Question 1

Which of the following equations for the Book value Plus Adjustment method is correct? A)Value of equity (V_E)= market value of equity - adjustments B)Value of equity (V_E)= book value of equity + adjustments C)Value of equity (V_E)= book value of equity - adjustments D)Value of equity (V_E)= market value of equity + adjustments

Accepted Answer

The Book value Plus Adjustment method is calculated by adding adjustments to the book value of equity. Therefore, the correct equation is B) Value of equity (V_E)= book value of equity + adjustments.

Question 2

________ are common forms of non-cash expenses for a firm.
A)Depreciation and amortization
B)Depreciation and interest
C)Depreciation and dividends
D)All of the above

Accepted Answer

Depreciation and amortization are common forms of non-cash expenses for a firm. Depreciation refers to the gradual loss of value of a fixed asset over time, while amortization is the gradual reduction of the value of an intangible asset over time. Neither of these expenses require the outflow of cash, as they are simply accounting adjustments to reflect the decrease in value of the asset. Option B is incorrect because interest is a cash expense, while options C and D are incorrect as dividends are cash payments made to shareholders.

Question 3

Which of the following descriptions of the component costs of capital is INCORRECT? A)The cost of preferred shares,K_p,is estimated as the current dividend yield on any existing preferred shares or shares of similar firms. B)The cost of debt,K_d,is estimated as the after-tax cost of issuing new debt (such as bonds)today. C)The cost of debt is estimated using the CAPM as the risk-free rate or long-term government bond yield plus beta times a market risk premium. D)All of the above are correct.

Accepted Answer

The incorrect description is option C. The cost of debt is typically estimated using either the yield on existing debt or the cost of issuing new debt, but not using the CAPM. The correct formula for cost of debt is generally: [(interest rate on debt) x (1 - tax rate)].

Question 4

By changing a firm's capital structure to one more optimal,a firm may be able to
A)reduce its cost of capital.
B)increase its value.
C)find that more of its potential projects are financially attractive due to lower capital costs.
D)find that all of the above are true.

Accepted Answer

By changing its capital structure to a more optimal one, a firm can reduce its cost of capital, increase its value, and find more attractive financial projects with lower capital costs. Therefore, all of the options mentioned in A, B, and C are true.

Question 5

Which of the following statements regarding the selection of how many years to use in estimating FCFF is FALSE?
A)There is no set rule for how many years to use.
B)Common practice suggest five to ten years is a reasonable amount of time to estimate individual year cash flows.
C)One guiding principle is to project out the number of years until you're willing to assume that a firm's free cash flows will grow at a constant rate.
D)All of the above are true.

Accepted Answer

All of the statements are true regarding the selection of how many years to use in estimating FCFF. There is no set rule for how many years to use, common practice suggests five to ten years, and one guiding principle is to project out the number of years until you're willing to assume that a firm's free cash flows will grow at a constant rate.

Question 6

Mason Construction Inc.had net sales of $480,000,costs of sales of $130,000,additional expenses of $200,000,depreciation of $40,000,and a tax rate of 30%.Use this information to determine the firm's after tax earnings on a cash basis.
A)$77,000
B)$105,000
C)$117,000
D)$145,000

Accepted Answer

To calculate after-tax earnings on a cash basis, first find the earnings before tax (EBT) by subtracting costs of sales, additional expenses, and depreciation from net sales: $480,000 - $130,000 - $200,000 - $40,000 = $110,000. Then, calculate taxes: $110,000 * 30% = $33,000. Subtract taxes from EBT to get after-tax earnings: $110,000 - $33,000 = $77,000. Finally, add back depreciation (a non-cash expense) to get cash basis earnings: $77,000 + $40,000 = $117,000.

Question 7

Simpson Productions Inc.had net sales of $300,000,costs of sales of $150,000,additional expenses of $100,000,depreciation of $50,000,and a tax rate of 30%.Use this information to determine the firm's after tax earnings on a cash basis.
A)$0
B)$30,000
C)$35,000
D)$50,000

Accepted Answer

The answer of Simpson Productions Inc.had net sales of $300,000,costs...

