Chapter: Chapter 08: Frameworks for Valuation
Multiple Choice
1. The framework for valuation that compresses free cash flow and the interest tax shield into one
number, making it difficult to compare operating performance among companies and over time, is the:
a) Discounted economic profit model.
b) Capital cash flow model.
c) Equity cash flow model.
e) Enterprise discounted cash flow (DCF) model.
2. Which of the following is best to use when valuing a financial institution?
a) Enterprise discounted cash flow model.
b) Adjusted present value (APV).
c) Equity cash flow model.
d) Capital cash flow model.
3. Which of the following valuation methods use(s) the weighted average cost of capital (WACC) as the
discount factor?
I. The economic profit model.
II. The adjusted present value model.
III. The discounted cash flow model.
IV. None of the above.
a) I and II only.
b) I and III only.
c) II and III only.
d) IV.
4. Given the following information, compute the estimated value per share.
a) $5.80
b) $6.04
c) $7.00
d). $7.92
5. Given the following information, compute the estimated value per share.
Present value of cash flow
$25m
Midyear adjustment factor
$0.6m
Value of tax loss carryforwards
$1m
Value of debt
$8.6m
Value of capitalized operating leases
$2.2m
Number of shares outstanding
8m
a) $5.00
b) $4.68
c) $7.55
d) $11.2
McKinsey/Valuation
47
6. Use the following information to find the NOPLAT in year t+1 that yields the continuing value
expressed below.
NOPLATt+1 = ?
NOPLAT growth rate = 1.5%
Return on new invested capital = 9%
Weighted average cost of capital = 6.8%
Continuing value = $1,750
a) $111m
b) $95m
c) $105m
d) $184m
7. Use the following information below to answer the question.
NOPLATt+1 = $72.2m
NOPLAT growth rate = 3%
Return on new invested capital = 11.2%
Weighted average cost of capital = 7.4%
Which of the following is closest to the continuing value in year t?
a) $1,005m
b) $1,201m
c) $4,485m
d) $6,126m
8. A firm is financed with 62 percent debt and 38 percent equity. The pretax costs of debt and equity
capital are 6.6 percent and 11.3 percent, respectively. What is the tax rate if the WACC is 7 percent?
a) 31 percent.
b) 34 percent.
c) 37 percent.
d) 64 percent.
McKinsey/Valuation
48
Ans: [b]
Response: [0.07 = 0.38 × 0.113 + 0.62 × 0.066 × (1 – x). Solving for x = 34%]
9. Given the following data, what is the enterprise value of the company?
Free cash flow (FCF) for year 1
$50m
FCF for year 2
$50m
Continuing value of FCF at t = 2
$291.6m
Interest tax shield (ITS) for year 1
$5m
ITS for year 2
$5m
Continuing value of ITS at t = 2
$17.5m
Unlevered cost of equity
8%
WACC
7%
Midyear adjustment factor
$4m
Excess cash and investments
$18m
a) $301m
b) $285m
c) $349m
d) $100m
10. In the APV approach, why is the unlevered cost of equity used instead of the WACC?
a) To account for retained earnings risk.
b) To avoid measuring the impact of debt.
c) To value the company as if it were all equity financed.
d) To incorporate the risk of newly issued shares.
McKinsey/Valuation
49
True/False
11. When valuing a parent company that owns less than 100 percent of a subsidiary, the minority
interest holder of the subsidiary has a claim on the company’s assets.
12. Since employee options represent just the possibility of acquiring stock instead of an obligation, the
value of these options should not be factored into estimating the equity value.
13. Operating leases represent the most common form of off-balance-sheet debt.
14. Preferred stock in well-established companies more closely resembles unsecured debt than equity.
15. Enterprise DCF and economic-profit models differ with respect to the discount rate used to estimate
the future income streams.
McKinsey/Valuation
50
16. Bigger Brewing Co. is a U.S.-based company that is undergoing a leveraged buyout with a projected
capital structure of 80 percent debt in the near term. There is a projected loan repayment schedule,
with the goal of having a capital structure of 50 percent debt in three years. Based on this information,
the best methodology to value this firm would be the enterprise discounted cash flow methodology.
17. List the four basic steps in valuing a company’s common equity using the enterprise discounted cash
flow methodology.
Ans: [1. Value the company’s operations by discounting free cash flow using the weighted average cost