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Free CFA® CFA-Level-II Exam Braindumps (page: 30)

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PDF with 715 Questions

Matthew Emery, CFA, is responsible for analyzing companies in the retail industry. He is currently reviewing the status of Ferguson Department Stores, Inc. (FDS). FDS has recently gone through extensive restructuring in the wake of a slowdown in the economy that has made retailing particularly challenging. As part of his analysis, Emery has gathered information from a number of sources.
Ferguson Department Stores, Inc.

FDS went public in 1969 following a major acquisition, and the Ferguson name quickly became one of the most recognized in retailing. Ferguson had been successful through most of its first 30 years in business and has prided itself on being the one-stop shopping destination for consumers living on the West Coast of the United States. Recently, FDS began to experience both top and bottom line difficulties due to increased competition from specialty retailers who could operate more efficiently and offer a wider range of products in a focused retailing sector. When the company's main bank reduced FDS's line of credit, a serious working capital crisis ensued, and the company was forced to issue additional equity in an effort to overcome the problem. FDS has a cost of capital of 10% and a required rate of return on equity of 12%. Dividends are growing at a rate of 8%, but the growth rate is expected to decline linearly over the next six years to a long-term growth rate of 4%. The company recently paid an annual dividend of $1.

At the end of 2008, FDS announced that it would be expanding its retail operations, moving to a warehouse concept, and opening new stores around the country. FDS also announced it would close some existing stores, write-down assets, and take a large restructuring charge. Upon reviewing the prospects of the firm, Emery issued an earnings per share forecast for 2009 of $0.90. He set a 12- month share price target of $22.50. Immediately following the expansion announcement, the share price of FDS jumped from $14 to $18.



In 2008, FDS also reported an unusual expense of $189.1 million related to restructuring costs and asset write downs.

In response to questions from a colleague, Emery makes the following statements regarding the merits of earnings yield compared to the P/E ratio:
Statement 1: For ranking purposes, earnings yield may be useful whenever earnings are either negative or close to zero.
Statement 2: A high E/P implies the security is overpriced.

According to FDS's price-to-sales ratio for 2008, based on the post-expansion announcement stock price, FDS is:

  1. underpriced relative to the industry.
  2. overpriced relative to the industry.
  3. properly priced relative to the industry.

Answer(s): A

Explanation:

FDS has a price-to-salcs ratio in 2008 of:



Because its price-to-sales ratio is less than the industry average of 0.50, FDS is relatively underpriced. (Study Session 12, LOS 42.j,o)



Michael Robbins, CFA, is analyzing Universal Home Supplies, Inc. (UHS), which has recently gone through some extensive restructuring.

Universal Home Supplies, Inc.
UHS operates nearly 200 department stores and 78 specialty stores in over 30 states. The company offers a wide range of products, including women's, men's, and children's clothing and accessories as well as home furnishings, electronics, and other consumer goods. The company is considering cutting back on or eliminating its electronics business entirely. UHS manufactures many of its own apparel products domestically in a large factory located in Kentucky. This central location permits shipping to distribution points around the country at reasonable costs. The company operates primarily in suburban shopping malls and offers mid- to high-end merchandise mainly under its own private label. At present more than 70% of the company's customers live within a 10-minute drive of one of the company's stores. Web site activity measured in dollar sales volume has increased by over 18% in the past year. Shares of UHS stock are currently priced at $25. Dividends are expected to grow at a rate of 6% over the next eight years and then continue to grow at that same rate indefinitely. The company has a cost of capital of 10.2%, a beta of 0.8, and just paid an annual dividend of $1.25.

UHS has faced serious cash flow problems in recent years as a consequence of its strategy to pursue an upscale clientele in the face of increased competition from several "niche retailers." The firm has been able to issue new debt recently and has also managed to extend its line of credit. The two financing agreements required a pledge of additional assets and a promise to install a super- efficient inventory tracking system in time to meet holiday shopping demand.




Robbins is asked by his supervisor to carefully consider the advantages and drawbacks of using the price-to-sales ratio (P/S) and to determine the appropriate valuation metrics to use when returns follow patterns of persistence or reversals.
Robbins also estimates a cross-sectional model to predict UHS's P/E:

predicted P/E = 5 - (10 x beta) + [3 x 4-year average ROE(%)]
+ [2 X 5-ycar growth forecast(%)]

Based on the H-model, the implied expected rate of return for UHS is closest to:

  1. 8.8%.
  2. 10.2%.
  3. 11,3%.

Answer(s): C

Explanation:

Notice that in this case, gs = g, and, accordingly, the H-model simplifies to the Gordon growth model. We can then solve for the unknown rate:

(Study Session 11, LOS 40.n)



Michael Robbins, CFA, is analyzing Universal Home Supplies, Inc. (UHS), which has recently gone through some extensive restructuring.

