Corporate Valuation Flashcards by Sandie Huang

Calculate equity value based on following information:

EV = $234,503
Net debt = $9,542
Cash = $2,618
Options/ warrant proceeds = $1,408

(General Formula) Equity Value = EV - Net debt + cash & cash equivalents

Note that equity value is found by taking the company’s FULLY DILUTED shares outstanding and multiplying it by the stock price offered in the context of M&A or market stock price. Fully diluted means that aside from just the basic shares outstanding, it includes:

In-the-money options
Warrants
Convertible securities

In this case, we have the following equity value:
Equity Value = EV - Net debt + cash & cash equivalents + options and warrant proceeds

Equity Value = 234,503 - 9,542 + 2,618 + 1,408 = 228,987

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Equity value is found by taking the company’s FULLY DILUTED shares outstanding and multiplying it by the stock price offered in the context of M&A or market stock price. Fully diluted means that aside from just the basic shares outstanding, it includes: choose 1-5
A) In-the-money options
B) Out-of-the-money options
C) Warrants
D) Convertible securities
E) Preferred stocks

Fully diluted means that aside from just the basic shares outstanding, it includes: choose 1-5
A) In-the-money options
C) Warrants
D) Convertible securities

NOT E) Preferred stocks are hybrid securities that have features of both equity and debt. They are treated more as debt, in this case, because they pay a fixed amount of dividends and have a higher priority in asset and earning claims than common stock. In an acquisition, they normally must be repaid just like debt.

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The valuation method is used in reality for the valuation of real estate assets and holding companies (: companies devoted to investing in other companies)?
A) DCF
B) Multiples
C) Asset-Based Methods
D) LBO
E) APV

Asset-Based Methods are used to compute the market value of single investments and compare this with the balance sheet values. Afterward, by deducting the financial position to calculate the market value of equity.

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According to the “valuation framework as a function of uncertainty and managerial flexibility”, a risk that is characterized by low managerial flexibility and high uncertainty entail?
A) risks that are highly significant and specific. In this event, the average scenario will never materialize. Therefore, you must use two different scenario plans: either it happens or it does not happen
B) a risk that is of significant impact if materialized, but you are able to react.
C) a risk that is of insignificant impact but no managerial ability to react and improve the situation of the scenario materializes
D) none of the above

A) risks that are highly significant and specific. In this event, the average scenario will never materialize. Therefore, you must use two different scenario plans: either it happens or it does not happen.
- Example: you own a manufacturing company with 50% of revenues coming from Armani – if a license is renewed, you maintain current profit, if not, you don’t. Therefore, you use the high uncertainty scenario framework.

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In the CAPM, the risk-free rate measures:
A) the market risk
B) the exposure to market risk (systematic risk)
C) time value of money
D) none of the above

In the CAPM, the risk-free rate measures: C) time value of money
R_f is the return that is required on a risk-free asset (since the investor could otherwise invest the capital in a risk-free asset). With this having theoretically no uncertainty, this part of the formula simply measures the time value of money.

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Reinvestment risk is defined as:
A) the risk of the company not being able to reinvest at the same rate as estimated in DCF valuation.
B) the risk that a positive reinvestment rate (positive growth) amplifies any potential negative return of the company
C) the risk that a “risk-free” investment turns out to be not risk-free
D) the risk that an investment’s cash flows will earn less in a new security investment, creating an opportunity cost. It is the potential that the investor will be unable to reinvest cash flows at a rate comparable to their current rate of return.

Reinvestment risk is defined as: D)
the risk that an investment’s cash flows will earn less in a new security investment, creating an opportunity cost. It is the potential that the investor will be unable to reinvest cash flows at a rate comparable to their current rate of return.

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Theoretically, there should be zero variance and zero standard deviation in a risk-free investment, which entails that a risk-free rate has no risk nor uncertainty. It needs to have no default risk and no reinvestment risk. Therefore, this rate should only measure the time value of money, which is a very accurate assumption of the risk-free rate in real-life valuation.

TRUE/ FALSE

FALSE: In reality, it is highly unlikely that any asset has zero volatility. Therefore, this methodology is an approach to capture reality in the best POSSIBLE way but does NOT fully represent real life.

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Most of the time, the approach to incorporate the “risk-free” rate is:
A) CFs of each country of operation is to be discounted with separate discount rates, based on the risk-free rates in each individual country
B) Dominating country, based on sale: e.g., the government bond YTM in the country with dominating sale is used as the risk-free rate
C) Weighted average rate (based on % sale in each country): e.g., the weighted average of the governments’ bonds’ YTM based on % of sale in each country is used as the risk-free rate

B) Dominating country, based on sale: e.g., the government bond YTM in the country with dominating sale is used as the risk-free rate

This is the most common method used.

