CFA® Exam: Level 2 Sample Questions

Agnes Fisher is a junior consultant at Finance Advisory Group (FAG). She graduated from Capital Investments and Corporate Financing Strategies Department at a prestigious university. Agnes passed the first level of the CFA examination last year and now she is preparing to sit for her level II exam.

FAG works for several big companies, both public and private. One of its clients is MedicPlus, one of the fastest growing companies providing medical services and distributing drugs.

MedicPlus seeks advice regarding two problems. First of all, the expansion of the company forces it to change their corporate governance in order to better regulate fiduciary responsibilities of its managers. The second matter is connected to the planned distribution of the company’s earnings to shareholders. This issue is a job for Fisher. She receives a list from her supervisor with tasks to do. The tasks involve the following:

1) MedicPlus hesitates whether to introduce a share repurchase program and pay out dividends. To make the proper decision, the management together with FAG has to take several issues into consideration. During the first meeting of Fisher’s team with the CEO of MedicPlus, Jeff Bluster, he says that one of his company’s aims is to increase its financial leverage. Fisher has to explain what consequences an increase in financial leverage may have on MedicPlus.

2) Jeff Bluster, CEO, is also interested in the reaction of the market to the information about the share repurchase program initiation. Fisher has to prepare an analysis interpreting the problem.

3) The CEO of MedicPlus would like to learn more about trends in dividend policies around the world. Agnes has to prepare a short summary. In her analysis, she plans to write that:
Statement 1: A greater percentage of European companies pay dividends compared to U.S. companies.
Statement 2: More and more companies in developed countries pay dividends.
Statement 3: More and more companies make stock repurchases (both in the continental Europe and the United States).

4) The management of MedicPlus considers different dividend policies. They would like to choose the policy which would result in dividends least likely dependent on the short-term volatility of earnings. Fisher’s role is to indicate the most suitable one.

5) One of the issues to consider is that MedicPlus operates in the split-rate tax system. The MedicPlus’s management wants to know what the effective tax rate on dividends would be. Fisher is given the following set of information:

net income before taxes = USD 210,000,000
payout ratio = 60%
personal tax rate = 25%
corporate tax rate allocated to retained earnings = 35%
corporate tax rate allocated to dividends = 25%

6) The management board also wants to know what the expected dividend coverage ratio based on the following forecast would be:
net income = USD 230,000,000
FCFF = USD 200,000,000
FCFE = USD 150,000,000
dividends = 138,000,000
share repurchases = USD 20,000,000

These tasks are just an introduction to Fisher’s work on the project. 

QUESTION 1

Which of the following statements best describes the consequence of increasing financial leverage?

• a. The required rate of return decreases.
• b. The weighted average cost of capital increases.
• c. The weighted average cost of capital decreases.

QUESTION 2

Share repurchase is most likely:

• a. a positive signal for investors because it is a sign that the company perceives its own stocks as a good investment.
• b. a negative signal for investors because it is a sign of the lack of profitable investment opportunities for the company.
• c. a neutral signal for investors because positive and negative aspects of the company purchasing its own stocks are balanced.

QUESTION 3

Which of the following dividend policies results in dividend payments least likely dependent on short-term volatility in earnings?

• a. Stable dividend policy
• b. Residual dividend policy
• c. Constant dividend payout ratio policy

QUESTION 4

The effective tax rate on dividends for MedicPlus is closest to:

• a. 43.75%.
• b. 48.75%.
• c. 50.00%.

QUESTION 5

Which of the following statements Fisher is to include in her report about trends in dividend policies is least likely correct?

• a. Statement 1
• b. Statement 2
• c. Statement 3

QUESTION 6

The dividend coverage ratio for MedicPlus would be closest to:

• a. 0.95.
• b. 1.46.
• c. 1.67.

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