Kostecka
Jacob Kostecka, CFA, is a portfolio manager at Forkson Investment Management, an asset
management and research focused organization. After obtaining his CFA charter last month,
Kostecka was transferred to the private wealth management division at Forkson.
Dharshi Bope, a private wealth client, was involved in a major motorcycle accident and is in
critical condition, fighting for his life. Bope is a single parent with a daughter, Paveen Nathoo, in
her mid-twenties. Since the accident, Nathoo has managed her father’s affairs, paying all
expenses, including investment advisory fees. In several conversations with Nathoo, Kostecka
highlighted Bope’s low risk tolerance and investment goal of capital preservation. Nathoo has
indicated her interest in managing the account more aggressively and possibly moving to
another management firm. Nathoo recently petitioned the court to appoint her full power of
attorney to legally manage Bope’s affairs. Prior to the court decision, Nathoo asks Kostecka to
invest her father’s account in the initial public offering (IPO) of Chatterbox, a highly sought after
social media company that has yet to generate a profit.
The following week, the court approves Nathoo’s request to act on behalf of her father. Going
through records in her father’s home, Nathoo discovers documents showing Bope embezzled
several million dollars from his employer, a real estate development company. Most of these
funds were placed directly into Bope’s personal account, for which Nathoo is now responsible.
Nathoo informs Kostecka about her discovery; however, Kostecka does not act on this
information, however, because it is a large account for Forkson.
Nathoo establishes a non-discretionary investment account at Forkson tied to her newly
established business. Shortly thereafter, Kostecka joins the board of Jabbertalk.com, a smaller
social media competitor to Chatterbox. Based on his knowledge of Chatterbox, Kostecka
believes the stock of Jabbertalk is a good investment, even though it is not yet profitable.
Buoyed by his faith in social media, Kostecka ultimately purchases shares of Jabbertalk’s IPO for
Nathoo’s account, as well as for all clients he currently manages. When Kostecka informs
Nathoo of the purchase, she expresses concern about her legal responsibilities and lack of
accounting knowledge in overseeing the account. Kostecka provides Nathoo a list of
recommended professionals he has worked with in the past, including attorneys and
accountants. When he was in college 10 years earlier, Kostecka was engaged to one of the
attorneys but broke off the relationship prior to their wedding, and one of the accountants was
Kostecka’s college roommate. Since then, Kostecka has not had any contact with the lawyer and
accountant.
The Jabbertalk investment is profitable on the first day of trading, doubling from its opening
price. Kostecka tells his clients the multifactor valuation model used by Forkson shows
Jabbertalk stock is still undervalued. Forkson’s research report, due out the next day, will
recommend investors hold their Jabbertalk shares. However, Kostecka tells all his clients
simultaneously they should sell their shares because he believes Jabbertalk is overvalued and
the stock price will fall soon. Kostecka notes he has followed through on this belief by selling his
personal holdings of Jabbertalk shares. Nathoo ignores Kostecka’s recommendation to sell
Jabbertalk. Over the next week, the stock declines 75%.
Watching Jabbertalk’s severe share price decline, Nathoo becomes furious with Kostecka
because he did not sell shares of Jabbertalk in her account. She files a complaint with Kostecka’s
supervisor, Sally Fang, CFA, claiming she was misled on the value of the IPO in the days
immediately after the stock started trading. Kostecka responds to the complaint by telling Fang,
“the analyst who wrote the hold recommendation on Jabbertalk has only passed his CFA Level II
examination. As a charterholder, I have earned the right to use the CFA designation, so I am
more qualified to manage clients’ investments.”
In order to build his client base, Kostecka prepares performance information to show
prospective clients. He includes the firm’s composite performance based on similar
discretionary client portfolios that are in compliance with the GIPS Standards. In addition,
Kostecka prepares his own composite performance, including all accounts he manages. This
presentation includes Nathoo’s account assuming she had sold her shares of Jabbertalk. Along
with his performance record, Kostecka provides a footnote disclosing the following language: “If
your account is managed on a discretionary basis, you might expect results similar to those
shown above.”
1.) With regard to the investment request made by Nathoo to invest in Chatterbox,
Kostecka should most likely:
A. seek advice from the court.
B. comply with her request.
C. follow Bope’s investment goals.
2.) By not acting on the information reported by Nathoo, which CFA Institute Standard of
Professional Conduct has Kostecka least likely violated?
A. Loyalty, Prudence, and Care
B. Duties to Employers
C. Knowledge of the Law
3.) With regard to investing in Jabbertalk and recommending experts, Kostecka most likely
needs to disclose conflicts related to his:
A. attorney relationship.
B. board membership.
C. accountant relationship.
4.) In relation to Kostecka’s handling of the Jabbertalk stock recommendation, which of the
following CFA Institute Standards of Professional Conduct did he least likely violate?
