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CFA® CFA-Level-II Exam (page: 21)
CFA® Level II Chartered Financial Analyst
Updated on: 25-Dec-2025

Viewing Page 21 of 145
CFA-Level-II PDF 715 Questions

Lauren Jacobs, CFA, is an equity analyst for DF Investments. She is evaluating Iron Parts Inc. Iron Parts is a manufacturer of interior systems and components for automobiles. The company is the world's second largest original equipment auto parts supplier, with a market capitalization of $1.8 billion. Based on Iron Parts's low price-to-book value ratio of 0.9* and low price-to-sales ratio of 0.15x, Jacobs believes the stock could be an interesting investment. However, she wants to review the disclosures found in the company's financial footnotes. In particular, Jacobs is concerned about Iron Parts's defined benefit pension plan. The following information for 2007 and 2008 is provided.


Iron Parts has adopted SFAS No. 158, Employers' Accounting for Defined Benefit Pensions and Other Postretirement Plans.
Jacobs wants to fully understand the impact of changing pension assumptions on Iron Parts's balance sheet and income statement. In addition, she would like to compute Iron Parts's economic pension expense.

For the year ended December 31, 2008, Iron Parts's economic pension expense is closest to:

  1. $57 million.
  2. $110 million.
  3. $147 million.

Answer(s): B

Explanation:

Economic pension expense can be calculated by summing the changes in the PBO for the period (excluding benefits paid) and then subtracting the actual return on assets. The change in the PBO (excluding benefits) is $147 (635 reported 2008 PBO + 22 benefits paid - 510 reported 2007 PBO). Subtract the actual return to get economic pension expense of $110 (147 change in PBO excluding benefits paid - 37 actual return).
Alternatively, economic pension expense is equal to the change in the funded status for the period excluding the firm's contributions. 2008 funded status was -240 (395 plan assets -635 PBO) and the funded status for 2007 was -183 (327 plan assets - 510 PBO). Contributions were $53 (calculated in Question 81). Thus, economic pension expense is $110 (-57 change in funded status - 53 contributions). (Study Session 6, LOS 22.g)



Carl Warner, CFA, has been asked to review the financial information of Global Drug World (GDW) in preparation for a possible takeover bid by rival competitor Consolidated Drugstores International (Consolidated). GDW has produced impressive results since going public via an initial public offering in 1998. Through a program of aggressive growth by acquisition, GDW is currently seen as a major player and a threat to Consolidated^ own plans for growth and profitability. In preparation for his analysis, Warner has gathered the following financial data from GDW's year-end statements:

Partial GDW Balance Sheet on May 31, 2008






As part of his analysis, Warner needs to forecast the free cash flow to the firm (FCFF) for 2009. The best information he has points to an increase in sales of 6%. The earnings before interest and tax (EBIT) margin is not expected to change from the rate of 6.4% achieved in 2008. Additional fixed capital spending is expected to be $36,470. Investment in net working capital is expected to be $24,313. Moreover, Warner notes that the only noncash charge is depreciation, which he estimates will be $60,000.

Warner has been asked to analyze the effect each of the following corporate events, if taken during 2009, would have on GDW's free cash flow to equity (FCFE):
• 20% increase in dividends per share.
• Repurchase of 25% of the firm's outstanding shares using cash.
• New common share offering that would increase shares outstanding by 30%.
• New issue of convertible bonds that are not callable for fi\e years and would increase the level of debt by 10%.

The 2008 free cash flow to the firm (FCFF) for Global Drug World (GDW) in dollars is closest to:

  1. $87,728.
  2. $95,374.
  3. $102,378.

Answer(s): A

Explanation:

Free cash flow to the firm can be calculated in various ways. One approach to calculate FCFF is to start with net income:



Carl Warner, CFA, has been asked to review the financial information of Global Drug World (GDW) in preparation for a possible takeover bid by rival competitor Consolidated Drugstores International (Consolidated). GDW has produced impressive results since going public via an initial public offering in 1998. Through a program of aggressive growth by acquisition, GDW is currently seen as a major player and a threat to Consolidated^ own plans for growth and profitability. In preparation for his analysis, Warner has gathered the following financial data from GDW's year-end statements:

Partial GDW Balance Sheet on May 31, 2008






As part of his analysis, Warner needs to forecast the free cash flow to the firm (FCFF) for 2009. The best information he has points to an increase in sales of 6%. The earnings before interest and tax (EBIT) margin is not expected to change from the rate of 6.4% achieved in 2008. Additional fixed capital spending is expected to be $36,470. Investment in net working capital is expected to be $24,313. Moreover, Warner notes that the only noncash charge is depreciation, which he estimates will be $60,000.

