CFAI Practice: M02 — Investors and Other Stakeholders

Source: CFAI Official Practice Problems 2026

Questions

1-3. Case: Firm with assets=200, 100% equity vs. 80% debt/20% equity, Revenue=200, OpEx=140, Interest rate=20%

1. Calculate net income and ROE for each firm:

• Equity-only: NI = 200-140 = 60, ROE = 60/200 = 30%
• Debt+Equity: NI = 200-140-32 = 28, ROE = 28/40 = 70%

ROE higher with debt because interest cost (20%) < return on assets (30%).

2. ROE with ±20% revenue change:

• +20%: Equity ROE = 50%, Debt+Equity ROE = 170%
• -20%: Equity ROE = 10%, Debt+Equity ROE = -30%

Debt increases variance of ROE — amplifies both upside and downside.

3. New investment (LT assets +40): Compare Share Issuance vs Debt vs Cash on Hand:

• Share: ROE = 72/240 = 30%
• Debt: ROE = 64/200 = 32%
• Cash: ROE = 72/200 = 36% (highest — no dilution, no interest)

4. Supplier stakeholder relationship with high leverage:

Supplier is a stakeholder with vested interest. High leverage = risk of inability to pay for goods → threatens supplier’s interests.

5. Why management may not act in shareholders’ best interests:

Principal-agent problem. Managers may pursue insufficient effort, perquisite consumption, empire building. Mitigated by independent board oversight and equity-based compensation.