A. Fair Dealing
B. Communication with Clients
C. Priority of Transactions
5.) When Kostecka defends himself against Nathoo’s complaint, he most likely violated the
CFA Institute Code of Ethics and Standards of Professional Conduct concerning the:
A. misrepresentation of the meaning of the designation.
B. right to use the CFA designation.
C. reference to candidacy in the CFA Program.
6.) Kostecka’s performance presentation most likely conforms to the CFA Institute Standard
III (D) Performance Presentation with regard to:
A. composites representing similar discretionary investment portfolios.
B. fair and accurate representation of performance.
C. disclosure in the footnote.
KingFisher
The government of a developing country published a request for proposal (RFP) for the
development of policies to improve the business conduct of its capital markets licensees, with
the hope of improving confidence levels among investors.
Kingfisher Financial Development Partners responded with a detailed proposal including the
following justifications for why the firm should win the tender:
Justification 1:
Justification 2:
Justification 3:
With a team of three CFA charterholders, Kingfisher is more qualified than our
competitors to design policies to uphold and enhance capital market integrity.
Each team member must annually renew his or her commitment to abide by
the CFA Institute Code of Ethics and Standards of Professional Conduct (Code
and Standards).
In addition, every team member passed each level of the CFA exam on the
first attempt.
Kingfisher is later notified that it had won the tender. The Kingfisher team consists of team
leader Khalid Juma, CFA, and his two associates, Vimal Bachu, CFA, and Anila Patel, CFA.
Kingfisher and the government agree that the first step toward improving market integrity is to
create an industry-wide code of conduct based on the Code and Standards. Although the Code
and Standards are not intended to be adopted in full by the government, the decision is made to
concentrate on four main areas: professionalism, capital market integrity, duties to clients, and
investment recommendations.
The Kingfisher team subsequently drafts the following policy statements:
Levels of Professionalism
Financial services professionals must act in a professional manner at all times to help protect the
integrity of the country’s capital markets. As such, financial services professionals must ensure
that they meet at a minimum three major requirements. Professionals must (1) disclose all
conflicts of interest, (2) selectively differentiate services to clients, and (3) outline all manager
compensation arrangements for clients.
Capital Market Integrity
Financial services professionals must protect the integrity of the capital markets by ensuring
that any insider information obtained is managed in such a way as to prevent the investing
public from being disadvantaged. In addition, no financial services professional can knowingly
participate in any activity devised to mislead investors or distort any price-setting mechanism.
Duties to Clients
Clients’ interests must come before those of the financial services firm and/or its staff. To
ensure that clients’ interests are protected, all portfolios must be invested according to each
client’s investment plan and must be well diversified across all asset classes available.
Furthermore, fund managers must annually review client needs and objectives and rebalance
portfolios if required.
Investment Recommendations
All investment recommendations should be made after extensive research undertaken by or on
behalf of the firm. In addition, each research report must
Requirement 1:
Requirement 2:
Requirement 3:
be reviewed by peers as soon as practical to ensure adequate basis and due
diligence policies were followed,
be assessed to determine the quality of the recommendation over time, and
only include names of team members who took part in the research and
agreed with the recommendation.
The Kingfisher team and the government committee meet to agree on the draft code of
conduct. Members of the government committee suggest the following additional policy: “Each
financial services firm must have a compliance supervisor to ensure that
Task 1: systems are in place to detect violations of laws, rules, regulations, firm policies, and the
industry-wide code of conduct and to enforce investment-related compliance policies;
Task 2: the firm has adequate documented compliance policies and procedures and it trains all
personnel on the same and makes sure the policies and procedures are followed; and
Task 3: inadequate procedures are identified and recommendations to correct inadequate
procedures are submitted to senior management for approval and implementation.”
1.) Which of Kingfisher's statements in the RFP regarding its qualifications most likely
violates the CFA Institute Standards of Professional Conduct?
A. Justification 2.
B. Justification 3.
C. Justification 1.
2.) With regard to the proposed policy statement relating to Levels of Professionalism,
which draft requirement least likely reflects any of the CFA Institute Standards of
Professional Conduct?
A. Differentiation of services
B. Conflicts of interest
C. Compensation arrangements
3.) Do Kingfisher's proposed policy statements related to Capital Market Integrity most
likely violate any CFA Institute Standards of Professional Conduct?
A. Yes, with regard to material nonpublic information
B. No
C. Yes, with regard to market manipulation
4.) Which of Kingfisher's proposed requirements to ensure Duties to Clients is least
appropriate to prevent violations of CFA Institute Standards of Professional Conduct?
