Corporate Issuers Volume 3 CFA Institute - Solutions

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Discuss key risks, opportunities, and questions regarding DiaSera’s business model.
Discuss key risks, opportunities, and questions regarding the HealthyPet business model.
Complete the table of business model features for DiaSera.Customers Products Channels Pricing strategy
Complete the grid of business model features for HealthyPet.Customers Products Channels Pricing strategy
The sequence of processes involved in the creation of a product, both within and external to a firm, including all the steps involved in producing a physical product and delivering it to the end customer, regardless of whether those steps are performed by a single firm, is referred to as the:A.
Explain why there might be so many fewer OTA companies than hotel companies.
Describe the differences in features between the hotel business model and the home-sharing business model.
Given an increase in the price of raw materials/commodities, what is the difference in revenue/profit impact for producers versus manufacturers versus distributors and retailers?
What most likely would distinguish Bynta from Ocean Hill Inc.?
What attributes of a conventional retail business model will Bynta and Ocean Hill Inc. likely share?
An analyst sits down for a meeting with the management team of Luggo Corporation, who is describing their business. The CEO makes the following statement:Luggo makes premium parts to secure wheels onto cars and trucks. We differentiate ourselves from our competitors by using premium designs and
Which company will most likely:a. be larger?b. have higher prices?c. have higher costs?
Why might the risks of increases in material costs be lower for Carbondash than for Winston Bikes?
Why might the risks of supplier disruption be lower for Winston Bikes than for Carbondash?
If a sudden change in market demand happens, which company will be better able to handle it?
____________ involves user communities that enable voluntary collaboration between users of a product with generally a small amount of moderation and oversight by the community host or operator.A. Franchising B. Crowdsourcing C. A loyalty program
____________ refers to the increase in the value of a network to its users as more users join.A. “Value chain”B. “Network effects”C. “Value proposition”
Two examples of pricing models for complex products are ____________, which refers to incentivizing or requiring the purchase of multiple products or services, and ____________, which combines a low price on an initial purchase of a durable good with high-margin prices on associated consumables.A.
Companies selling in markets with many competitors and little or no product differentiation are often ____________; in contrast, companies selling differentiated products with few competitors tend to have ____________.A. crowdsourcing; bundling B. price takers; pricing power C. omnichannel; direct
The objective of ________________ is to maximize profit in situations where different customers have different willingness or ability to pay.A. unit economics B. price discrimination C. functional separation
________________ refers to characterizing types of customers a firm may serve according to attributes such as geography, demographics, behavior, preferences, income, affinity for technology, and self-image.A. Channeling B. Segmenting C. Direct selling
A financial analyst is evaluating the capital structure for Plover, Inc., a European-based unleveraged firm with a constant (perpetual) cash flow of EUR10.0 million per year before taxes. The firm has a market value of EUR100.0 million and a corporate tax rate of 20%. Plover plans to issue EUR35.0
The level of debt that will maximize the value of Boulder Inc. is closest to:A. $15 million.B. $20 million.C. $30 million.
Including the present value of the cost of distress, the value of Boulder is closest to:A. $49 million.B. $55 million.C. $59.5 million.
The use of the $15 million of debt financing increases the value of Boulder by ____________ over its unlevered value. Ignore the costs of financial distress.A. $4.5 million B. $10.5 million C. $15 million
The WACC of the unleveraged firm, prior to the debt issue, is closest to:A. 4.00%.B. 9.33%.C. 13.33%.
True or False: The target capital structure should be estimated using the market value of equity and debt in calculating WACC.A. True B. False
The value-reducing impact of financial distress or bankruptcy increases if the firm has:A. higher business risk.B. lower operating and financial leverage.C. assets with a ready secondary market.
Match each of the following concepts on the left with a capital structure theory/hypothesis on the right:Concepts Capital Structure Theory/Hypothesis 1 Optimal capital structure A. Free cash flow hypothesis 2 Agency costs B. Pecking order theory 3 Asymmetric information C. Static trade-off theory
Company Z announces that a debt-to-equity ratio of 1.2 is consistent with its target capital structure. Given this value, the weight for equity in the WACC calculation is:A. 45%.B. 55%.C. 83%.