Question 8

Figure 13-1 Bestor Travel Inc.Balance Sheet
  Suppose you were fortunate on the timing of your property investment and the firm's property is now worth $750,000.An investor has offered you $100,000 for the patent.Further,some of the firm's inventory has become obsolete and is now worth only $180,000.
-Assume the information in Figure 13-1 is correct,EXCEPT the market value of property is now estimated to be $450,000.Use the Book value Plus Adjustment method along with the information from 13-1 and the new estimated value of property to value the firm's equity.
A)$1,100,000
B)$1,200,000
C)$1,300,000
D)$1,400,000

Accepted Answer

The Book Value Plus Adjustment method takes the book value of equity and adds or subtracts the difference between the market value and book value of assets. In this case, the market value of property is now estimated to be $450,000, which is $100,000 more than the book value of $350,000. Therefore, we add $100,000 to the book value of equity of $1,100,000 to get a value of $1,200,000.

Question 9

An advantage of the book value of equity plus adjustments approach is:
A)that it implicitly assumes that a firm is going to be shut down.
B)it doesn't consider the firm being valued as an ongoing concern.
C)we can immediately "plug in" the starting point of the book value of equity without having to do any calculations.
D)All of the above.

Accepted Answer

The advantage of the book value of equity plus adjustments approach is that we can easily use the starting point of the book value of equity without having to do any calculations. Option A and B are incorrect as the approach does not assume that the firm will be shut down and it does consider the firm being valued as an ongoing concern.

Question 10

For the FCFF calculation:
A)we must examine changes in net working capital.
B)a firm that is not growing may be expected to have no changes in net working capital.
C)it is important to consider only incremental or changing working capital needs.
D)all of the above are true.

Accepted Answer

All three statements are true. For the FCFF calculation, we must examine changes in net working capital. If a firm is not growing, we may expect to have no changes in net working capital. And it is important to consider only incremental or changing working capital needs. Therefore, choice D is the best answer.

Question 11

If a viable firm is not growing but is expected to continue over time,then we would expect changes in net working capital to be equal to:
A)a percentage of total sale.
B)EBIT.
C)depreciation.
D)$0

Accepted Answer

If a firm is not growing, it implies that it is not investing in new projects or making any significant changes in its operations. Therefore, the firm's net working capital would remain relatively stable, and we would not expect any significant changes over time. As a result, the answer is $0.

Question 12

If a viable firm is not growing but is expected to continue over time,then we would expect capital expenditures to be equal to:
A)sales.
B)depreciation.
C)EBIT.
D)taxes payable.

Accepted Answer

When a viable firm is not growing but is expected to continue, it is likely to invest in capital assets that would eventually require replacement. Therefore, the capital expenditures of the firm would be similar to its depreciation expense. Hence, the correct choice is B.

Question 13

Compared to a publicly traded firm,a comparable private firm is thought to be:
A)20% to 30% less valuable.
B)less liquid for the owners.
C)more difficult to accurately value.
D)all of the above.

Accepted Answer

A) Private firms are known to be less valuable than publicly traded firms due to less access to capital markets and less transparency in financial reporting. The discount factor ranges from 20% to 30%.

B) Private firms are less liquid as the owners cannot sell their shares on a stock exchange; instead, they have to find a buyer privately, which can take time, effort, and cost.

C) Private firms do not have to disclose as much financial information as publicly traded firms, making it harder to value them. Private firms have unique assets, liabilities, and risks, making valuation harder.

Question 14

Which of the following statements regarding firms and value is NOT true?
A)We can create value by taking on negative net present value projects.
B)Shareholder control in and of itself has value.
C)Value is ultimately what someone is willing to pay for a firm.
D)It is important to know what is being valued; the assets or the equity in a firm.

Accepted Answer

Taking on negative net present value projects does not create value for a firm. In fact, it can decrease the overall value of the firm. The other statements are true - shareholder control has value, value is ultimately determined by what someone is willing to pay for a firm, and it is important to distinguish between valuing the assets or equity in a firm.

Question 15

Which of the following is NOT a necessary step in the Discounted Cash Flow Analysis method of valuing equity?
A)Estimate a cost of capital.
B)Estimate the present value of terminal value cash flows.
C)Calculate the present value of free cash flows over the number of years in question.
D)All of the above are necessary steps for the discounted cash flow method of valuation.

Accepted Answer

All of the given steps are necessary in the Discounted Cash Flow Analysis method of valuing equity. The estimation of cost of capital, present value of terminal value cash flows, and present value of free cash flows over the number of years in question are crucial elements in determining the value of a company's stock using this method.