The requirement calling for a(n):
A. investment plan.
B. diversified portfolio.
C. periodic review.
5.) Which of Kingfisher's proposed requirements regarding investment recommendations is
most appropriate to prevent violations of Standard V(A): Diligence and Reasonable
Basis?
A. Requirement 2
B. Requirement 1
C. Requirement 3
6.) Which of the following tasks suggested by the government committee would least likely
conform to Standard IV(C): Responsibilities of Supervisors?
A. Task 1
B. Task 3
C. Task 2
National Plastics
National Plastics Corp. is a leading manufacturer of high-quality injection-molded plastic
packaging materials used by various industries, primarily food and beverage processing and
packaging firms. In late November 2012, the company received approval for two important
patent applications—one providing for improved tamper protection for plastic containers and
another for an improved biodegradable plastic film that allows for better food preservation.
On 4 January 2013, Haines Foods and Snacks, Inc., launched a hostile takeover bid for all of the
shares of National at $30 per share (a $5 premium in excess of the pre-bid price). Haines Foods
is a national distributor of deli and dairy products. If its bid is successful, it plans to continue to
operate National as a wholly owned subsidiary.
Zenith ThermoPlastics Inc. produces plastic containers and bags that are used by the food and
beverage industry. Keith Whelan, who is both chief executive officer and chief financial officer of
Zenith, had been in discussions with National to either purchase or license their newly patented
technologies. As a possible alternative, in view of the Haines bid, Whelan began to consider
having Zenith make its own takeover bid for National.
Whelan provided National’s most recent financial statements, shown in Exhibits 1, 2, and 3, to
one of his assistants, Mike Noth, with directions to calculate National’s free cash flow using the
discounted cash flow approach as a first step in determining the maximum value that Zenith
should be willing to pay for National’s shares.
Exhibit 1: National Plastics Corp. Selected Financial Data, for Year
Ending 31 December
($ millions)
Revenues
Cost of goods sold
Selling, general, and administrative expense
Earnings before interest, taxes, depreciation, and
amortization (EBITDA)
Depreciation expense
Operating income
Interest expense
Pretax income
Income tax (32%)
Net income
Share Information
Number of outstanding shares (millions)
2012 Earnings per share
2012 Dividends paid (millions)
2012 Dividends per share
2012
1,614
841
436
337
61
276
47
229
73
156
60
$2.60
$37
$0.62
Exhibit 2: National Plastics Corp. Consolidated Balance Sheets
as of 31 December
($ millions)
2012
2011
Cash and cash equivalents
8
5
Other current assets
315
295
Total current assets
323
300
Long-term assets, net
1,203
1,130
Total assets
1,526
1,430
Current liabilities
Long-term debt
Common stockholders’ equity
696
562
268
Total liabilities and stockholders’ equity 1,526
670
611
149
1,430
Exhibit 3: Other Financial Information
for National Plastics Corp. as of 31
December 2012
Effective tax rate
Cost of equity
Weighted average cost of
capital
32.00%
12.00%
9.00%
Noth soon returns and points out that the free cash flows from National will differ in future
years as a result of its new patents—he suggests that, just as Zenith wanted to license the
technology, other plastic firms would also be interested. Noth also suggests that because
National has a lower debt-to-equity ratio than the rest of the industry, it could support more
debt, so he has adjusted the weighted average cost of capital (WACC) accordingly. Noth’s
projected cash flows and other estimates are provided in Exhibit 4.
Exhibit 4: Estimates and Assumptions of Mike Noth Used in Valuing National
Plastics as of January 2013
($ millions except WACC)
2013
End-of-year
free cash 170
flow to firm
2014
2015
2016
Thereafter
165
180
195
Growth at 5% a year
WACC
Total debt immediately following acquisition
10.50%
650
After a discussion about the appropriate cash flow estimates and discount rates to use in
determining the value of National to Zenith, Whelan decides that Zenith should make a mixed
offer for all of National’s shares at $35 per share, consisting of $23 in cash and Zenith common
stock with an exchange ratio of 0.24. The details of the offer are in Exhibit 5.
Exhibit 5: Details of Zenith’s Planned Tender Offer for All of National
Plastics’ Common Shares
National Plastics
Pre-merger price
$25/share
Shares outstanding 60 million
Zenith ThermoPlastics
$50/share
100 million
Tender Offer
Zenith will pay $35 per share for National,
consisting of $23 in cash and Zenith common
shares with an exchange ratio of 0.24.
Post-merger
Following the merger, Zenith’s shares are
expected to be priced at $53/share.
Synergies from the
merger
Zenith believes that most of the synergies arising
from the merger will result from National’s new
patents.
