# Thread: Free CFA Level 2 practice question bank for June 2011 exam

1. Dear Ashish,

Thanks for pointing out the mistake in Q14.
The correct answer will be \$38.025

This has happened because by mistake I took the retention ratio as 60% instead of 40%.

I will ask Daulat Guru admin to repost the correct option for the 2 questions.

We do a check on the solution, but due to time pressure we get some of the answer wrong, due to some typo or silly mistakes.
We are thankful to the forum members for highlighting these errors and helping us to improve the content.
Thanks a lot for the help.

Thanks
Ratan Gupta, FRM
Knowledge Varsity

Originally Posted by ashish24
Thank you for the explanation for Q12. However for Q13 none of the answers that I get as value per share match any of the choices listed.

The answer I get is \$38.02.

Please verify or explain as the case maybe.

2. @Ratan,

Thank you for the clarifications. We have made the required changes.

@Ashish
Thank you for pointing out the issues.

Regards,
Team DG

3. Q19 Ans: B

We need to find out the residual income and book values

Item-------------------------20X1--------------------20X2----------------20X3
Beginning BV-----------------------\$23.4------------------------\$25--------------------\$26.7094
EPS---------------------------------\$4---------------------------\$4.2735---------------\$4.5657
Dividend----------------------------\$2.4-------------------------\$2.5641---------------\$2.739
Ending Book Value-----------------\$25-------------------------\$1.7094---------------\$28.535
Equity Charge----------------------\$2.34-----------------------\$2.5-------------------\$2.671
Residual Income-------------------\$1.6------------------------\$1.7735---------------\$1.8947

Using the above table
R1 (Residual income in year 1) = 1.6
R2 (Residual income in year 2) = 1.7735
R3 (Residual income in year 3) = 1.8947
Terminal Value = \$37.0955 (from the previous problem)
Starting book value (B0) = \$23.4
Value = B0 + PV(R1) + PV(R2) + PV(R3) +PV(Terminal value)
Required rate of return = cost of equity = 10%
Use the cash flow function to find out the value
CF0 = 23.4; CF1 = 1.6; CF2 = 1.7735; CF3 = (1.8947+37.0955)
NPV = \$55.614

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Today's Question (Questions and answers provided by Knowledge Varsity)

Q20. It has been found out that Dharampur has capitalised many expenses like research and development cost which are general expenses. The capitalised expenses in total comes to \$0.1 per share. Which of the following adjustment Karan should do while valuing Dharampur?

A) Increase the EPS by \$0.1
B) Increase the book value by \$0.1
C) Decrease the EPS by \$0.1

4. The answer to Q. 20 according to me is A as capitalization of expenses leads to higher net income. C is not applicable therefore and B is wrong, in fact the book value decreases.

5. Q20 Ans C:

The capitalized expense should be treated in the balance sheet and hence the EPS should be decreased.

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Today's Question (Questions and answers provided by Knowledge Varsity)

Case Study

Vizag steel, a manufacturer of hot rolled bars and girders used in the construction industry is considering acquisition of Salem steel. Salem steel is also in the same industry segment as that of Vizag steel.

Varun Kharde, a CFA level 2 candidate and an employee of Vizag steel is analyzing Salem steel to come up with a fair acquisition price.

Varun through his level 2 study is aware of the various valuation approaches and he plans to use those approaches in his estimate of the fair acquisition price.

Salem steel, a debt free company has 50 million shares outstanding and is currently trading at a price of \$12 per share. Varun goes through the dynamics of the industry and financials of Salem steel. He project the cash flows of Salem steel and believes that the firm will be generating free cash flows of \$20 million, \$30 million and \$35 million in year 1, 2 and 3 respectively. After the 3rd year, he expects that the cash flow will grow at a constant rate of 7% per year till perpetuity. He concludes that the appropriate discount rate to value Salem Steel would be 12%. Using these inputs he value Salem steel.

To value the company using comparable approach, Varun identifies 3 firms, Bokaro Steel, Tara Steel and Bhillai Steel. Exhibit 1 has key variables for the four companies.

He believes that P/E, P/B and P/S ratios of the comparable companies can be used to estimate the Value of Salem Steel.