True or False: Under the pecking order theory, the firm has no optimal capital structure and a firm’s capital structure reflects its historic need for external financing.A. True B. False
Calculate the proportions of debt and equity for the WACC analysis if Gerhardt announces that a debt-to-equity ratio of 0.7 reflects its target capital structure.
Calculate the proportions of debt and equity for the WACC analysis using the capital structure of Gerhardt’s competitors.
Calculate the proportions of debt and equity for the WACC analysis using Gerhardt’s current capital structure.
If Company Y is an all-equity-financed firm, its cost of equity will be ________ its WACC.A. greater than B. equal to C. lower than
Fill in the blanks: The cost of equity for Company Y will be _____________ if it pays no corporate taxes and _____________ if it pays corporate taxes.
MM Proposition II without taxes differs from MM Proposition I without taxes since it concludes that:A. WACC is unaffected by capital structure.B. the value of the levered firm is equal to that of the unlevered firm.C. higher leverage raises the cost of equity, which exactly offsets the lower cost
True or False: What is clear from MM is that the primary driver of firm value is capital structure.A. True B. False
The view that debt financing is highly advantageous and the optimal capital structure is 100% debt is consistent with:A. MM without taxes.B. MM with taxes and financial distress costs.C. MM with taxes and no financial distress cost.
The business model used by Oldtech can best be described as:A. capital light.B. capital intensive.C. contractual rather than ownership relationships
Given the forecast of deteriorating business conditions, which company will experience a greater change in cash flow and profitability?A. Newtech B. No difference C. Oldtech
Newtech will likely finance activity by issuing:A. unsecured debt.B. equity through an IPO.C. equity sourced from founders and employees.
The cost of debt and equity is likely to be higher for a firm with A. stable revenue growth.B. high operating leverage.C. high interest coverage.
Match each of the following phases of the company life cycle with the debt type:Phase of company life cycle Likely debt type A. Startup i. Unsecured B. Growth ii. Convertible C. Mature iii. Secured
Which firm might investors require lower rates of return for on debt and equity? Explain your answer.
Calculate ROE and interest coverage for each firm if both experience a 25%decrease in operating income.
Calculate ROE and interest coverage for each firm if both experience a 25%increase in operating income.
Calculate profit, interest coverage, and ROE for each firm.
Which firm might debt investors be willing to extend credit to at a lower cost of debt? Explain your answer.
Calculate the ROE for each firm if both firms experience a 25% decrease in sales.
Calculate the return on equity (ROE) for each firm if both firms experience a 25% increase in sales.
Calculate profit (revenue – total costs) for each firm, and compare their returns on equity (profit/total equity).
Fill in the blanks using the following two terms:higher lower Shareholder value is increased by a ________________ return on investment and a capital structure that results in a ________________ WACC.
If the marginal corporate tax rate is 20% and the stock price increases to$25, the WACC for Company X is closest to:A. 7.60%.B. 8.26%.C. 8.55%.
In calculating WACC for Company X, the weight for debt using book values for the balance sheet components is likely to be ________________ than the weight for debt using market values for the balance sheet components.A. lower B. the same C. higher
True or False: Since the cost of debt and equity are controlled by the firm, managers can lower the cost of capital for the firm by reduce reducing the cost of debt and equity used in their capital allocation process.A. True B. False
XYZ corporation has a capital structure of 30% debt and 70% equity, and interest expense is tax deductible. Debt investors require a before-tax return of 6%, and equity investors’ required return is 12%. If the marginal corporate tax rate rises from 20% to 25%, the change in the WACC is closest
Assume that ABC Corporation is financed with 40% debt and 60%equity. Also assume that interest expense is tax deductible. ABC Corporation wishes to maintain these proportions as it raises new funds.ABC’s debt investors’ required rate of return, measured before taxes, is 4%, and its equity
Under Modigliani and Miller (MM), if one assumes no taxes and no financial distress cost, among other assumptions, the value of the company is:A. determined by its capital structure.B. determined solely by its expected future cash flows.C. set so the value of levered company is greater than that of
The amount and type of financing needed or the weights in the WACC calculation depend on the issuer’s:A. business model.B. financial leverage.C. proportion of fixed cost to total costs.