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Under the “historical risk premium” approach, which of the following is NOT an underlying methodology?

A) CFs of each country of operation is to be discounted with separate discount rates, based on the market risk premium in each individual country, using each respective country’s market index return as (r_M).
B) Dominating country, based on % sale: the dominating country’s market index return is used as the r_M and as the basis of market risk premium calculation.
C) Weighted average return on indices (based on % sale in each country): weights based on % sales are assigned to each country’s market index return, which accumulates to a proxy for r_M used in market risk premium calculation and CAPM of the entire company
D) Implied risk premium approach: where r_M is implied in the estimates of CFs returned to all shareholders n the index (dividends and buybacks), at consensus growth
E) MRP directly estimated by Damodaran’s research

WRONG:
D) is NOT a “historical risk premium” approach, but an “Implied risk premium approach”, where r_M is implied in the estimates of CFs returned to all shareholders n the index (dividends and buybacks), at consensus growth.
E) is NOT a “historical risk premium” approach, but a different credible approach, where MRP is directly estimated by Damodaran’s research

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1) The asset/stock is exactly as volatile as the market when β is _____
2) The asset/stock is more volatile than the market (the stock is procyclical) when β is _____
3) The asset/stock is less volatile than the market when β is _____
4) The asset/ stock is uncorrelated to the market when β is _____
5) The asset/stock is negatively correlated to the market when β is _____

1) The asset/stock is exactly as volatile as the market when β is EQUAL TO 1
2) The asset/stock is more volatile than the market (the stock is procyclical) when β is ABOVE 1
3) The asset/stock is less volatile than the market when β is BETWEEN 0 AND 1
4) The asset/ stock is uncorrelated to the market when β is EQUAL TO 0
5) The asset/stock is negatively correlated to the market when β is NEGATIVE

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The higher amount of fixed financing cost (interest payments connected to debt financing) relative to variable financing costs (dividend payout connected to equity financing), the HIGHER/LOWER the raw (levered) beta.

The rationale is: the higher the proportion of fixed costs, the higher the risk for the company. The same counts for fixed and variable operating costs: The higher amount of fixed operating expenses (salaries, depreciation) than variable operating costs, the higher the beta.

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Which of the following about “unlevering beta” is NOT true?
A) A common methodology applied to unlever beta is the Hamada formula
B) A common methodology applied to unlever beta is the Blume formula
C) When unlevering beta for comparable companies under the fundamentals (bottom-up) approach, we need each individual comparable comps’ levered beta, D/E ratio, and tax rate
D) the debt used in the D/E ratio may be either net debt (net cash) or gross debt - as long as the valuation is consistent in using either one
E) it is probable that some of the comparable comps have negative net D/E ratios, in which case we set the ratio to 0 (common in real life valuation).

WRONG: B) A common methodology applied to unlever beta is the Blume formula

The Blume formula is used to adjust raw beta to take into account the assumption that beta moves toward 1 - that is, putting 2/3 weight on the actual raw beta and 1/3 weight on market beta (=1)

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In the context of valuation - e.g., when calculating the industry beta using the bottom-up approach, why may it be appropriate to compute the MEDIAN of the comparable comp betas, rather than AVERAGE?

MEDIAN is a good way to exclude any potential outliers, while the AVERAGE incorporates such outliers.

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Which of the following statements about the risk profile of the company to be assessed by the WACC is NOT true?
A) cost of debt is always lower than the cost of equity - even when k_D embeds specific default risk
B) the beta used in cost of capital calculation excludes specific risks due to the assumption of diversification
C) firm-specific risks (non-systematic) can be incorporated directly into WACC as additional premium factors
D) WACC does not incorporate any non-systematic risks

WRONG: D) WACC does not incorporate any non-systematic risks

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Damodaran has contributed to the field of valuation thought: select 1-4
A) Market risk premium estimate used in CAPM
B) Adjustment of beta to take into account that firms over time become more diversified and mature, and therefore have a beta approaching 1
C) Unlever/ reliever beta formula
D) Rating-based cost of debt estimation: if no credit rating on the target company exists, an implied rating can be derived using Damodaran’s rating model for SMEs (latest: Aug. 2021).

Damodaran has contributed to the field of valuation thought:
A) Market risk premium estimate used in CAPM &
D) Rating-based cost of debt estimation: if no credit rating on the target company exists, an implied rating can be derived using Damodaran’s rating model for SMEs.