Because National and Zenith are based in the United States, Whelan also decides to have Noth
calculate the pre- and post-acquisition Herfindahl-Hirschman Index (HHI) for the industry. Noth’s
HHI calculations are 1,910 pre-acquisition and 2,000 post-acquisition. Based on the HHI values,
Whelan concludes that (1) the industry is currently highly concentrated but (2) under applicable
US law, an increase in the HHI of less than 100 should not generate any governmental
challenges to block the acquisition of National.
When Whelan presents Zenith’s proposed takeover to the board of directors the following day,
one of the directors made the following statements:
1. Although I am certainly in favor of this takeover, I think we would achieve the greatest
value from the acquisition if we offered more stock and less cash.
2. If Zenith does not realize the potential synergies of this acquisition in the next five years,
I suggest a “spin-off” as a means to recover some of the money lost in this venture.
3. A positive initial market reaction will confirm that we did not overpay for Zenith.
1.) If Haines Foods is successful in its attempt to acquire National Plastics, the business
combination is best classified as which type of merger?
A. Horizontal, conglomerate
B. Vertical, backward
C. Vertical, forward
2.) National's free cash flow to the firm (FCFF) for 2012 is closest to (in millions):
A. $104.
B. $121.
C. $182.
FCFF = NI + NCC + Int(1 – Tax rate) – FCInv – WCInv
NI
+ Int(1 –
Tax
rate)
+ NCC
– FCInv
Net income
+ Net interest
after tax
+ Non-cash
charges
– Capital
expenditures
–
WCInvª
– Changes in net
working capitalª
FCFF
Free cash flow
to firm
156
47 × (1 – 0.32)
32
Depreciation expense
61
(1,203 − 1,130) + 61
– 134
(315ª – 696) – (295ª –
670) = –6
– (6)
=121
ªChange in net working capital excludes changes in cash and cash
equivalents.
3.) Based on Noth's assumptions in Exhibit 4, the most that Zenith should be willing to
pay per share of National is closest to:
A. $60.
B. $51.
C. $40.
4.) Based on Zenith's proposed tender offer and information in Exhibit 5, the synergy
arising from this merger is closest to (in millions):
A. $943.
B. $1,063.
C. $643.
5.) The most accurate interpretation of Whelan's conclusions concerning the pre- and
post-acquisition HHI is that they are:
A. both correct.
B. incorrect in regard to the increase in HHI necessary to trigger a governmental
challenge to the acquisition.
C. incorrect in regard to the industry being highly concentrated.
6.) Which of the statements made by the member of the Board of Directors is most
accurate?
A. Statement 3
B. Statement 1
C. Statement 2
Sagara
Sagara, a resource-abundant West African country, has a developing economy with low
capital per worker available. Although the majority of its population is impoverished, Sagara
has a long history of advanced education and is committed to technological progress.
President Benjamin Banantoumou recently appointed Fatima N'Diarra, PhD, as Economic
Development Secretary, and asks her to help him develop economic policies to promote
growth.
Last year, Banantoumou attended a summit of international leaders, where he learned that
developing countries typically face several factors that affect their growth prospects, such as
1 enforcement of substantive laws,
2 restrictions on imports, and
3 low rates of saving.
N'Diarra, who has studied the Cobb–Douglas production function, believes that Sagara's
primary goal should be to raise the growth rate of per capita GDP. Her two
recommendations, therefore, are to
1 increase capital, and
2 invest in technology to raise total factor productivity (TFP).
N'Diarra adds this conclusion:
"Because the Cobb–Douglas function exhibits constant returns to scale, as we approach the
steady state rate of growth, we should place greater emphasis on continuing to grow TFP in
order to avoid diminishing marginal returns on capital."
Banantoumou believes that the Sagara economy relies too heavily on the export of natural
rubber. He is convinced that significant industrial capital investment will persuade foreign
direct investors that he is serious about economic development. He announces that the
Sagara government will construct a large tire factory to take advantage of the country's
rubber resources. Banantoumou expects that as a result of this investment, per capita
productivity will rise rapidly driving rapid growth in GDP.
N'Diarra is not as optimistic. She warns Banantoumou that Sagara could fall prey to a
resource curse known as the Dutch disease. As demand from the tire factory drives up the
price of rubber, capital flows out of the country and the local currency could depreciate
rapidly. This situation can be prevented if foreign investors are allowed to own rubber
plantations directly rather than just having access through international markets.
N'Diarra believes that according to the classical growth theory, gains in per capita GDP are
temporary because the resulting population explosion will lower per capita GDP to
subsistence real wage levels. She considers endogenous growth theory to be more realistic,
believing that (1) investments, such as the new tire factory, will increase the rate of per
capita output growth until the steady state rate of growth is achieved; and (2) investment in
research and development will boost growth even further, thus extending the abnormal
growth period before diminishing marginal returns eventually set in.