True or False: Managers cannot precisely estimate the optimal capital structure, but they often establish a target capital structure. An issuer’s actual capital structure may differ from its target based on business and financial market conditions.A. True B. False
The optimal capital structure is determined where the benefit of the debt tax shield is offset by the cost of financial distress under the:A. pecking order theory.B. free cash flow hypothesis.C. static trade-off theory of capital structure.
Nutry, Inc., has a capital structure of 30% debt and 70% equity, and interest expense is tax deductible. Debt investors require a before-tax return of 5%,and equity investors’ required return is 10%. If the marginal corporate tax rate is 20%, the WACC is closest to:A. 5.9%.B. 8.2%.C. 8.5%.
In computing WACC, the cost of equity is higher than the cost of debt because the:A. cost of debt is set by management.B. distributions to shareholders are tax deductible.C. debt investors take less risk than equity investors.
Considering ABC management’s ROIC-based investment criterion and the IRR and NPV of both projects, Soroka should recommend to:A. reject both projects A and B.B. invest only in Project B because it has a higher NPV.C. invest only in Project A because has positive cash flow during all four years.
Based on ABC’s balance sheet presented in Exhibit 2, Soroka should calculate:A. average invested capital of $72,510 and ROIC of 9.50%.B. average invested capital of $80,720 and ROIC of 10.94%.C. average invested capital of $92,995 and ROIC of 9.50%.
The most likely impact from the cash-flow timing considered by Soroka is that:A. both IRR and NPV would decrease.B. both IRR and NPV stay unchanged.C. only IRR would decrease but NPV would increase.
With regard to Project A and Project B, which of the following is true?A. Both projects should be invested in according to the IRR decision rule.B. Both projects should be invested in according to the NPV decision rule.C. Only Project B should be invested in according to the IRR decision rule.
When preparing the cash-flow forecasts for both projects, Soroka should include:A. only the cost of the market research.B. only the loss of revenue from existing products.C. both the market research cost and the loss of revenue from existing products.
Company XYZ is considering expanding its distribution center in a foreign country. The local government is working on a new environmental regulation that introduces subsidies and tax breaks for investments related to renewable energy. Once the new law is approved, XYZ could upgrade the distribution
Which of the following statements about real options is true?A. Using option pricing models estimates an option’s value with the highest accuracy.B. Real options allow companies to abandon an investment project if its profitability is poor.C. Real options would allow a refinery to hedge future
Explain why some managers might reject projects that significantly increase shareholder value (i.e., have a high NPV).
Bradshaw, a financial analyst, prepares a forecast of future expected gross(pre-tax) cash flows for an investment project. Bradshaw also forecasts future depreciation related to that project and assumes a required rate of return 6%. Based on the information provided and a tax rate of 18%, calculate
An analyst is analyzing company XYZ and has gathered annual invested capital and ROIC for each of the three XYZ business segments.Segment Capital Expenditures ($ m) ROIC 20X0 20X1 20X2 20X0 20X1 20X2 A 264 282 303 7.50% 7.10% 6.80%B 297 318 340 10.00% 8.90% 7.10%C 211 226 242 6.90% 7.80% 9.00%Based
Alexandra Tolonen, an investment analyst, prepares forecasts for expansion of a car battery plant and wants to consider the effect of rising lithium carbonate prices. Tolonen adjusts future after-tax cashflows downward to remove the effects of an expected lithium carbonate price increase of 5%and
True or false: Investment projects funded using internally generated funds (e.g., cash flow from operations) should be evaluated using a lower required rate of return as compared to projects funded using debt or share issuance.
Explain why a government-owned company may have a low required rate of return compared to a small technology company.
