Exam
Name___________________________________
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F‘ if the statement is false.
1) The discounted free cash flow model ignores interest income and expense but adjusts for cash and debt
directly.
Answer: True False
Explanation:
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
2) Year 1 2 3 4
Free Cash Flow $12 million $18 million $22 million $26 million
Conundrum Mining is expected to generate the above free cash flows over the next four years, after which
they are expected to grow at a rate of 5% per year. If the weighted average cost of capital is 12% and
Conundrum has cash of $80 million, debt of $60 million, and 30 million shares outstanding, what is
Conundrum’s expected terminal enterprise value?
A) $371.4 million
B) $390.0 million
C) $410.0 million
D) $391.4 million
3) Year 1 2 3 4
Free Cash Flow $12 million $18 million $22 million $26 million
Conundrum Mining is expected to generate the above free cash flows over the next four years, after which
they are expected to grow at a rate of 5% per year. If the weighted average cost of capital is 12% and
Conundrum has cash of $80 million, debt of $60 million, and 30 million shares outstanding, what is
Conundrum’s expected current share price?
A) $10.84
B) $13.72
C) $16.16
D) $16.25
4) Year 1 2 3 4 5
Free Cash Flow $22 million $26 million $29 million $30 million $32 million
General Industries is expected to generate the above free cash flows over the next five years, after which free
cash flows are expected to grow at a rate of 3% per year. If the weighted average cost of capital is 8% and
General Industries has cash of $10 million, debt of $40 million, and 80 million shares outstanding, what is
General Industries’ expected current share price?
A) $6.60
B) $6.72
C) $7.67
D) $9.48
5) Gonzales Corporation generated free cash flow of $88 million this year. For the next two years, the
company’s free cash flow is expected to grow at a rate of 8%. After that time, the company’s free cash flow
is expected to level off to the industry long–term growth rate of 4% per year. If the weighted average cost of
capital is 10% and Gonzales Corporation has cash of $100 million, debt of $300 million, and 100 million
shares outstanding, what is Gonzales Corporation’s expected terminal enterprise value in year 2?
A) $1,779.15
B) $1,641.60
C) $1,579.15
D) $1,441.60
6) Gonzales Corporation generated free cash flow of $88 million this year. For the next two years, the
company’s free cash flow is expected to grow at a rate of 8%. After that time, the company‘s free cash flow
is expected to level off to the industry long–term growth rate of 4% per year. If the weighted average cost of
capital is 10% and Gonzales Corporation has cash of $100 million, debt of $300 million, and 100 million
shares outstanding, what is Gonzales Corporation’s expected free cash flow in year 2?
A) $1,779.15
B) $95.04
C) $1,881.8
D) $102.64
7) Gonzales Corporation generated free cash flow of $88 million this year. For the next two years, the
company’s free cash flow is expected to grow at a rate of 8%. After that time, the company’s free cash flow
is expected to level off to the industry long–term growth rate of 4% per year. If the weighted average cost of
capital is 10% and Gonzales Corporation has cash of $100 million, debt of $300 million, and 100 million
shares outstanding, what is Gonzales Corporation’s expected current share price?
A) $16.42
B) $13.85
C) $14.42
D) $18.42
FCF Forecast ($ million)
Year 0 1 2 3 4
Sales 240 270 290 310 325.5
Growth versus Prior Year 12.5% 7.4% 6.9% 5.0%
EBIT (10% of Sales) 27.00 29.00 31.00 32.55
Less: Income Tax (37%) (9.99) 10.73 11.47 12.44
Less Increase in NWC (12% of Change in Sales 3.6 2.4 2.4 1.86
Free Cash Flow 13.41 15.87 17.13 18.65
8) Banco Industries expect sales to grow at a rapid rate over the next three years, but settle to an industry
growth rate of 5% in year 4. The spreadsheet above shows a simplified pro forma for Banco Industries. If
Banco industries has a weighted average cost of capital of 12%, $50 million in cash, $60 million in debt, and
18 million shares outstanding, which of the following is the best estimate of Banco’s stock price at the start of
year 1?