Universal Home Supplies, Inc.
UHS operates nearly 200 department stores and 78 specialty stores in over 30 states. The company offers a wide range of products, including women's, men's, and children's clothing and accessories as well as home furnishings, electronics, and other consumer goods. The company is considering cutting back on or eliminating its electronics business entirely. UHS manufactures many of its own apparel products domestically in a large factory located in Kentucky. This central location permits shipping to distribution points around the country at reasonable costs. The company operates primarily in suburban shopping malls and offers mid- to high-end merchandise mainly under its own private label. At present more than 70% of the company's customers live within a 10-minute drive of one of the company's stores. Web site activity measured in dollar sales volume has increased by over 18% in the past year. Shares of UHS stock are currently priced at $25. Dividends are expected to grow at a rate of 6% over the next eight years and then continue to grow at that same rate indefinitely. The company has a cost of capital of 10.2%, a beta of 0.8, and just paid an annual dividend of $1.25.

UHS has faced serious cash flow problems in recent years as a consequence of its strategy to pursue an upscale clientele in the face of increased competition from several "niche retailers." The firm has been able to issue new debt recently and has also managed to extend its line of credit. The two financing agreements required a pledge of additional assets and a promise to install a super- efficient inventory tracking system in time to meet holiday shopping demand.





Robbins is asked by his supervisor to carefully consider the advantages and drawbacks of using the price-to-sales ratio (P/S) and to determine the appropriate valuation metrics to use when returns follow patterns of persistence or reversals.
Robbins also estimates a cross-sectional model to predict UHS's P/E:

predicted P/E = 5 - (10 x beta) + [3 x 4-year average ROE(%)]
+ [2 X 5-ycar growth forecast(%)]

Robbins should conclude that a key drawback to using the price-to-sales (P/S) ratio in the investment process is that P/S is:

  1. positive even when earnings per share is negative.
  2. not appropriate for valuing the equity of mature companies.
  3. susceptible to manipulation with respect to revenue recognition.

Answer(s): C

Explanation:

Among the choices given, the only drawback to the P/S ratio is that it is susceptible to manipulation if management should choose to act aggressively with respect to the recognition of revenue. (Study Session 12, LOS 42.c)



Michael Robbins, CFA, is analyzing Universal Home Supplies, Inc. (UHS), which has recently gone through some extensive restructuring.

Universal Home Supplies, Inc.
UHS operates nearly 200 department stores and 78 specialty stores in over 30 states. The company offers a wide range of products, including women's, men's, and children's clothing and accessories as well as home furnishings, electronics, and other consumer goods. The company is considering cutting back on or eliminating its electronics business entirely. UHS manufactures many of its own apparel products domestically in a large factory located in Kentucky. This central location permits shipping to distribution points around the country at reasonable costs. The company operates primarily in suburban shopping malls and offers mid- to high-end merchandise mainly under its own private label. At present more than 70% of the company's customers live within a 10-minute drive of one of the company's stores. Web site activity measured in dollar sales volume has increased by over 18% in the past year. Shares of UHS stock are currently priced at $25. Dividends are expected to grow at a rate of 6% over the next eight years and then continue to grow at that same rate indefinitely. The company has a cost of capital of 10.2%, a beta of 0.8, and just paid an annual dividend of $1.25.

UHS has faced serious cash flow problems in recent years as a consequence of its strategy to pursue an upscale clientele in the face of increased competition from several "niche retailers." The firm has been able to issue new debt recently and has also managed to extend its line of credit. The two financing agreements required a pledge of additional assets and a promise to install a super- efficient inventory tracking system in time to meet holiday shopping demand.





Robbins is asked by his supervisor to carefully consider the advantages and drawbacks of using the price-to-sales ratio (P/S) and to determine the appropriate valuation metrics to use when returns follow patterns of persistence or reversals.
Robbins also estimates a cross-sectional model to predict UHS's P/E:

predicted P/E = 5 - (10 x beta) + [3 x 4-year average ROE(%)]
+ [2 X 5-ycar growth forecast(%)]


Is UHS stock, at the end of 2008, best described as overvalued or undervalued according to the:

Trailing PEG ratio? P/S ratio?

  1. Undervalued Undervalued
  2. Overvalued Undervalued
  3. Undervalued Overvalued

Answer(s): B

Explanation:

UHS trailing P/E = $25 / $0.82 = 30.49 UHS trailing PEG = 30.49 / 6% = 5-08
Trailing industry P/E = 22.50

Trailing industry PEG - 22.50 / 10% > 2.25
The PEG ratio for UHS exceeds that of the industry. This implies that UHS's growth rate is relatively more expensive than is the industry's growth rate. We can therefore conclude that on the basis of the PEG ratio, UHS stock is overvalued.


UHS P/S = $25 / ($7,400,100,000 / 95,366,000) = 0.32
Industry P/S = 0.50

Relative to the industry, the P/S ratio for UHS stock is low, and it would therefore be considered as undervalued.

Conflicting results between different ratios is common in practice. When this occurs, an analyst must look deeper to arrive at a reliable conclusion. An important consideration in this case is whether or not there has been any manipulation of sales and/or earnings. The estimation of the dividend growth rate is also an important factor. (Study Session 12, LOS 42.j,k)



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