Warner has been asked to analyze the effect each of the following corporate events, if taken during 2009, would have on GDW's free cash flow to equity (FCFE):
• 20% increase in dividends per share.
• Repurchase of 25% of the firm's outstanding shares using cash.
• New common share offering that would increase shares outstanding by 30%.
• New issue of convertible bonds that are not callable for fi\e years and would increase the level of debt by 10%.

By how much (in dollars) does GDW's FCFF exceed its free cash flow to equity (FCFE) in 2008?

  1. $9,567.
  2. $45,251.
  3. $52,897.

Answer(s): B

Explanation:

FCFE can be expressed in terms of FCFF as follows:
FCFE = FCFF - Int(l - tax rate) + net borrowing

Therefore, the amount by which FCFF exceeds FCFE can be written as:
FCFF - FCFE = Int(l - tax rate) - net borrowing
Int - $25,488

Net borrowing = $5,866 - $33,275 = -$27,409 (additional information)
Therefore: FCFF - FCFE = $25,488(1 - 0.3) - (-$27,409) = $45,251 (Study Session 12, LOS 41.e)



Carl Warner, CFA, has been asked to review the financial information of Global Drug World (GDW) in preparation for a possible takeover bid by rival competitor Consolidated Drugstores International (Consolidated). GDW has produced impressive results since going public via an initial public offering in 1998. Through a program of aggressive growth by acquisition, GDW is currently seen as a major player and a threat to Consolidated^ own plans for growth and profitability. In preparation for his analysis, Warner has gathered the following financial data from GDW's year-end statements:

Partial GDW Balance Sheet on May 31, 2008






As part of his analysis, Warner needs to forecast the free cash flow to the firm (FCFF) for 2009. The best information he has points to an increase in sales of 6%. The earnings before interest and tax (EBIT) margin is not expected to change from the rate of 6.4% achieved in 2008. Additional fixed capital spending is expected to be $36,470. Investment in net working capital is expected to be $24,313. Moreover, Warner notes that the only noncash charge is depreciation, which he estimates will be $60,000.

Warner has been asked to analyze the effect each of the following corporate events, if taken during 2009, would have on GDW's free cash flow to equity (FCFE):
• 20% increase in dividends per share.
• Repurchase of 25% of the firm's outstanding shares using cash.
• New common share offering that would increase shares outstanding by 30%.
• New issue of convertible bonds that are not callable for fi\e years and would increase the level of debt by 10%.

The cost of equity and the sustainable growth rate (using beginning equity) are closest to:
Cost of equity Sustainable growth rate

  1. 6% 8%
  2. 10% 8%
  3. 10% 16%

Answer(s): B

Explanation:

The cost of equity can be determined from the capital asset pricing model. We get:



Carl Warner, CFA, has been asked to review the financial information of Global Drug World (GDW) in preparation for a possible takeover bid by rival competitor Consolidated Drugstores International (Consolidated). GDW has produced impressive results since going public via an initial public offering in 1998. Through a program of aggressive growth by acquisition, GDW is currently seen as a major player and a threat to Consolidated^ own plans for growth and profitability. In preparation for his analysis, Warner has gathered the following financial data from GDW's year-end statements:

Partial GDW Balance Sheet on May 31, 2008






As part of his analysis, Warner needs to forecast the free cash flow to the firm (FCFF) for 2009. The best information he has points to an increase in sales of 6%. The earnings before interest and tax (EBIT) margin is not expected to change from the rate of 6.4% achieved in 2008. Additional fixed capital spending is expected to be $36,470. Investment in net working capital is expected to be $24,313. Moreover, Warner notes that the only noncash charge is depreciation, which he estimates will be $60,000.

Warner has been asked to analyze the effect each of the following corporate events, if taken during 2009, would have on GDW's free cash flow to equity (FCFE):
• 20% increase in dividends per share.
• Repurchase of 25% of the firm's outstanding shares using cash.
• New common share offering that would increase shares outstanding by 30%.
• New issue of convertible bonds that are not callable for fi\e years and would increase the level of debt by 10%.

The 2009 estimate of FCFF is closest to:

  1. $191,646.
  2. $210,329.
  3. $215,329.

Answer(s): A

Explanation:

When depreciation is the only noncash charge, FCFF can be estimated from:



Viewing Page 21 of 145



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