CFA Level 2 Corporate Issuers: notes and free practice
CFA Level 2 Corporate Issuers analyzes financing, distributions and corporate decisions through their effects on value. Use the case’s cash flows, capital costs and constraints rather than a financing label alone.
The key ideas, at a glance
Rebuild EPS after a buyback
Read the visual, then follow the worked example below. Use the stated case assumptions.
Illustrative worked case
EPS
- Before buyback
- 2
- After buyback
- 2.11
The case retires 1m shares and subtracts 0.8m after-tax interest. EPS rises to about 2.11; this alone does not prove value creation.
| Concept | Rule or decision | Common mistake |
|---|---|---|
| Rebuild EPS after a buyback | New EPS = (old earnings - after-tax borrowing cost) / remaining shares | The denominator changes, but debt-financed repurchases can change the numerator too. |
| Trace tax and coverage | Double-tax effective rate = 1 - (1 - corporate tax) × (1 - dividend tax) | A one-period cash shortfall warrants investigation but does not alone establish permanent inability to pay. |
| Weight the financing costs | WACC = wE × rE + wD × rD × (1 - tax) | A country-risk scenario must state which financing component changes; do not add the premium everywhere. |
| Price the synergy, not the story | Acquirer NPV = standalone target value + synergy PV - price - integration PV | Synergy estimates are uncertain; a positive model result is not a guaranteed acquisition outcome. |
01Rebuild EPS after a buyback
New EPS = (old earnings - after-tax borrowing cost) / remaining shares
Watch for: The denominator changes, but debt-financed repurchases can change the numerator too.
02Trace tax and coverage
Double-tax effective rate = 1 - (1 - corporate tax) × (1 - dividend tax)
Watch for: A one-period cash shortfall warrants investigation but does not alone establish permanent inability to pay.
03Weight the financing costs
WACC = wE × rE + wD × rD × (1 - tax)
Watch for: A country-risk scenario must state which financing component changes; do not add the premium everywhere.
04Price the synergy, not the story
Acquirer NPV = standalone target value + synergy PV - price - integration PV
Watch for: Synergy estimates are uncertain; a positive model result is not a guaranteed acquisition outcome.
Selected 2026 study concepts. Match your preparation to your registered exam-year curriculum. These notes are not complete curriculum coverage.
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CFA Level II: 20 practice MCQs
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Put the method to work
One worked example, from facts to answer
Given
Earnings 24m, shares 12m; borrow 20m at 5%, tax 20%, buy at 20 per share.
Method
Retire 1m shares; EPS = (24 - 20 × 0.05 × 0.8) / 11.
Answer and interpretation
EPS becomes about 2.11, versus 2.00 previously, under these assumptions.
Original independent teaching example. Assumptions are stated above; this is not an official exam question or scoring key.
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10 free Corporate Issuers questions
Five mini-cases, two questions each. Read the case facts, choose an answer and review the method. Short teaching cases, not complete exam item sets or a mock.
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- Question 1 of 10Level II topic sample · Case 1 of 5Corporate IssuersMultiple choice
Case facts
Pavo has annual net income of $40m and 20m shares. It borrows $50m at 6% to repurchase shares at $25 each at the start of the year. The tax rate is 25%, interest is fully deductible, operating earnings are unchanged and no other share movements occur.
Pavo’s pro forma annual EPS after the debt-funded repurchase is closest to:
Answer and explanations
Retire 50 / 25 = 2m shares; EPS = (40 - 50 × 6% × 75%) / 18 = about $2.10.
Review the method- A: 2.22 reduces shares to 18m but omits interest expense.
- B: 2.00 is the pre-transaction EPS.
- C - correct: Retire 50 / 25 = 2m shares; EPS = (40 - 50 × 6% × 75%) / 18 = about $2.10.
- Question 2 of 10Level II topic sample · Case 1 of 5Corporate IssuersMultiple choice
Case facts
Pavo has annual net income of $40m and 20m shares. It borrows $50m at 6% to repurchase shares at $25 each at the start of the year. The tax rate is 25%, interest is fully deductible, operating earnings are unchanged and no other share movements occur.
Which conclusion about Pavo’s higher EPS is justified?
Answer and explanations
The price paid, financing risk and economic value matter; EPS accretion alone is not a value-creation test.
Review the method- A: EPS accretion can occur without paying an economically attractive price.
- B - correct: The price paid, financing risk and economic value matter; EPS accretion alone is not a value-creation test.
- C: Borrowing to fund the repurchase does not demonstrate lower leverage.
- Question 3 of 10Level II topic sample · Case 2 of 5Corporate IssuersMultiple choice
Case facts
A company earns $100 before corporate tax. Its corporate tax rate is 25%, and it distributes all after-tax earnings. The shareholder pays 20% tax on the dividend received. This is a double-taxation system with no credits, exemptions or other taxes.