A) $6.03
B) $11.12
C) $12.03
D) $20.11
9) Banco Industries expect sales to grow at a rapid rate over the next 3 years, but settle to an industry growth
rate of 5% in year 4. The spreadsheet above shows a simplified pro forma for Banco Industries. Banco
industries has a weighted average cost of capital of 12%, $50 million in cash, $60 million in debt, and 18
million shares outstanding. If Banco Industries can reduce their operating expenses so that EBIT becomes
12% of sales, by how much will their stock price increase?
A) $2.81
B) $3.36
C) $4.98
D) $8.89
10) Which of the following is the appropriate way to calculate the price of a share of a given company using the
free cash flow valuation model?
A) P0 = Div1/(rE – g)
B) P0 = PV(Future Free Cash Flow of Firm)/(Shares Outstanding0)
C) P0 = [Div1/(rE – g)]/(Shares Outstanding0)
D)
P0 = (V0 + Cash0 – Debt0)/(Shares Outstanding0)
11) If you want to value a firm that consistently pays out its earnings as dividends, the simplest model for you to
use is the
A) enterprise value model.
B) method of comparables.
C) dividend–discount model.
D) discounted free cash flow model.
12) If you want to value a firm but do not want to explicitly forecast its dividends, what is the simplest model for
you to use?
A) the discounted free cash flow model
B) the dividend–discount model
C) the enterprise value model
D) None of the above models can be used if you do not want to forecast dividends or use of debt.
13) Which of the following statements is FALSE?
A) The more cash the firm uses to repurchase shares, the less it has available to pay dividends.
B) Free cash flow measures the cash generated by the firm after payments to debt or equity holders are
considered.
C) We estimate a firm’s current enterprise value by computing the present value (PV) of the firm’s free
cash flow.
D) We can interpret the enterprise value as the net cost of acquiring the firm’s equity, taking its cash, and
paying off all debts.
14) Which of the following statements is FALSE?
A) The firm’s weighted average cost of capital, denoted rwacc, is the cost of capital that reflects the risk of
the overall business, which is the combined risk of the firm’s equity and debt.
B) Intuitively, the difference between the discounted free cash flow model and the dividend–discount
model is that in the divided–discount model the firm’s cash and debt are included indirectly through
the effect of interest income and expenses on earnings in the dividend–discount model.
C) We interpret rwacc as the expected return the firm must pay to investors to compensate them for the
risk of holding the firm’s debt and equity together.
D) When using the discounted free cash flow model we should use the firm’s equity cost of capital.
15) Which of the following statements is FALSE?
A) The long–run growth rate gFCF is typically based on the expected long–run growth rate of the firm’s
revenues.
B) Because the firm’s free cash flow is equal to the sum of the free cash flows from the firm’s current and
future
investments,
we can interpret the firm’s enterprise value as the total net present value (NPV) that the firm will earn
from continuing its existing projects and initiating new ones.
C) If the firm has no debt, then rwacc equals the risk–free rate of return.
D) When using the discounted free cash flow model, we forecast the firm’s free cash flow up to some
horizon, together with some terminal (continuation) value of the enterprise.
SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.
16) What additional adjustments are required to find the share price, in case we are using the discounted cash
flow model?
TRUE/FALSE. Write ‘T’ if the statement is true and ‘F‘ if the statement is false.
17) In the method of comparables, the known values of a firm’s cash flows are used to estimate the unknown
cash flows of a similar firm.
18) Several methods should be used to provide an estimate of a stock’s value since no single method provides a
definitive value.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
19) On a particular date, FedEx has a stock price of $88.66 and an EPS of $6.34. Its competitor, UPS, had an EPS
of $0.40. What would be the expected price of UPS stock on this date, if estimated using the method of
comparables?
