Chapter 10 - Exam 2

Question 1

The valuation approach involving discounting present value cash flows for risk and delay is called discounted cash flow (DCF).

Answer 1

False

Question 2

The stepping stone year is the first year before the explicit forecast period.

Answer 2

False

Question 3

The terminal or horizon value is the value of a venture at the end of its explicit forecast period.

Answer 3

True

Question 4

The “stepping stone” year is the second year after the explicit forecast period when valuing a venture.

Answer 4

False

Question 5

The explicit forecast period is the two to ten year period in which the venture’s financial statements are explicitly forecast.

Answer 5

True

Question 6

The maximum dividend valuation method involves explicitly forecasted dividends to provide surplus cash which is positive.

Answer 6

False

Question 7

The easiest way to value a venture is to discount the projected maximum dividend/issue stream.

Answer 7

True

Question 8

The pseudo dividend method treats surplus cash as a free cash flow to equity.

Answer 8

True

Question 9

The reversion value of a venture is the present value of the venture’s terminal value.

Answer 9

True

Question 10

A venture’s reversion value is the present value of ongoing expenses.

Answer 10

False

Question 11

The “reversion value” is the future value of the terminal value.

Answer 11

False

Question 12

The “terminal” value is the value of the venture at the beginning of the explicit forecast period.

Answer 12

False

Question 13

As used in this textbook, the “terminal” value is the same as the “horizon” value.

Answer 13

True

Question 14

Finding the present value of the horizon value produces the venture’s reversion value.

Answer 14

True

Question 15

Surplus cash is the cash remaining after required cash, all operating expenses, and reinvestments are made.

Answer 15

True

Question 16

Surplus cash is the cash remaining after required cash, all operating expenses, reinvestments, and dividends payouts are made.

Answer 16

False

Question 17

Required cash is the amount of cash required to operate a venture through its day-to-day business.

Answer 17

True

Question 18

Surplus cash is the amount of cash required to pay scheduled dividends for next quarter.

Answer 18

False

Question 19

The capitalization or “cap” rate is the spread between the discount rate and the growth rate of cash flow in the terminal value period.

Answer 19

True

Question 20

Pre-money valuation is the present value of a venture prior to a new money investment.

Answer 20

True

Question 21

Post-money valuation is the pre-money valuation of a venture plus all monies previously contributed by the venture’s founders.

Answer 21

False

Question 22

“Net operating working capital” is current assets other than surplus cash less non-interest-bearing current liabilities.

Answer 22

True

Question 23

“Equity valuation cash flow” is defined as: net sales + depreciation and amortization expense – change in net operating working capital (excluding surplus cash) – capital expenditures + net debt issues.

Answer 23

False

Question 24

The “pseudo dividend method” (PDM) is a valuation method involving zero explicitly forecasted dividends and an adjustment to working capital to strip surplus cash.

Answer 24

True

Question 25

A “post-money” valuation differs from a “pre-money” valuation by the cost of financial capital.

Answer 25

False

Question 26

Applying the “maximum dividend method” (MDM) and the “pseudo dividend method” (PDM) result in different valuation estimates.

Answer 26

False

Question 27

The “maximum dividend method” assumes that all surplus cash will be paid out as dividends.

Answer 27

True

Question 28

A pseudo dividend involves excess cash that does not need to be invested in a venture’s assets or operations, and may be invested elsewhere for a period of time.

Answer 28

True

Question 29

The pseudo dividend method treats equity infusions and withdrawals in a “just in time” fashion.

Answer 29

True

Question 30

The pseudo dividend method treats surplus cash either as stripped out while not in use or as employed outside the venture and stored in a zero NPV investment

Answer 30

True

Question 31

The wider the capitalization or “cap” rate (i.e., the discount rate minus the growth rate in the terminal period), the higher the terminal value.

Answer 31

False

Question 32

The present value of the venture’s expected future cash flows is called?

	a. going-concern value
	b. present value
	c. terminal value
	d. reversion value
	e. net present value

Answer 32

a.

Question 33

The value today of all future cash flows discounted to the present at the investor’s required rate of return is called?

	a. going-concern value
	b. present value
	c. terminal value
	d. reversion value
	e. net present value

Answer 33

b.

Question 34

The value of the venture at the end of the explicit forecast period is called the horizon value, or what?

	a. going-concern value
	b. present value
	c. terminal value
	d. reversion value
	e. net present value

Answer 34

c.