Complete the sentences by filling in the blanks using the following terms.Note that each term can be used more than once.equity profit margin asset turnover long-term liabilities average invested capital ROIC can be increased by increasing ______ or ______. A high-______company can earn a low ROIC
A company is considering undertaking a new capital investment project that is expected to cost $33 million. The after-tax cash-flow projection for the next four years is shown below. Calculate NPV and IRR assuming a required rate of return of 7.5%.Year 1 2 3 4 Cash flow 0 16 24 7
Which of the following relationships is true?A. If IRR > Required rate of return, then NPV < 0.B. If IRR = Required rate of return, then NPV = 0.C. Required rate of return = Risk-free rate.
Which step in the capital allocation process most likely involves the calculation of NPV and IRR?A. Idea generation B. Investment analysis C. Planning and prioritization
True or false. During the planning and prioritization step in the capital allocation process, a firm’s management should accept any investment project with an estimated positive NPV.
What type of capital allocation project will most likely be implemented even if it has a negative estimated NPV?A. New lines of business and other B. Expansion of existing business C. Regulatory or compliance
It is true that the capital allocation process:A. involves the use of significant proprietary, non-public information about a company.B. aims at identifying projects with the highest absolute non-risk-adjusted rate of returns.C. uses less information compared to the process used to construct
Explain what real options are and how they influence company value.
The annual report of company XYZ contains the following disclosures:Disclosure 1: “XYZ’s management compensation is based on exceeding a target EPS growth rate.”Disclosure 2: “XYZ’s management does not change the required rate of return when evaluating capital projects based on whether
Explain why capital allocation decisions should not be based on accounting measures such as earnings per share (EPS).
Complete the following sentences by filling in the blanks using the terms provided.When calculating ROIC, an independent analyst should add _________________ and _________________ to calculating average invested capital. ROIC, _________________ project NPV and IRR, can be calculated using data
When calculating IRR, the interim cash flows are assumed to be reinvested and earn a rate of return rate that is:A. lower than IRR.B. the same as IRR.C. higher than IRR.
The following list contains either an example or an attribute of a capital investment project. Assign each item to either maintenance or growth.Acquisition Expand business scope Research and development Replace outdated facilities High-risk investment and uncertainty Limited downside risk and
An issuer eliminated the prompt-payment discount it had offered to customers.This action most likely will:A. increase the issuer’s liquidity B. decrease the issuer’s liquidity.C. not affect the issuer’s liquidity
An analyst is evaluating an issuer’s liquidity and calculates a negative cash conversion cycle for the issuer in the most recent fiscal year. This result is:A. not feasible.B. possible, because the issuer has sufficient cash and marketable securities on hand to support short-term needs.C.
An analyst gathers balance sheet information for the most recent fiscal year for three issuers.Issuer A Issuer B Issuer C Cash 100 120 50 Marketable securities 20 10 20 Accounts receivable 300 300 200 Inventory 500 600 300 Prepaid expenses 50 0 10 Accounts payable 400 500 300 Accrued expenses 40 20
Which of the following will most likely decrease an issuer’s cash conversion cycle?An increase in its days:A. sales outstanding.B. of inventory on hand.C. payable outstanding.
An issuer changing its credit terms for customers from 2/10, net 30 to 2/10, net 40 will most likely experience:A. a pull on its liquidity.B. a drag on its liquidity.C. no change in its liquidity.
The Lucor Corporation is seeking to raise liquidity and is evaluating two potential actions.Option 1 Selling accounts receivable to a financial intermediary at a 5% discount off their carrying value Option 2 Accelerating payments to suppliers to receive a 5% discount Which of the options would
Changing its accounts receivable policy to extend credit to customers with lower creditworthiness will most likely result in:A. a pull on liquidity.B. a drag on liquidity.C. no effect on liquidity
The most likely effect of this change is:A. an increase in accounts receivable.B. no change in accounts receivable.C. a decrease in accounts receivable.
A company changed the credit terms it offers its customers from 1/10, net 30 to 1/15, net
A company has USD30 million of accounts payable, for which it could delay payment to day 14, forgoing the 2% discount it would receive for paying within ten days. The liquidation cost in millions of USD is closest to:A. 0.6.B. 6.1.C. 8.4.

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Corporate Issuers Volume 3 CFA Institute - Solutions

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