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Web Problems
CHAPTER 9

1. CFA Examination Level II
CFA
®
The arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) have received much
attention from practitioners and academicians for use in asset pricing and valuation.
a. Explain the difference between APT and the CAPM with respect to:
(1) investor utility functions
(2) distribution of returns
(3) the market portfolio
b. Explain one conceptual difference between the APT and the CAPM other than those listed in Part a.
2. Describe the three risk factors specified by the Fama and French multifactor model. How do these
factors differ from those used in macroeconomic-based approaches to risk factor development such
as that used by Chen, Roll, and Ross?
3. CFA Examination Level III
CFA
®
Multifactor models of security returns have received increased attention. The arbitrage pricing the-
ory (APT) probably has drawn the most attention and has been proposed as a replacement for the
capital asset pricing model (CAPM).
a. Briefly explain the primary differences between the APT and the CAPM.
b. Identify the four systematic factors suggested by Roll and Ross that determine an asset™s riskiness.
Explain how these factors affect an asset™s expected rate of return.


CHAPTER 10

1. CFA Examination Level II
CFA
®
Patricia Bouvier, CFA, is an analyst following Telluride. In reviewing Telluride™s 1999 annual re-
port, Bouvier discovers the following footnotes:
Footnote (1) During the fourth quarter of 1999, Telluride changed its accounting policy from ex-
pensing to capitalizing software expenditures. The amount capitalized in 1999 was $15 million,
including $12 million that had been expensed during the first three quarters of the year.
Footnote (2) On December 31, 1999, Telluride established a restructuring charge of $20 million of
which $8 million was for severance pay for workers who would be terminated in the year 2000
and $12 million was for the write down of assets on December 31, 1999.
Footnote (3) Telluride leases assets under an operating lease that expired on December 31, 1999.
The lease renewal terms required Telluride to capitalize the lease, which has a present value of
$50 million. The amount of the monthly lease payment does not change.
Indicate, for each of the three footnotes, the effect of the adjustments on the financial ratios shown
in the following template for:
i. the year 1999
ii. the year 2000 compared to adjusted 1999
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2 Web Problems



Note: Assume all financial information remains unchanged from 1999 through 2000, except that refer-
enced in the footnotes above.
Answer this question using the following template. (18 minutes)


TEMPLATE FOR QUESTION 1
Effect on 1999 Effect on 2000 Ratio Compared to
Ratio Ratio (circle one) Adjusted 1999 Ratio (circle one)
Footnote (1)

Operating Cash Flow/Sales Increase Increase
Decrease Decrease
No Effect No Effect
Net Income/Sales Increase Increase
Decrease Decrease
No Effect No Effect
Sales/Net Fixed Assets Increase Increase
Decrease Decrease
No Effect No Effect

Footnote (2)

Operating Cash Flow/Sales Increase Increase
Decrease Decrease
No Effect No Effect
Net Income/Sales Increase Increase
Decrease Decrease
No Effect No Effect
Sales/Net Fixed Assets Increase Increase
Decrease Decrease
No Effect No Effect

Footnote (3)

Operating Cash Flow/Sales Increase Increase
Decrease Decrease
No Effect No Effect
Net Income/Sales Increase Increase
Decrease Decrease
No Effect No Effect
Sales/Net Fixed Assets Increase Increase
Decrease Decrease
No Effect No Effect



2. CFA Examination Level II
CFA
®
Candidates should use Exhibits 10.1, 10.2, and 10.3 to answer Question 2.
One of the companies that Jones is researching is Mackinac Inc., a U.S.-based manufacturing
company. Mackinac has released its June 2001 financial statements, which are shown in Exhibits
10.1, 10.2, and 10.3.
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3
Chapter 10




Exhibit 10.1 Mackinac Inc. Annual Income Statement for the Year Ended June 30, 2001
(In Thousands, Except Per-Share Data)