A) $5.59
B) $8.39
C) $10.49
D) $13.98
20) Which of the following statements concerning the valuation of firms using the method of comparables is
FALSE?
A) If two different firms generate identical cash flows, the Law of One Price will imply that both firms
have the same value.
B) Comparables adjust for scale differences when valuing similar firms.
C) Valuation multiples take into account differences in the risk and future growth between the firms being
compared.
D) Two firms that sell very similar products or offer very similar services will have different values if they
are of different sizes.
Use the figure for the question(s) below.
21) On a particular date, the above information concerning Office Depot, Incorporated, was given on Google
Finance. Its competitor, Staples Incorporated, had a stock price of $24.72. Which of the following is closest to
the EPS of Staples Incorporated if it is estimated using valuation multiples based on price–earnings ratios?
A) $1.65
B) $1.83
C) $2.67
D) $14.37
22) An investor estimates the value of a firm which manufactures cookware by examining the cash flows of
similar firms. Which of the following is assumed to be the same for these firms?
A) P/E
B) annual growth rates
C) payout rates
D) all of the above
Use the table for the question(s) below.
Name Market Enterprise Enterprise Enterprise
Capitalization Value Price/ Value/ Value/
($ million) ($ million) P/E Book Sales EBITDA
Gannet 6350 10,163 7.36 0.73 1.4 5.04
New York Times 2423 3472 18.09 2.64 1.10 7.21
McClatchy 675 3061 9.76 1.68 1.40 5.64
Media General 326 1192 14.89 0.39 1.31 7.65
Lee Enterprises 267 1724 6.55 0.82 1.57 6.65
Average 11.33 1.25 1.35 6.44
Maximum +60% 112% +16% +22%
Minimum –40% 69% –18% –19%
23) The table above shows the stock prices and multiples for a number of firms in the newspaper publishing
industry. Another newspaper publishing firm (not shown) had sales of $620 million, EBITDA of $84
million, excess cash of $66 million, $14 million of debt, and 120 million shares outstanding. If the average
enterprise value to sales for comparable businesses is used, which of the following is the best estimate of the
firm’s share price?
A) $6.89
B) $6.98
C) $7.41
D) $7.65
24) The table above shows the stock prices and multiples for a number of firms in the newspaper publishing
industry. Another newspaper publishing firm (not shown) had sales of $620 million, EBITDA of $84
million, excess cash of $66 million, $14 million of debt, and 120 million shares outstanding. If the average
enterprise value to sales for comparable businesses is used, which of the following is the range of reasonable
share price estimates?
A) $6.07 to $8.59
B) $5.72 to $8.09
C) $1.12 to $1.68
D) $6.00 to $9.04
25) The table above shows the stock prices and multiples for a number of firms in the newspaper publishing
industry. Another newspaper publishing firm (not shown) had sales of $620 million, EBITDA of $84
million, excess cash of $66 million, $14 million of debt, and 120 million shares outstanding. If the firm had an
EPS of $0.48, what is the difference between the estimated share price of this firm if the average
price–earnings ratio is used and the estimated share price if the average enterprise value/EBITDA ratio is
used?
A) $0.34
B) $0.49
C) $4.94
D) $5.43
26) The table above shows the stock prices and multiples for a number of firms in the newspaper publishing
industry. Which of the following ratios would most likely be the most reliable in determining the stock
price of a comparable firm?
A) P/E
B) Price/Book
C) Enterprise Value/Sales
D) Enterprise Value/EBITDA
27) Which of the following is NOT an advantage of the valuation multiple method as compared to the
discounted cash flow method?
A) calculations based upon widely available information
B) based upon actual stock prices of real firms
C) does not rely on estimates of future cash flows
D) takes into account important differences between different firms
28) Which of the following statements is FALSE?
A) Even two firms in the same industry selling the same types of products, while similar in many respects,
are likely to be of different size or scale.