5 questions will be shown from 30 free practice questions to prepare you for the CFA level 2 exam. Enjoy!
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1. In regard to calculating Wadgett’s FCFF, the comment that is most appropriate is the one dealing with:
. Cash flow from operations (CFO) already reflects changes in working capital items, therefore Paschel’s first comment is correct. EBITDA has the non-cash charges of depreciation and amortization added back, so Covey’s statement is incorrect, not all non-cash charges will need to be added back. Net borrowing is added back for FCFE not FCFF, so Paschel’s second statement is incorrect.
. Depreciation has already been added back to EBITDA, though there may be other items that still need to be added back.
. Adjusting for net borrowing is not necessary for FCFF (just FCFE).
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2. The most accurate interpretation of Whelan’s conclusions concerning the pre- and post-acquisition HHI is that they are:
An HHI greater than 1,800 indicates that an industry is highly concentrated. Should the HHI in a highly concentrated industry change by 50 or more, a governmental challenge to a particular business combination is very likely. In this instance, the industry is highly concentrated and the HHI changes by 90, making Whelan’s second conclusion incorrect. A government challenge is likely.
Whelan’s second conclusion is not correct.
Whelan’s conclusion that the industry is highly concentrated is correct.
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3. In the discussion of residual income valuation, which analyst makes the most accurate statement?
Chance’s statement is the most accurate. When cash flows are negative in the analyst’s comfortable forecast time horizon, the RI model is most appropriate. Residual income is sometimes called economic profit because it estimates the company’s profit after deducting the cost of all capital. The RI model is less sensitive to estimates of ter- minal value than discounted dividend or cash flow models.
Tinker is incorrect: Residual income is sometimes called economic profit because it is an estimate of the profit of the company after deducting the cost of all capital. . Evers is incorrect: The residual income model is less sensitive to estimates
of terminal value than discounted dividend or cash flow models.
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4. The lower market prices Betta observes for Bay Corp bonds is most likely explained by:
. Betta has taken the correct approach in using actual coupon bonds for Bay Corp and estimating implied zero-coupon bonds. Because the bonds rank equally, there is no need to adjust for differences in priority in case of default. In practice, bond prices will be affected by liquidity, and investors expect additional spread or a liquidity premium to compensate for less liquid corporate bonds relative to sovereign bonds.
because there is a need to convert coupon bonds to implied zero-coupon bonds to infer the spread.
because no adjustment is necessary for differences in priority since all the bonds in this case rank equally.
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5. Using the backward induction method and the data in Exhibit 2, the value of the bond Hake has been asked to value is closest to:
. Find prices one period from the end. Value at Year 2:
0.5 × [(104/1.0450) + (104/1.0450)] + 4 = 103.522 0.5 × [(104/1.0325) + (104/1.0325)] + 4 = 104.726 0.5 × [(104/1.0235) + (104/1.0235)] + 4 = 105.612
Find prices two periods from the end. Time 1 values are the average of Time 2 dis- counted plus the coupon payment.
0.5 × [(103.522/1.0360) + (104.726/1.0360)] + 4 = 104.506
0.5 × [(104.726/1.0260) + (105.612/1.0260)] + 4 = 106.504
Find prices at Time 0. There is no coupon paid in this node.
0.5 × [(104.506/1.029) + (106.504/1.029)] = 102.532
because the discount rate used is an average across time.
because the calculation omits the 4 coupon in the last period.
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