Sales $250,000
Cost of Goods Sold 125,000
Gross Operating Profit $125,000
Selling, General, and Administrative Expenses 50,000
Earnings Before Interest, Taxes, Depreciation,
and Amortization (EBITDA) $ 75,000
Depreciation and Amortization 10,500
Earnings Before Interest and Taxes (EBIT) $ 64,500
Interest Expense 11,000
Pretax Income $ 53,500
Income Taxes 16,050
Net Income $ 37,450
Shares Outstanding 13,000
Earnings Per Share (EPS) $ 2.88




Exhibit 10.2 Mackinac Inc. Balance Sheet as of June 30, 2001 (In Thousands)


Current Assets:
Cash and Equivalents $ 20,000
Receivables 40,000
Inventories 29,000
Other Current Assets 23,000
Total Current Assets $112,000

Noncurrent Assets:
Property, Plant, and Equipment $145,000
Less: Accumulated Depreciation (43,000)
Net Property, Plant, and Equipment $102,000
Investments 70,000
Other Noncurrent Assets 36,000
Total Noncurrent Assets $208,000
Total Assets $320,000

Current Liabilities:
Accounts Payable $ 41,000
Short-Term Debt 12,000
Other Current Liabilities 17,000
Total Current Liabilities $ 70,000

Continued
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4 Web Problems




Exhibit 10.2 Mackinac Inc. Balance Sheet as of June 30, 2001 (In Thousands)
(continued)


Noncurrent Liabilities:
Long-Term Debt $100,000
Total Noncurrent Liabilities $100,000
Total Liabilities $170,000

Shareholders™ Equity:
Common Equity $ 40,000
Retained Earnings 110,000
Total Equity $150,000
Total Liabilities and Equity $320,000




Exhibit 10.3 Mackinac Inc. Cash Flow Statement for the Year Ended June 30, 2001
(In Thousands)


Cash Flow from Operating Activities:
Net Income $ 37,450
Depreciation and Amortization 10,500
Change in Working Capital:
(Increase) Decrease in Receivables ($ 5,000)
(Increase) Decrease in Inventories (8,000)
Increase (Decrease) in Payables 6,000
Increase (Decrease) in Other Current Liabilities 1,500
Net Change in Working Capital ($ 5,500)
Net Cash from Operating Activities $42,450
Cash Flow from Investing Activities:
Purchase of Property, Plant, and Equipment ($15,000)
Net Cash from Investing Activities ($15,000)

Cash Flow from Financing Activities:
Change in Debt Outstanding $ 4,000
Payment of Cash Dividends (22,470)
Net Cash from Financing Activities ($18,470)
Net Change in Cash and Cash Equivalents $ 8,980
Cash at Beginning of Period 11,020
Cash at End of Period $20,000




Jones is particularly interested in Mackinac™s sustainable growth and sources of return.
a. Calculate Mackinac™s sustainable growth rate. Show your calculations.
Note: Use June 30, 2001, year-end balance sheet data rather than averages in ratio calculations.
(4 minutes)
b. Name each of the five components in the extended DuPont System and calculate a value for each
component for Mackinac.
Note: Use June 30, 2001, year-end balance sheet data rather than averages in ratio calculations.
(10 minutes)
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5
Chapter 13




CHAPTER 13

1. CFA Examination Level II
CFA
®
Scott Kelly, a U.S.-based equity analyst, is analyzing the toy industry to determine which companies
will be most competitive. He has determined that the U.S. toy industry is relatively mature and that
revenue and earnings growth are slowing. His report contains the following statements:
• I recommend that we invest in toy companies with a substantial percentage of revenues derived
from non-U.S. sales.
• Companies selected for the portfolio should derive a large portion of revenues from the largest
discount toy retailer.
• I am particularly interested in a start-up company that has an exciting new toy coming out based
on a very popular television show.
• Although MasterToy has the dominant market share, I feel that smaller companies will have bet-
ter opportunities for growth in a mature market.
State whether each of Kelly™s statements is valid or not valid. Cite two industry characteristics by
number from the following exhibit to support your decision. [16 minutes]

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