The shareholder’s cash after both layers of tax is:
Answer and explanations
100 × (1 - 0.25) × (1 - 0.20) = $60 after both tax layers.
Review the method- A - correct: 100 × (1 - 0.25) × (1 - 0.20) = $60 after both tax layers.
- B: 55 subtracts both rates directly from pretax earnings.
- C: 75 is the distribution before the shareholder’s dividend tax.
- Question 4 of 10Level II topic sample · Case 2 of 5Corporate IssuersMultiple choice
Case facts
A company earns $100 before corporate tax. Its corporate tax rate is 25%, and it distributes all after-tax earnings. The shareholder pays 20% tax on the dividend received. This is a double-taxation system with no credits, exemptions or other taxes.
The combined effective tax rate on the original corporate earnings is:
Answer and explanations
1 - (0.75 × 0.80) = 40%, equivalent to $40 total tax on $100 pretax earnings.
Review the method- A: 45% adds the rates despite their different tax bases.
- B: 20% is the shareholder rate alone.
- C - correct: 1 - (0.75 × 0.80) = 40%, equivalent to $40 total tax on $100 pretax earnings.
- Question 5 of 10Level II topic sample · Case 3 of 5Corporate IssuersMultiple choice
Case facts
Faro targets 70% equity and 30% debt using market values. Required equity return is 11%, pretax debt cost 6% and tax rate 25%. Interest is deductible. A separate country-risk scenario raises only the required equity return by 2 percentage points; weights and debt cost do not change.
Faro’s baseline weighted average cost of capital is:
Answer and explanations
Weight equity cost and after-tax debt cost: 0.70 × 11% + 0.30 × 6% × 0.75 = 9.05%.
Review the method- A: 9.50% omits the debt interest tax adjustment.
- B - correct: Weight equity cost and after-tax debt cost: 0.70 × 11% + 0.30 × 6% × 0.75 = 9.05%.
- C: 11% is equity cost, not the weighted financing cost.
- Question 6 of 10Level II topic sample · Case 3 of 5Corporate IssuersMultiple choice
Case facts
Faro targets 70% equity and 30% debt using market values. Required equity return is 11%, pretax debt cost 6% and tax rate 25%. Interest is deductible. A separate country-risk scenario raises only the required equity return by 2 percentage points; weights and debt cost do not change.
Under Faro’s specified country-risk scenario, WACC becomes:
Answer and explanations
Equity cost rises to 13%; 0.70 × 13% + 0.30 × 6% × 0.75 = 10.45%.
Review the method- A - correct: Equity cost rises to 13%; 0.70 × 13% + 0.30 × 6% × 0.75 = 10.45%.
- B: 11.05% adds the full two-point change to WACC instead of weighting it.
- C: 13% is the revised equity cost alone.
- Question 7 of 10Level II topic sample · Case 4 of 5Corporate IssuersMultiple choice
Case facts
An acquirer values a target at $200m as a standalone business. Present value of realizable synergies is $60m. It proposes paying $240m in cash plus $10m in integration costs measured at present value. Ignore financing side effects and other costs.
The proposed acquisition’s NPV to the acquirer is:
Answer and explanations
200 + 60 - 240 - 10 = $10m NPV under the given assumptions.
Review the method- A: 60 is synergy PV before paying the premium and integration costs.
- B: 20 subtracts price but omits integration cost.
- C - correct: 200 + 60 - 240 - 10 = $10m NPV under the given assumptions.
- Question 8 of 10Level II topic sample · Case 4 of 5Corporate IssuersMultiple choice
Case facts
An acquirer values a target at $200m as a standalone business. Present value of realizable synergies is $60m. It proposes paying $240m in cash plus $10m in integration costs measured at present value. Ignore financing side effects and other costs.
The maximum cash purchase price consistent with zero acquirer NPV is:
Answer and explanations
The zero-NPV price is standalone value 200 + synergies 60 - integration 10 = $250m.
Review the method- A: 260 does not leave room for the $10m integration cost.
- B - correct: The zero-NPV price is standalone value 200 + synergies 60 - integration 10 = $250m.
- C: 200 ignores the net synergy benefit available in the supplied model.
- Question 9 of 10Level II topic sample · Case 5 of 5Corporate IssuersMultiple choice
Case facts
A company compares a constant payout policy of 40% of earnings with maintaining a $40m regular dividend. Next-year earnings are forecast at $80m and free cash flow available to equity at $30m. There are no preferred dividends. Use these forecasts only, not an assumption of permanent distress.
Under the constant 40% payout policy, next year’s dividend would be:
Answer and explanations
40% × forecast earnings $80m = $32m under the constant-ratio policy.
Review the method- A - correct: 40% × forecast earnings $80m = $32m under the constant-ratio policy.