Question 35

The present value of the terminal value is called?

	a. going-concern value
	b. present value
	c. terminal value
	d. reversion value
	e. net present value

Answer 35

d.

Question 36

The present value of a set of future flows plus the current undiscounted flow is called?

	a. going-concern value
	b. present value
	c. terminal value
	d. reversion value
	e. net present value

Answer 36

e.

Question 37

The calculation of equity valuation cash flows nets the cash impact of all other balance sheet and income accounts to focus on the ______ account as the repository of any remaining cash flow.

	a. cash
	b. debt
	c. equity
	d. non-interest-bearing liabilities
	e. net income

Answer 37

c.

Question 38

Equity valuation cash flow = Net income plus

a. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures plus net debt issues
b. Depreciation and amortization expense plus the change in net operating working capital plus minus capital expenditures plus net debt issues
c. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures minus net debt issues
d. Depreciation and amortization expense minus the change in net operating working capital plus minus capital expenditures plus net debt issues
e. Depreciation and amortization expense minus the change in net operating working capital plus capital expenditures plus net debt issues

Answer 38

d.

Question 39

In a wildly successful first year in business that started and ended with no required cash, your firm has operating income of $989,000, net income of $637,000, current assets of $900,000, current liabilities of $659,000, net capital expenditures were $690,000, and depreciation was $460,000. The firm has never financed itself with debt. What is your equity valuation cash flow?

	a. $648,000
	b. $900,000
	c. $2,028,000
	d. $166,000

Answer 39

d.

Question 40

Your firm has been in business for two years. In its first year, the firm ended with $227,000 of current assets, long-term assets of $143,000, $70,000 in surplus cash, current liabilities of $52,000, and long-term assets of $68,000. At the end of the second year, current assets were $279,000, long-term assets of $195,000, surplus cash of $90,000, current liabilities of $62,000, and long-term assets of $78,000. What is your firm’s change in net operating working capital?

	a. $22,000
	b. $62,000
	c. $42,000
	d. $244,000
	e. $32,000

Answer 40

a.

Question 41

The equity valuation method involving explicitly forecasted dividends to provide surplus cash of zero is called?

	a. maximum dividend method
	b. pseudo dividend method
	c. sustainable growth method
	d. dividend payout method

Answer 41

a.

Question 42

The equity valuation method involving zero explicitly forecasted dividends and an adjustment to working capital to strip surplus cash is called?

	a. maximum dividend method
	b. pseudo dividend method
	c. sustainable growth method
	d. dividend payout method

Answer 42

b.

Question 43

“Just in time” capital injections by equity investors is a reference to

	a. sustainable growth
	b. the present value of the terminal value 
	c. equity investors’ providing money only when needed
	d. dividend payout

Answer 43

c.

Question 44

The maximum dividend method is

a. the cleanest for valuing assets, but creates problems valuing surplus cash
b. the cleanest for valuation purposes but its dividend-laden financial statements can dramatically understate the firm’s cash position
c. the cleanest for cash planning, but creates problems valuing the venture by discounting the dividends
d. calculated by directly discounting the cash flow statement’s projected dividend flow to investors, but ignores risks associated with periodic gluts of surplus cash

Answer 44

b.

Question 45

The pseudo dividend method is

a. the cleanest for valuing assets, but creates problems valuing surplus cash
b. the cleanest for valuation purposes but its dividend-laden financial statements can dramatically understate the firm’s cash position
c. the cleanest for cash planning, but creates problems valuing the venture by discounting the dividends
d. calculated by directly discounting the cash flow statement’s projected dividend flow to investors, but ignores risks associated with periodic gluts of surplus cash

Answer 45

c.

Question 46

“Required cash” is?

a. the cash needed to pay interest expense
b. a valuation method for early stage ventures
c. cash needed to cover a venture’s day-to-day operations
d. cash available to pay as a dividend

Answer 46

c.

Question 47

Most discounted cash flow valuations involve using cash flows from an:

a. historical period, an explicit forecast period, and a terminal value
b. historical period and a terminal value
c. historical period and an explicit forecast period
d. explicit forecast period and a terminal value

Answer 47

d.

Question 48

Which one of the following equity valuation methods records surplus cash on the balance sheet but assumes that the surplus cash is paid out over time for valuation purposes?

a. maximum dividend method
b. pseudo dividend method
c. sustainable growth method
d. return on equity method

Answer 48

b.