In the years after the tire factory begins production, Sagara's GDP is expected to grow at a
rate exceeding 10% annually, the per capita GDP will increase commensurately, and the
country's literacy rate will double. Manufacturing is likely to grow by 15% annually. But this
rapid growth will also bring concerns regarding regulation of the manufacturing sector. The
government has at times struggled to advance the regulatory structure to address problems
associated with the impact of rapid growth on such problems as pollution, power outages,
and water shortages. Banantoumou is worried that companies have learned to preemptively
cooperate with their regulators with the expectation that the regulators will favor their
point of view over a competitor's.
As the local financial markets evolve, N'Diarra recommends that she and Banantoumou
study and discuss the legal and regulatory structure of the United States to generate ideas
that they can implement in Sagara. During their discussion, N'Diarra remarks, "In the United
States, self-regulated organizations can become independent regulators empowered by a
government agency to enforce laws. The US government usually provides this type of
regulator with funding."
1.) Of the factors cited by Banantoumou after the international leaders summit, which
is least likely to limit sustainable growth?
A. Factor 1
B. Factor 3
C. Factor 2
2.) In reference to the Cobb–Douglas function, N'Diarra's conclusion is best described
as:
A. incorrect because the Cobb–Douglas function does not exhibit constant returns
to scale.
B. incorrect because increased TFP is not subject to the law of diminishing returns.
C. correct.
3.) N'Diarra's warning regarding the resource curse and its prevention is most likely
incorrect with respect to:
A. her comments about both currency depreciation and direct ownership of rubber
plantations.
B. her comment about currency depreciation.
C. her comment about owning rubber plantations directly.
4.) N'Diarra's understanding of the two growth theories is most accurate with regard
to:
A. endogenous growth theory.
B. both classical growth theory and endogenous growth theory.
C. classical growth theory.
5.) Banantoumou's concern regarding the regulatory structure is most likely an example
of regulatory:
A. arbitrage.
B. capture.
C. competition.
6.) N'Diarra's remark about self-regulated organizations (SROs) is best described as:
A. correct.
B. incorrect because SROs do not enforce laws.
C. incorrect because the US government does not fund independent regulators.
Treadway
Hannah Treadway is an analyst at Knight Investment Management. Knight holds Cooper
Creek Cable Limited (CCCL) as part of its Australian and Far East investment portfolio. CCCL
is a diversified cable and communications company operating in Western Australia. The
company consists of three divisions:
Cable: Provides subscription television services and high speed internet to
residential customers.
Media: Owns and operates a group of radio stations and publishes several
magazines.
Wireless: Offers wireless voice and data communications services.
Treadway is just starting her annual review of the company based on its most recent
financial statements, excerpts of which are shown in Exhibits 1 and 2. The financial
statements for CCCL are prepared in accordance with Australian Accounting Standards
(AASB) which comply with International Financial Reporting Standards (IFRS). All figures are
in Australian dollars.
Exhibit 1: Cooper Creek Cable Limited Statement of Earnings, For Years Ending 31 December
(A$ thousands)
2013
2012
Revenue
711,200
674,600
Programming and communication expenses
312,900
317,000
Gross margin
398,300
357,600
Depreciation expense
98,750
78,650
Amortization of intangibles
7,250
8,150
Reversal of impairment loss
-12,500
0
Gain (loss) on sale of assets held for sale
-14,400
0
Operating costs
185,900
173,000
Interest expense
64,100
65,900
Income from investments in associates
1,200
850
Profit before tax
70,400
32,750
Tax benefit (expense)
17,600
-8,187
Net profit for the year
88,000
24,563
Exhibit 2: Cooper Creek Cable Limited Balance Sheet, As of 31 December
(A$ thousands)
2013
2012
Cash
95,600
74,400
Accounts receivable, net
35,700
33,500
Assets held for sale
______0
23,500
Total current assets
131,300
131,400
Investments in associates
42,700
42,300
Capital assets, net
221,800
241,200
Intangible assets, net
Goodwill
Deferred tax assets
Total assets
43,250
11,000
185,500
635,550
24,500
6,500
169,900
615,800
Trade payables
Interest bearing loans
Short-term unearned revenue
Other liabilities
Total current liabilities
Interest bearing debt
Long-term unearned revenue
Total liabilities
92,100
49,700
12,500
23,800
178,100
703,800
6,500
888,400
104,200
0
21,250
23,000
148,450
814,300
13,500
976,250
Issued capital
Accumulated losses
Total equity
Total liabilities and equity
556,400
-809,250
-252,850
635,550
536,800
-897,250
-360,450
615,800
CCCL sustained substantial losses in its start-up period (1998–2002), from which it is still
benefiting for tax purposes, but it has been profitable since 2002 and reported a record
profit after tax in 2013. But Treadway is wondering if CCCL’s revenues in general are
supported by cash flows and if the company might be trying to increase the appearance of
profitability in order to increase the share price, which remains low.
