order will be first executed at the most aggressively priced buy order; that is, 7 contracts will be sold to Peterson at a price of € 25.8. Davenport has five contracts remaining and two of these contracts will be sold to Smith at the next most aggressively priced sell order; the limit price will be € 25.7. Davenport has three contracts remaining but these will not be sold to Martin as the price is lower than the trader’s limit price. Average trade price = [(7 × € 25.8) + (2 × € 25.7)]/9 = € 25.78 86. The Gordon growth model cannot be used to estimate intrinsic value if the associated company: A. is rapidly growing. B. assumes a perpetual dividend growth rate. C. retains a portion of its profits for reinvestment purposes.
CFA Level I Mock Exam 5 – Solutions (PM) FinQuiz.com © 2016 - All rights reserved. 62 Correct Answer: A Reference: CFA Level 1, Volume 4, Study Session 14, Reading 51, LOS e & f The Gordon growth model assumes that the dividend growth rate is perpetual and never changes; therefore, the model cannot be used if a company is rapidly growing; i.e. does not have a stable dividend growth rate.The Gordon growth model can be applied if the company retains a portion of its profits for reinvestment as long as this amount is kept constant and does not result in fluctuating dividend payments. 87. The exhibit below summarizes information concerning a market-capitalization weighted index: Stock Beginning of period price per share ($) Dividends per share ($) End of period price per share ($) Shares outstanding A 120 50 140 45,570 B 200 25 250 59,650 C 180 30 160 112,740 Total 217,960 The price return on the market-capitalization weighted index is closest to: A. 4.08%. B. 4.35%. C. 6.49%. Correct Answer: B Reference: CFA Level 1, Volume 4, Study Session 13, Reading 47, LOS b
CFA Level I Mock Exam 5 – Solutions (PM) FinQuiz.com © 2016 - All rights reserved. 63 Price return = (End of period value – beginning of period value)/beginning of period value Beginning of period value = ($120 × 45,570) + ($200 × 59,650) + ($180 × 112,740) = $37,691,600 End of period value = ($140 × 45,570) + ($250 × 59,650) + ($160 × 112,740) = $39,330,700 Price return = ($39,330,700 – $37,691,600)/$37,691,600 = 4.35% 88. Greenex Inc.’s option-free perpetual preferred stock is currently selling in the market for $945.63. The annual dividend rate is quoted at 5.5% and the par value
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