Question 49

When estimating the terminal value of a venture using an equity valuation method, a perpetuity growth equation is often applied that uses the capitalization rate for discounting purposes. This “cap” rate is measured as the:

a. equity discount rate minus the perpetuity growth rate
b. equity discount rate plus the perpetuity growth rate
c. risk-free rate plus the perpetuity growth rate
d. risk-free rate minus the perpetuity growth rate

Answer 49

a.

Question 50

A venture’s going-concern value is the:

a. present value of the expected future cash flows
b. net present value of the current and expected future cash flows
c. future value of the expected cash flows
d. net future value of the current and expected cash flows

Answer 50

a.

Question 51

The purpose of the stepping stone year is?

a. to assure that there is sufficient required cash
b. to assure that future dividends are constant
c. to assure that investment flows are consistent with terminal growth rates
d. to allow for a final year of higher-than-sustainable growth

Answer 51

a.

Question 52

When estimating the terminal value of a cash flow perpetuity, which one of the following is not a component?

	a. the next period’s cash flow
	b. a constant discount rate
	c. a constant growth rate
	d. the payback period

Answer 52

d.

Question 53

Which one of the following components is not a component of the equity valuation cash flow?

	a. NOPAT
	b. depreciation and amortization expense
	c. change in net operating working capital (without surplus cash)
	d. capital expenditures
	e. net debt issues

Answer 53

a.

Question 54

What is the difference between pre-money valuation and post-money valuation?

	a. size of the capitalization rate
	b. amount of money injected by new investors
	c. revision value
	d. amount of money previously contributed by founders
	e. amount of money previously contributed by venture investors

Answer 54

b.

Question 55

To calculate a terminal value, one divides the next period’s cash flow by the:

	a. constant discount rate plus a constant growth rate
	b. constant discount rate plus a variable growth rate
	c. constant discount rate minus a constant growth rate
	d. constant growth rate minus constant discount rate
	e. constant growth rate plus a variable discount rate

Answer 55

c.

Question 56

The MDM equity valuation method is an abbreviation for:

	a. minimum dividend method
	b. maximum discount method
	c. maximum dividend method
	d. minimum discount method e. Montgomery design method

Answer 56

c.

Question 57

The PDM equity valuation method is an abbreviation for:

	a. pseudo dividend method
	b. proximate dividend method
	c. pseudo discount method
	d. proximate discount method
	e. pre-money discount method

Answer 57

a.

Question 58

Estimate a venture’s equity valuation cash flow based on the following information: net income = $6,372; depreciation = $4,600; change in net operating working capital = $2,415; capital expenditures = $6,900; and new debt issues = $1,000.

a. $6,487

	b. $5,487	
	c. $4,487
	d. $3,787
	e. $5,787

Answer 58

b.

Question 59

Estimate a venture’s terminal value based on the following information: current year’s net income = $20,000; next year’s expected cash flow = $26,000; constant future growth rate = 7%; and venture investors’ required rate of return = 20%.

	a. $156,846 b. $285,714 c. $200,000 d. $150,000 e. $428,571

Answer 59

c.

Question 60

Estimate a venture’s required rate of return based on the following information: terminal value = $400,000; current year’s net income = $20,000; next year’s expected cash flow = $25,000; and a constant growth rate = 7%.

	a. 6% b. 7% c. 8% d. 9% e. 10%

Answer 60

d.

Question 61

Estimate a venture’s constant growth rate (g) based on the following information: terminal value = $400,000; current year’s net income = $20,000; next year’s expected cash flow = $25,000; and a required rate of return of 20%.

	a. 2% b. 4% c. 6% d. 8% e. 10%

Answer 61

b.

Question 62

Which one of the following components is not a component of the equity valuation cash flow calculation?

	a. net income
	b. depreciation and amortization expense
	c. change in net operating working capital (without surplus cash)
	d. capital expenditures
	e. net equity repurchases

Answer 62

e.

Question 63

Estimate a venture’s terminal value based on the following information: current year’s net sales = $500,000; next year’s expected cash flow = $16,000; constant future growth rate = 10%; and venture investors’ required rate of return = 20%.

	a. $156,846 b. $285,714 c. $200,000 d. $150,000 e. $160,000

Answer 63

e.

Question 64

Estimate a venture’s cash flow expected next year based on the following information: current year’s net sales = $400,000; terminal value = $500,000; constant future growth rate = 10%; and venture investors’ required rate of return = 20%.

	a. $20,000 b. $40,000 c. $50,000 d. $60,000 e. $80,000

Answer 64

c.