The wireless division was acquired by CCCL in a share purchase in late 2012. Treadway
wants to review the accounting policies CCCL has adopted for both revenue and expenses
incurred on long-term wireless contracts. Excerpts of the accounting policies are shown in
Exhibit 3.
Exhibit 3: Excerpts of Accounting Policy Notes
(all figures A$ thousands)
Note 1 d) Long-Term Wireless Contracts
Customers who enter into long-term service contracts for wireless services can obtain their
handsets for a nominal amount. Commencing in 2013 the discount offered on the handsets,
relative to the regular price, is capitalized as a customer acquisition cost and straight-line
amortized over the life of the contract, or a minimum of three years.
Note 1 g) Unearned Revenue
Unearned revenue for subscriptions, or for services paid in advance, was historically
recognized on a straight-line basis over the term of the contract or subscription. After
reviewing the historical pattern of usage and cancellations for service contracts in 2013, the
pattern of recognition was changed to recognize the majority of the revenues in the first 12
months after the service contract is signed and the remainder in the year following.
Note 12) Broadcast Licenses
During 2013, the company successfully disposed of broadcast licenses that were held for
sale for $37,900 (net book value of $23,500). Based on the successful completion of that
sale, the impairment losses taken in 2011 on other licenses have been reversed, restoring
those intangible assets to their amortized historical cost.
After reading the note about the rapid reversal of the impairment loss related to the
broadcast licenses (Exhibit 3, Note 12), Treadway strongly believes that it arose as an
attempt by management to manage earnings. She realizes that both her 2011 and 2012
analyses were affected by these actions and now need to be reconsidered.
Finally, Treadway noted that during 2013, CCCL acquired 100% of MusicMusic (MM), a
specialty cable music channel. At the time of the acquisition the company disclosed the
following information:
The company has assigned the following values to the two intangibles (the MusicMusic brand
name and its associated broadcast licenses) that arise from this acquisition:
MusicMusic brand name
Broadcast licenses
A$2,000 (A$ thousands)
A$5,500 (A$ thousands)
1.) The cash collected from customers in 2013 is closest to (A$ thousands):
A. $700,250.
B. $709,000.
C. $693,250.
2.) The cash received from CCCL's investments in associates in 2013 is closest to (A$
thousands):
A. $800.
B. $1,200.
C. $400.
3.) The change in which of the following items is most likely an indication that CCCL
might be recognizing revenue early?
A. Deferred tax assets
B. Days sales in receivables
C. Unearned revenue
4.) The new accounting policy adopted in 2013 for the customer acquisition cost (Note
1d) most likely increases CCCL's:
A. cash from operations.
B. debt-to-asset ratio.
C. quality of earnings.
5.) If Treadway's belief about management's motivation behind the 2011 treatment of
the broadcast licenses is correct, compared with the economic reality in 2012, her
original 2012 analysis would most likely have:
A. overstated net profit margin.
B. understated return on assets.
C. understated fixed asset turnover.
6.) The amount of customer acquisition costs, Exhibit 3, Note 1d, capitalized during
2013 is closest to (A$ thousands):
A. $18,500.
B. $6,000.
C. $13,500.
Ready Power
Ready Power Inc. is a manufacturer of high-quality industrial electric generators. Although
many companies have been negatively affected by the continued global economic
weakness, Ready Power has experienced strong demand for its products, largely as a result
of several recent natural disasters and many occurrences of rolling brownouts and blackouts
arising from excessive strains on power grids. Although this strong demand has resulted in
higher inventory costs in recent years, the company has been able to pass the cost on to
customers through higher prices. The company’s generators have expected useful lives of
about 25 years. The company also normally depreciates its assets on a straight-line basis.
Margo Lenz, CFA, an equity analyst at Livermore Investment Council, is reviewing Ready
Power’s recent financial statements, which are prepared according to US GAAP.
Exhibits 1 and 2 contain selected portions of the company’s statement of operations and
statement of financial position, and Exhibit 3 contains selected notes from the company’s
2013 financial statements.
Exhibit 1: Ready Power Consolidated Results of Operations
($ millions)
For the Year Ending 31 December
2013
2012
Sales
Cost of goods sold
Gross profit
24,910
17,729
7,181
21,803
15,935
5,868
Net profit
2,122
1,712
Exhibit 2: Ready Power Consolidated Financial Position
($ millions)
As of 31 December
2013
2012
Cash
318
665
Receivables
8,983
8,381
Inventories
3,811
3,134
Other current assets
744
1,441
Current assets
13,856
13,621
Net property, plant, and equipment
5,311
4,794
Other assets
11,360
9,826
Total assets
30,527
28,241
Exhibit 3: Ready Power Selected Notes to Consolidated Financial Statements
Note 1. Operations and Summary of Significant Accounting Policies
D. Inventories
Inventories are stated at the lower of cost or market, with cost determined using
the last in, first out (LIFO) method.