Question 16

Figure 13-1 Bestor Travel Inc.Balance Sheet
  Suppose you were fortunate on the timing of your property investment and the firm's property is now worth $750,000.An investor has offered you $100,000 for the patent.Further,some of the firm's inventory has become obsolete and is now worth only $180,000.
-Bestor Travel,Inc manufactures and sells high quality light weight luggage highly prized in the market for its style and durability.Use the information from Figure 13-1 and the Book value Plus Adjustment method to value the firm's equity.
A)$1,100,000
B)$1,200,000
C)$1,300,000
D)$1,400,000

Accepted Answer

The answer of Figure 13-1 Bestor Travel Inc.Balance Sheet
 ...

Question 17

Despite the clear cons of book value plus equity method of firm evaluation,we often see it used as a starting point for valuation.

Accepted Answer

Even though there are disadvantages of using book value plus equity method for firm evaluation, it is still commonly used as a preliminary step in valuation. This is because it provides a simple and straightforward method of assessing the financial position of a company, which can be useful in setting a baseline for more in-depth analysis. However, it is important to recognize the limitations of this approach and to use additional valuation methods to provide a more complete picture of a company's value.

Question 18

Which of the following formulas correctly estimates free cash flows to the firm?
A)FCFF = EBIT × (1 + tax rate)+ non cash expenses - capital expenditures - net increases in working capital
B)FCFF = EBIT × (1 - tax rate)+ non cash expenses - capital expenditures - net increases in working capital
C)FCFF = EBIT × (1 - tax rate)+ non cash expenses + capital expenditures - net increases in working capital
D)FCFF = EBIT × (1 - tax rate)- non cash expenses + capital expenditures - net increases in working capital

Accepted Answer

The correct formula to estimate free cash flows to the firm (FCFF) is FCFF = EBIT × (1 - tax rate)+ non cash expenses - capital expenditures - net increases in working capital. This formula takes into account the taxes paid by the firm (by subtracting the product of EBIT and the tax rate from EBIT) and the investments made in long-term assets (by subtracting capital expenditures) and working capital (by subtracting net increases in working capital) from the cash flows generated by the firm's operations (EBIT + non-cash expenses). Therefore, option B is the best choice.

Question 19

Compared to a publicly traded firm,a comparable private firm is thought to be up to 20% to 30% more valuable.

Accepted Answer

This statement is false. Private firms are generally considered to be less valuable than publicly traded firms due to the lack of liquidity and transparency.

Question 20

Managers can create value by undertaking positive net present value projects.

Accepted Answer

Undertaking positive net present value projects means that the value created by the project is greater than the initial investment. This creates a positive impact on the company's financial performance and increases shareholder value. Therefore, managers can create value by choosing and executing positive net present value projects.

Quiz 13: Measuring and Creating Value

Which of the following equations for the Book value Plus Adjustment method is correct?

________ are common forms of non-cash expenses for a firm.

Which of the following descriptions of the component costs of capital is INCORRECT?

By changing a firm's capital structure to one more optimal,a firm may be able to

Which of the following statements regarding the selection of how many years to use in estimating FCFF is FALSE?

Mason Construction Inc.had net sales of $480,000,costs of sales of $130,000,additional expenses of $200,000,depreciation of $40,000,and a tax rate of 30%.Use this information to determine the firm's after tax earnings on a cash basis.

Simpson Productions Inc.had net sales of $300,000,costs of sales of $150,000,additional expenses of $100,000,depreciation of $50,000,and a tax rate of 30%.Use this information to determine the firm's after tax earnings on a cash basis.

An advantage of the book value of equity plus adjustments approach is:

For the FCFF calculation:

If a viable firm is not growing but is expected to continue over time,then we would expect changes in net working capital to be equal to:

If a viable firm is not growing but is expected to continue over time,then we would expect capital expenditures to be equal to:

Compared to a publicly traded firm,a comparable private firm is thought to be:

Which of the following statements regarding firms and value is NOT true?

Which of the following is NOT a necessary step in the Discounted Cash Flow Analysis method of valuing equity?

Despite the clear cons of book value plus equity method of firm evaluation,we often see it used as a starting point for valuation.

Which of the following formulas correctly estimates free cash flows to the firm?

Compared to a publicly traded firm,a comparable private firm is thought to be up to 20% to 30% more valuable.

Managers can create value by undertaking positive net present value projects.