- B: 40 is the alternative maintained regular dividend, not the ratio result.
- C: 30 is forecast free cash flow, not 40% of earnings.
- Question 10 of 10Level II topic sample · Case 5 of 5Corporate IssuersMultiple choice
Case facts
A company compares a constant payout policy of 40% of earnings with maintaining a $40m regular dividend. Next-year earnings are forecast at $80m and free cash flow available to equity at $30m. There are no preferred dividends. Use these forecasts only, not an assumption of permanent distress.
Forecast free-cash-flow coverage of the maintained $40m dividend is:
Answer and explanations
Free cash flow 30 / proposed dividend 40 = 0.75 times, indicating a forecast funding shortfall for that year.
Review the method- A: 2.00 uses earnings rather than free cash flow.
- B: 1.33 reverses cash-flow coverage’s numerator and denominator.
- C - correct: Free cash flow 30 / proposed dividend 40 = 0.75 times, indicating a forecast funding shortfall for that year.
Four ideas to put to work
Find the method you need
Start with: EPS, tax shields, market-value weights and present-value calculations.
METHOD 01
Rebuild EPS after a buyback
New EPS = (old earnings - after-tax borrowing cost) / remaining shares
- Divide repurchase spending by the purchase price to find shares retired.
- Deduct incremental after-tax interest when debt funds the repurchase.
- An EPS increase alone does not prove that shareholder value increased.
Worked example
- Given
- Earnings 24m, shares 12m; borrow 20m at 5%, tax 20%, buy at 20 per share.
- Calculate / decide
- Retire 1m shares; EPS = (24 - 20 × 0.05 × 0.8) / 11.
- Result
- EPS becomes about 2.11, versus 2.00 previously, under these assumptions.
Watch for: The denominator changes, but debt-financed repurchases can change the numerator too.
Practise this ideaMETHOD 02
Trace tax and coverage
Double-tax effective rate = 1 - (1 - corporate tax) × (1 - dividend tax)
- Apply dividend tax to the after-corporate-tax distribution.
- A constant payout ratio makes dividends vary with earnings.
- Compare the proposed dividend with both earnings and cash available to equity.
Worked example
- Given
- Pretax earnings 100, corporate tax 20%, dividend tax 15%.
- Calculate / decide
- Shareholder receives 100 × 0.80 × 0.85 = 68.
- Result
- Combined tax is 32%, not the unadjusted sum of the two tax rates.
Watch for: A one-period cash shortfall warrants investigation but does not alone establish permanent inability to pay.
Practise this ideaMETHOD 03
Weight the financing costs
WACC = wE × rE + wD × rD × (1 - tax)
- Use relevant market-value target weights rather than book weights by default.
- Apply the interest tax adjustment only to deductible debt cost.
- Trace a changed financing component through its weight.
Worked example
- Given
- Equity weight 60%, cost 12%; debt weight 40%, cost 5%; tax 20%.
- Calculate / decide
- 0.60 × 12% + 0.40 × 5% × 0.80 = 8.80%.
- Result
- A one-point equity-cost rise increases WACC by 0.60 points with fixed weights.
Watch for: A country-risk scenario must state which financing component changes; do not add the premium everywhere.
Practise this ideaMETHOD 04
Price the synergy, not the story
Acquirer NPV = standalone target value + synergy PV - price - integration PV
- Value synergies incrementally and avoid double-counting them in the target value.
- Include integration costs and the full consideration paid.
- Compare price with the zero-NPV ceiling, not EPS accretion alone.
Worked example
- Given
- Target value 150, synergy PV 35, price 165, integration PV 8.
- Calculate / decide
- 150 + 35 - 165 - 8 = 12.
- Result
- Acquirer NPV is 12 under the supplied valuations.
Watch for: Synergy estimates are uncertain; a positive model result is not a guaranteed acquisition outcome.
Practise this ideaQuestions about this topic
- Does a share repurchase automatically create economic value?
- No. It can change share count and per-share measures, but economic value depends on the price paid, financing, opportunity costs and other case conditions. EPS growth alone is not proof of value creation.
- Why does capital cost matter to corporate decisions?
- It represents the required compensation for the relevant financing risk under the model. Compare appropriately defined incremental cash flows with a discount rate consistent with those cash flows and risks.
- Are dividends and repurchases identical in every setting?
- No. Timing, flexibility, investor taxation, signaling and financing consequences can differ. Use the facts and assumptions supplied rather than assuming a universal advantage for one distribution method.
Sources and curriculum scope
Official outlines establish curriculum scope. The explanations and worked examples are independent teaching material; the sources do not verify or endorse them.
- 2026 CFA Level II outline: Corporate Issuers
- CFA Institute: Level II exam and item-set format
- 2026 CFA Level 2 curriculum outline
- 2027 CFA Level 2 curriculum outline
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