($ millions)
2013
2012
LIFO reserve
1,442
1,407
No LIFO liquidation occurred during 2012 and 2013.
F. Depreciation and amortization
Depreciation of plant and equipment is computed using the straight-line
depreciation method.
($ millions)
2013
2012
Consolidated
depreciation expense
332
235
J. Income taxes: The company’s effective tax rate has always been 29%.
Note 10. Property, plant, and equipment (PP&E)
31-Dec
($ millions)
Land
2013
110
2012
92
Plant and equipment
10,257
9,426
Total plant and
equipment
10,367
9,518
Less accumulated
depreciation
–5,056
–4,724
Net PP&E
5,311
4,794
Harold Mays, one of Lenz’s assistants, made the following comments about Ready Power’s
inventory policy:
1. One of the advantages of using LIFO is that it simplifies the accounting process
for inventory because it gives the same results for inventory and cost of goods sold
whether the company uses a periodic or perpetual inventory system.
2. Another advantage of using LIFO is that it appears to improve the company’s
cash conversion cycle.
3. One disadvantage with LIFO, however, is that it is more likely that the company
will incur inventory write-downs than under the first in, first out (FIFO) method
Lenz mentioned to Mays that earlier that day, she had seen Bill Jacobs, the CEO of Ready
Power, in an exclusive interview on a cable news network specializing in financial news and
information. Lenz was particularly interested in the portion of the interview dealing with the
company’s new program to lease electrical generators. An excerpt from a transcript of the
interview is shown in Exhibit 4.
Exhibit 4: Excerpt from an Interview of Bill Jacobs on Cable TV, 4 March 2014
Jacobs: The firm is meeting the growing demand for our electrical generators and will be
introducing a leasing program to further consolidate our lead in this area. We anticipate that
about 80% of the leases we grant will have a term of 20 years or more, with the remainder
having shorter terms of around 5 years.
After reading the excerpt from the interview, Mays wondered what impact the company’s
new position as a lessor and its classification of leases would have on the company’s future
financial statements. Finally, he comments:
1. For a given leased asset, in the initial year of the lease, Ready Power’s profits
should be higher if the company classifies the lease as an operating lease.
2. Regardless of how the company classifies a lease, its total cash flow and
operating cash flow over the lease term will be the same.
3. The leasing program will decrease Ready Power’s liquidity position.
1.) If Ready Power had used the FIFO method to account for its inventory, its cost of
goods sold (COGS) in 2013 would have been closest to (in millions):
A. $17,694.
B. $16,287.
C. $17,764.
D.
2.) If Ready Power had been using FIFO accounting since incorporation, its retained
earnings at the end of 2013 would most likely be higher by (in millions):
A. $1,024.
B. $2,927.
C. $1,442.
3.) The statement in Note 1.D of Exhibit 3 concerning LIFO liquidations most likely
means that for the stated period:
A. there were no inventory write-downs in either of the two years.
B. units manufactured (or purchased) equaled or exceeded unit sales for each
year.
C. costs and prices must have been rising throughout.
4.) With regard to Mays' comments about the LIFO method, which of his statements is
most accurate?
A. Statement 3
B. Statement 1
C. Statement 2
D.
5.) In 2013, the estimated remaining life (in years) of the company's asset base is
closest to:
A. 15.7.
B. 16.0.
C. 15.2.
6.) Which of May's statements about the new leasing program is most accurate?
A. Statement 1
B. Statement 2
C. Statement 3
Moyle
Bridget Moyle is a senior associate in the risk management division of ANM Financial
Advisers (ANMFA). Moyle specializes in the use of derivatives to help ANMFA manage its
various risk exposures. Moyle is meeting with two recently hired analysts, Jordan Petsas and
Katy Iacocca. Petsas and Iacocca have been asked to prepare for a discussion on the
fundamentals of futures, options, and swaps.
Moyle asks, “Is it true that the futures price on an asset must equal the spot price of the
asset on the expiration date of the futures contract? Explain why or why not.”
Petsas responds,
At expiration, futures prices and spot prices must converge. If the spot price exceeds
the futures price, then an investor could purchase the futures contract and execute
the contract to purchase the underlying at the lower futures price, sell it at the
higher spot price, and make an arbitrage profit. If the spot price is less than the
futures price at expiration, then an investor could purchase the asset at the spot
price and enter into a short futures contract to sell it at the higher price, thus
locking in a profit.
