CFA CFA-Level-II Exam (page: 22)
CFA Level II Chartered Financial Analyst
Updated on: 24-Mar-2026

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%.

Warner determines that on a per-share basis, the FCFE for GDW in 2008 is $0.19. Further analysis suggests that FCFE per share will grow by $0.02 in each of the next two years before leveling off to a long-term growth rate of 5%. The current value of one share of GDW's equity is closest to:

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%.

Which corporate event that Warner is analyzing is likely to have the largest effect on FCFE in 2009?

Matthew Emery, CFA, is responsible for analyzing companies in the retail industry. He is currently reviewing the status of Ferguson Department Stores, Inc. (FDS). FDS has recently gone through extensive restructuring in the wake of a slowdown in the economy that has made retailing particularly challenging. As part of his analysis, Emery has gathered information from a number of sources.

Ferguson Department Stores, Inc.
FDS went public in 1969 following a major acquisition, and the Ferguson name quickly became one of the most recognized in retailing. Ferguson had been successful through most of its first 30 years in business and has prided itself on being the one-stop shopping destination for consumers living on the West Coast of the United States. Recently, FDS began to experience both top and bottom line difficulties due to increased competition from specialty retailers who could operate more efficiently and offer a wider range of products in a focused retailing sector. When the company's main bank reduced FDS's line of credit, a serious working capital crisis ensued, and the company was forced to issue additional equity in an effort to overcome the problem. FDS has a cost of capital of 10% and a required rate of return on equity of 12%. Dividends are growing at a rate of 8%, but the growth rate is expected to decline linearly over the next six years to a long-term growth rate of 4%. The company recently paid an annual dividend of $1.

At the end of 2008, FDS announced that it would be expanding its retail operations, moving to a warehouse concept, and opening new stores around the country. FDS also announced it would close some existing stores, write-down assets, and take a large restructuring charge. Upon reviewing the prospects of the firm, Emery issued an earnings per share forecast for 2009 of $0.90. He set a 12- month share price target of $22.50. Immediately following the expansion announcement, the share price of FDS jumped from $14 to $18.



In 2008, FDS also reported an unusual expense of $189.1 million related to restructuring costs and asset write downs.



In response to questions from a colleague, Emery makes the following statements regarding the merits of earnings yield compared to the P/E ratio:
Statement 1: For ranking purposes, earnings yield may be useful whenever earnings are either negative or close to zero.
Statement 2: A high E/P implies the security is overpriced.

The value of one share of FDS using the H-model is closest to:

Matthew Emery, CFA, is responsible for analyzing companies in the retail industry. He is currently reviewing the status of Ferguson Department Stores, Inc. (FDS). FDS has recently gone through extensive restructuring in the wake of a slowdown in the economy that has made retailing particularly challenging. As part of his analysis, Emery has gathered information from a number of sources.

Ferguson Department Stores, Inc.
FDS went public in 1969 following a major acquisition, and the Ferguson name quickly became one of the most recognized in retailing. Ferguson had been successful through most of its first 30 years in business and has prided itself on being the one-stop shopping destination for consumers living on the West Coast of the United States. Recently, FDS began to experience both top and bottom line difficulties due to increased competition from specialty retailers who could operate more efficiently and offer a wider range of products in a focused retailing sector. When the company's main bank reduced FDS's line of credit, a serious working capital crisis ensued, and the company was forced to issue additional equity in an effort to overcome the problem. FDS has a cost of capital of 10% and a required rate of return on equity of 12%. Dividends are growing at a rate of 8%, but the growth rate is expected to decline linearly over the next six years to a long-term growth rate of 4%. The company recently paid an annual dividend of $1.

At the end of 2008, FDS announced that it would be expanding its retail operations, moving to a warehouse concept, and opening new stores around the country. FDS also announced it would close some existing stores, write-down assets, and take a large restructuring charge. Upon reviewing the prospects of the firm, Emery issued an earnings per share forecast for 2009 of $0.90. He set a 12- month share price target of $22.50. Immediately following the expansion announcement, the share price of FDS jumped from $14 to $18.


In 2008, FDS also reported an unusual expense of $189.1 million related to restructuring costs and asset write downs.



In response to questions from a colleague, Emery makes the following statements regarding the merits of earnings yield compared to the P/E ratio:
Statement 1: For ranking purposes, earnings yield may be useful whenever earnings are either negative or close to zero.
Statement 2: A high E/P implies the security is overpriced.

Given Emery's dividend forecast for FDS, is the H-model the appropriate valuation model to use to value FDS?

Matthew Emery, CFA, is responsible for analyzing companies in the retail industry. He is currently reviewing the status of Ferguson Department Stores, Inc. (FDS). FDS has recently gone through extensive restructuring in the wake of a slowdown in the economy that has made retailing particularly challenging. As part of his analysis, Emery has gathered information from a number of sources.

Ferguson Department Stores, Inc.
FDS went public in 1969 following a major acquisition, and the Ferguson name quickly became one of the most recognized in retailing. Ferguson had been successful through most of its first 30 years in business and has prided itself on being the one-stop shopping destination for consumers living on the West Coast of the United States. Recently, FDS began to experience both top and bottom line difficulties due to increased competition from specialty retailers who could operate more efficiently and offer a wider range of products in a focused retailing sector. When the company's main bank reduced FDS's line of credit, a serious working capital crisis ensued, and the company was forced to issue additional equity in an effort to overcome the problem. FDS has a cost of capital of 10% and a required rate of return on equity of 12%. Dividends are growing at a rate of 8%, but the growth rate is expected to decline linearly over the next six years to a long-term growth rate of 4%. The company recently paid an annual dividend of $1.

At the end of 2008, FDS announced that it would be expanding its retail operations, moving to a warehouse concept, and opening new stores around the country. FDS also announced it would close some existing stores, write-down assets, and take a large restructuring charge. Upon reviewing the prospects of the firm, Emery issued an earnings per share forecast for 2009 of $0.90. He set a 12- month share price target of $22.50. Immediately following the expansion announcement, the share price of FDS jumped from $14 to $18.



In 2008, FDS also reported an unusual expense of $189.1 million related to restructuring costs and asset write downs.



In response to questions from a colleague, Emery makes the following statements regarding the merits of earnings yield compared to the P/E ratio:
Statement 1: For ranking purposes, earnings yield may be useful whenever earnings are either negative or close to zero.
Statement 2: A high E/P implies the security is overpriced.

Assuming that the cost of equity for FDS does not change, the present value of growth opportunities in the share price following the announcement that the company would be expanding its retail operations, using Emery's 2009 earnings forecast, is closest to: