Question 1

Conceptually,firms with P/E ratios less than their projected growth rates may be considered undervalued; while those with P/E ratios greater than their projected growth rates may be viewed as overvalued.

Accepted Answer

This statement is true. A lower P/E ratio compared to the projected growth rate suggests that the stock may be undervalued in relation to its potential future earnings. Conversely, a higher P/E ratio compared to the projected growth rate may suggest that the stock is overvalued and may not provide a good return on investment.

Question 2

In constructing the enterprise value,the market value of the firm's common equity value is added to the market value of the firm's long-term debt and the market value of preferred stock.

Accepted Answer

This is correct. Enterprise value is calculated by adding the market value of the firm's common equity, long-term debt, and preferred stock.

Question 3

Like the recent transactions method,comparable company valuation estimates do not require the addition of a purchase price premium.

Accepted Answer

Comparable company valuation typically involves analyzing the market values of similar companies, but it does not inherently include a purchase price premium. The purchase price premium is specific to transactions and reflects the additional amount a buyer is willing to pay over the market price to acquire a company, which is not a direct component of the comparable company valuation method.

Question 4

The enterprise value to EBITDA multiple relates the total book value of the firm from the perspective of the liability side of the balance sheet (i.e.,long-term debt plus preferred and common equity),excluding cash,to EBITDA.

Accepted Answer

The answer of The enterprise value to EBITDA multiple relates...

Question 5

The comparable companies' method and recent transactions methods of valuation are conceptually similar.

Accepted Answer

Both methods involve comparing the company being valued to similar companies or recent transactions in the same industry to determine a fair value. However, the specific metrics and factors considered may differ between the two methods.

Question 6

Investors may be willing to pay considerably more for a stock whose PEG ratio is greater than one if they believe the increase in earnings will result in future financial returns that significantly exceed the firm's cost of equity.

Accepted Answer

A PEG ratio greater than one indicates that the stock may be overvalued based on its earnings growth, but if investors believe that the earnings growth will result in significant financial returns that exceed the cost of equity, they may be willing to pay more for the stock.

Question 7

The analyst should be careful not to mechanically add an acquisition premium to the target firm's estimated value based on the comparable companies' method if there is evidence that the market values of these "comparable firms" already reflect the effects of acquisition activity elsewhere in the industry.

Accepted Answer

If the market values of comparable firms already reflect the effects of acquisition activity, then adding an acquisition premium to the targeted firm's estimated value would be redundant and may overvalue the firm. The analyst should consider the specific circumstances of each acquisition and evaluate whether an acquisition premium is appropriate based on those factors.

Question 8

It is critical for the analyst to remember that high growth rates by themselves are likely to increase multiples such as a firm's price to earnings ratio even without any improvement in financial returns.

Accepted Answer

The answer of It is critical for the analyst to...

Question 9

Disadvantages of the comparable industry method of valuation include the presumption that industry multiples are actually comparable and that analysts' earnings projections are unbiased.

Accepted Answer

The comparable industry method of valuation relies on the assumption that industry multiples can be compared across companies, but this is not always the case. Additionally, analysts' earnings projections may be biased, leading to inaccurate valuations.

Question 10

A higher P/E ratio for a firm may be justified if its earnings are expected to grow significantly faster than firm's future earnings.

Accepted Answer

A higher P/E ratio may indicate that investors are willing to pay a premium for a company's stock because they expect the company's earnings to grow at a faster rate in the future.

Question 11

The comparable companies' transactions valuation method is generally considered the most accurate of all the valuation methods.

Accepted Answer

While the comparable companies' transactions valuation method is one of the widely used and considered relatively accurate, no single valuation method can be deemed as the most accurate. Valuation methods should be used in conjunction with qualitative and quantitative analysis to arrive at a justifiable valuation.

Question 12

The enterprise value to EBITDA method is useful because more firms are likely to have negative earnings than negative EBITDA.

Accepted Answer

The enterprise value to EBITDA method is useful because it takes into consideration the total value of the company (enterprise value) and compares it to its earnings before interest, taxes, depreciation, and amortization (EBITDA), which is a measure of operating cash flow. This method is useful because EBITDA is less likely to be negative than earnings due to factors such as non-cash expenses like depreciation and amortization. Therefore, the enterprise value to EBITDA method is a more reliable way to compare the value of different companies.

Question 13

The so-called PEG ratio is calculated by dividing the firm's price-to-earning ratio by the expected growth rate in the firm's share price.

Accepted Answer

The answer of The so-called PEG ratio is calculated by...

Question 14

Market-based valuation methods are less prone to manipulation than discounted cash flow methods because they require a more detailed statement of assumptions.

Accepted Answer

Market-based valuation methods rely on market prices and comparables, which can fluctuate due to market conditions and may not require a detailed statement of assumptions, unlike discounted cash flow methods that necessitate explicit assumptions about future cash flows and growth rates.

Question 15

The enterprise to EBITDA method of valuation can be compared more readily among firms exhibiting different levels of leverage than for other measures of earnings,since the numerator represents the total value of the firm and the denominator measures earnings before interest.

Accepted Answer

The enterprise to EBITDA method of valuation is based on the total value of the firm (enterprise value) and its earnings before interest, taxes, depreciation, and amortization (EBITDA). This method eliminates the effects of different levels of leverage on the valuation comparison, which makes it more comparable among firms with different capital structures. Therefore, the statement is true.

Question 16

Studies show that rival firms' share prices will rise in response to the announced acquisition of a competitor,regardless of whether the proposed acquisition is ultimately successful or unsuccessful.

Accepted Answer

This is true. The announcement of an acquisition can indicate favorable market conditions and potential growth opportunities for the industry as a whole, leading to increased investor confidence and higher stock prices for rival firms.

Question 17

Analysts have increasingly used the relationship between enterprise value to earnings before interest and taxes,depreciation,and amortization to value firms.

Accepted Answer

This statement is true. The Enterprise Value/EBITDA ratio is a commonly used valuation metric in financial analysis.

Question 18

The comparable companies' method is widely used in so-called "fairness opinion" letters.

Accepted Answer

The comparable companies' method is often used in fairness opinion letters, which analyze the fairness of a proposed transaction from a financial perspective. This method involves comparing the financial ratios and multiples of the subject company to those of similar publicly traded companies to determine a valuation range.

Question 19

The value of the comparable companies' method may vary widely depending upon when it is calculated in the business cycle.

Accepted Answer

The value of the comparable companies' method is highly dependent on market conditions, which may vary throughout the business cycle. For example, during an economic downturn, companies may be undervalued and thus appear attractive for investment, whereas during a booming economy, companies may be overvalued and appear less attractive for investment. Therefore, the timing of when the method is calculated is crucial in accurately determining the value of a company.

Question 20

Empirical evidence suggests that forecasts of earnings and other value indicators are better predictors of firm value than value indicators based on historical data.

Accepted Answer

Empirical evidence has found that forecasts of earnings and other value indicators are better predictors of firm value as they account for expected future changes and developments, rather than relying solely on past performance.

Quiz 8: Relative,asset-Oriented,and Real Option Valuation Basics