Moyle provides Petsas and Iacocca with the following information for a Treasury bond and
asks them to calculate the price of a futures contract on this bond. The bond has a face
value of $100,000, pays a 7% semiannual coupon, and matures in 15 years. The bond is
priced at $156,000 and yields 2.5%. The futures contract expires in eight months, and the
annualized risk-free rate is 1.5%. There are multiple deliverable bonds, and the conversion
factor for this bond is 1.098.
The next item on the agenda is a discussion of option valuation models. Moyle states, “We
are currently considering the purchase of put options on shares of the Rousseff Corporation.
Selected information is provided in Exhibit 1.
Exhibit 1: Selected Stock and Options Data for Rousseff Corporation and the Risk-Free
Interest Rate
Exercise price
Days to expiration (two 30-day periods)
Current stock price
Up move on stock (per 30-day period)
Down move on stock (per 30-day period)
30-day risk-free interest rate
$590
60
$609.90
12%
4%
0.25%
Iacocca responds, “In general, we could value the option using either the Black–Scholes–
Merton model or the binomial option pricing model. But there is not enough information
presented to use the Black–Scholes–Merton model.”
“That is correct,” states Moyle, and continues, “With respect to the Black–Scholes–Merton
model, can you explain how the risk-free rate, time to expiration, and volatility affect
European option prices?”
In answer to Moyle’s question, Iacocca states, “Higher risk-free rates result in lower call and
put option prices. Longer times to expiration result in higher call prices, but the impact on
put prices is unclear. Higher volatility results in higher call and put option prices.”
The group turns its attention to swaps. Moyle states, “As you all know, a plain vanilla
interest rate swap allows the buyer of the swap to make a fixed payment and receive a
variable payment. Can you explain how these interest rate swaps can be described as being
equivalent to a combination of other assets?”
Petsas responds, “An interest rate swap can be viewed as a series of forward rate
agreements (FRAs) priced at the swap fixed rate or as a combination of a purchase of an
interest rate call option and the purchase of an interest rate put option.”
Finally, Moyle presents the term structure of Libor spot rates in Exhibit 2 and asks Iacocca
and Petsas to use this information to calculate the annualized swap fixed rate on a one-year
interest rate swap with quarterly payments, for which the underlying is 90-day Libor.
Exhibit 2: Current Libor Term Structure of
Spot Rates
Days
Rate (%)
90
3.13
180
3.41
270
3.73
360
4.12
1.) Is Petsas' response to Moyle regarding futures and spot prices most likely correct?
A. No, the explanation of when the spot price exceeds the futures price is incorrect
B. Yes
C. No, the explanation of when the spot price is less than the futures price is
incorrect
2.) Based on the information provided by Moyle, the futures price on the Treasury
bond is closest to:
A. $140,298.
B. $154,047.
C. $143,494.
3.) Based on the information in Exhibit 1, the price of the put option using the twoperiod binomial option pricing model is closest to:
A. $9.31.
B. $14.98.
C. $1.96.
4.) With respect to Moyle's question about the impact of selected inputs on the price of
options, Iacocca is least likely correct about:
A. volatility.
B. time to expiration.
C. the risk-free rate.
5.) Is Petsas' response to Moyle regarding an interest rate swap most likely correct?
A. No, he is incorrect about the combination of calls and puts
B. No, he is incorrect about the pricing of FRAs
C. Yes
6.) Based on the information in Exhibit 2, the annualized fixed rate on the swap is
closest to:
A. 3.60%.
B. 4.04%.
C. 4.12%.
Metev
Rila Rakia & Beer Ltd. (RRBL), a small privately owned company, produces high quality rakia
(a high-potency hard liquor), vino (wine), and bira (beer) in Bulgaria. After Bulgaria joined
the European Union in 2007, international demand for the country’s liquor, wine, and beer
increased substantially. Most firms in the industry, including RRBL, have been reporting
double-digit sales growth on a year-over-year basis.
Metiu Metev, a portfolio strategist at a major German investment consulting firm, inherited
RRBL from his grandparents. Frankfurter Destillerie & LiqueurFabrik (FDLF), a German
distillery interested in entering the Bulgarian market, has made a cash offer of BGN900
million for the company’s equity (BGN = Bulgarian Lev; EUR1 = BGN1.95586, pegged rate).
FDLF will assume RRBL’s entire outstanding debt, including both current liabilities and longterm debt. If Metev does not want to sell a controlling interest, FDLF’s minimum equity
stake will be 40%, with an appropriate discount for lack of control.
Metev starts by evaluating the company himself using the capitalized cash flow method
(CCM) and taking the following steps:
·
Using the build-up method to estimate the required rate of return on equity