Varun, then goes and select from the recent transaction database, the transaction happening in the industry. He comes across the latest 3 transaction involving the purchase of Durgapur Steel, Rourkela Steel and Bellary Steel. The relevant information are shown Exhibit 2.

Varun estimate the value using all the 3 methods and prepare a presentation for the board meeting.

In the board meeting, looking at the valuation provided by Varun, the CEO of Vizag Steel, Mr. Murali Muthuswamy recommends that Vizag should acquire Salem steel. The CFO, Mr. Pravin Lal, recommends an all cash deal at \$13.5 per share which means that the valuation of Salem steel is \$675 million. Mr. Lal believes that there would be synergy and cost rationalization because of the acquisition, he believes the present value of such synergies to be \$100 million.

The current price and number of shares outstanding of Vizag steel is mentioned in Exhibit 3 (as given below).

Share Price - \$30
No of Shares - 100 million

One of the board members, Mr. Bhushan Sharma believes that rather than paying all cash, Vizag would be better off if the acquisition is done through a mixture of cash and equity. He does some calculation and says that Salem can be paid \$500 million in cash and can be allotted 1 share of Vizag for every 8 share of Salem Steel.

Another board member, Mr. Naval Lakhani is worried that the deal may not be passed by the regulator because the combined entity can become a dominant player. The board then goes through the market share of the companies in the sector.
There are total of 10 companies in the hot rolled segment. Vizag jointly leads the segment along with Bhuj Steel with 25% market share, the 3rd largest player has 15% market share. All other players each have 5% market share.

The board is evaluating the concentration using the Herfindahl Hirschman index (HHI) methodology.

Q21. Which of the following is most likely the value of Salem steel using the discounted cash flow approach?

A. \$599.8 million
B. \$815.68 million
C. \$564.93 million

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6. Hello all,

For Q 21 I get an answer of \$574.90 million
This is how I get my answer:

V = 20/1.12 + 30/(1.12)^2 + {[749+35*(1.07)]/0.12-0.07}/(1.12)^3
= \$599.8 million.

Therefore the correct answer is A.

7. Q21 Ans A:

First compute the terminal cash flow
Cash flow terminal = \$35 * (1.07) / (0.12-0.07) = \$749 million
CF1 = \$20 million, CF2 = \$30 million, CF3 = \$35 + \$749 = \$782 million
Plug the above in the cash flow function and calculate the NPV as \$599.8 million

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Today's Question (Questions and answers provided by Knowledge Varsity)

Q22. Which of the following is most likely the stock price of Salem Steel using the comparable company valuation approach?

A. \$13.5455
B. \$13.193
C. \$13.1244

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8. The answer according to my calculations is B or \$13.193.

9. Q22 Ans B:

Using the comparable approach, we need to come up with the P/E, P/S and P/B ratio of the comparables. Once we have these ratios we have to find out the average and then get the value of the Vizag share price for each of the multiples and finally take the average of the share prices.
Below is the calculation methodology
Item-----------------Bokaro-----------Tara-----------Bhillai----------Average
Stock Price---------------\$30------------------\$40---------------\$50
P/E-----------------------8.571-----------------8----------------7.1425------------ 7.9045
P/S-----------------------1.875----------------1.8182----------2.1739-------------1.9557
P/B------------------------1.667----------------2---------------2.381---------------2.016

Applying the average value obtained above on Salem’s financial

Item---------Average--------Salem Steel----------------Multiplied Value (for Salem)
P/E--------------7.9045-------------EPS---\$2---------------------------- \$15.81
P/S--------------1.9557------------Sales--\$7-----------------------------\$13.69
P/B--------------2.016---------Book Value---\$5--------------------------\$10.08
Average Value (for Salem)---------------------------------------------- \$13.193

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Today's Question (Questions and answers provided by Knowledge Varsity)

Q23. If we take into account the takeover premium paid, what could be the fair acquisition price per share of Salem Steel’s stock?

A. \$14.28
B. \$12
C. \$18.84

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10. For Q 14,

I am not sure, but I think the answer is B. Please provide a explanation if the correct response is otherwise.