B) Adjustment of beta to take into account that firms over time become more diversified and mature, and therefore have a beta approaching 1. This is the Blume formula

C) Unlever/ reliever beta formula is the Hamada formula

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The capital structure theory helps us evaluate and understand whether a certain level of leverage creates value.

TRUE/ FALSE

TRUE

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When computing a DCF of a company with NO growth and WITH Taxes, which of the following characteristics is/are TRUE? select 1-5
A) the perpetuity formula is used to make the DCF computation:
DCF = (CF_(Annual Constant)) / WACC
B) growth rate, g=0
C) income and cash flows can be assumed constant and perpetual
D) any investments made are only for maintenance. There is no change in working capital or CAPEX.
E) leverage increases EV, because interest expenses are tax-deductible.

All of the statements are TRUE

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If a company has no debt, following is TRUE: Select 1-4
A) the company’s FCFE = FCFO
B) the company’s EV (market value of capital employed) = Equity Value
C) the required return to equity-holders is the cost of unlevered equity
D) cost of unlevered equity estimated by using CAPM is:
k_EU = r_F + β_U * (r_M-r_F)
E) all of the above are true

E) all of the above are true

A) the company’s FCFE = FCFO –> FCFE = FCFO - interest expense + tax shield. In the absence of debt, interest is 0 and so is the tax shield.
B) the company’s EV (market value of capital employed) = Equity Value. If the company was financed by any debt, the EV would be equal to equity value + net debt (debt-cash) –> EV would be higher than equity value
C) the required return to equity-holders is the cost of unlevered equity - same rational as WACC : but now there is no debt nor any tax shield or cost of debt
D) cost of unlevered equity estimated by using CAPM is:
k_EU = r_F + β_U * (r_M-r_F)
- unlevered cost of equity uses unlevered beta!

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With no debt, Equity Value = EV. According to Modigliani and Miller, as debt increases, EV _____ relative to equity value
A) increases
B) decreases

With no debt, Equity Value = EV. According to Modigliani and Miller, as debt increases, EV INCREASES relative to equity value.

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MM2 argues that as debt increases, the cost of equity levered increases too. Why is that?

Cost of equity levered increases as the debt of the company increases, because debt increases risk of the firm (default risk), which in turn leads to higher required return by equiyt investors.

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In case of the Classical model, as leverage increases, WACC decreases, despite that cost of equity will rise with the increased risk. The decreased WACC is the standard result, reflecting the advantages to debt provided by the tax system (interest is deductible).

TRUE/ FALSE

TRUE

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In the generalized asset-side DCF model with growht, which of the following statements are TRUE? Select 1-4
A) Under a real-life scenario, the steady state hypotheses are relaxed, and the valuation is generally split into two parts: business plan and terminal value - it is a two-staged model
B) Business plan: the explicit part, where FCFO will depend on the company’s business plan for a few first explicit years, which are independently discounted.
C) Terminal value: the synthetic part, where the years beyond will be valued through a synthetic terminal value, under a steady growth equilibrium scenario.
D) WACC is (usually) constant across all periods

All four statements are correct

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In the steady state scenario at the end of the business plan horizon (where TV is computed), which of the following characteristics apply? Select 1-4
A) CAPEX = DD&A: investments are only made to the maintenance of already existing assets. No reinvestments are made beyond those made for maintenance
B) Given NO growth, the change in NWC = zero or NWC is growing at the steady growth rate (generally the inflation rate)
C) No change in gross debt
D) Gross debt will typically decrease

All are characteristics of a steady state scenario where TV is computed from, EXCEPT D.

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Positive growth is always enterprise value enhancing.

TRUE/ FALSE

FALSE
Growth rate does translate into enhanced enterprise value, provided that the return of the growth rate is higher than the cost of capital.

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If the cost of capital (WACC) > ROI, growht ______ the enterprise value If the cost of capital (WACC) < ROI, growth ______ the enterprise value If the cost of capital (WACC) =ROI, growth ______the enterprise value Plug in the right places: increases, decreases, is irrelevant for the

If the cost of capital (WACC) > ROI, growht DECREASES the enterprise value If the cost of capital (WACC) < ROI, growth INCREASES the enterprise value If the cost of capital (WACC) =ROI, growth IS IRRELEVANT the enterprise value

In restated financial statements (finanicals for valuation purpose), operating, financing and surplus activities should be shown separately. Match the mentioned categories to the following descriptions: ____ refers to the daily tasks of a company: buying/ selling goods, investing, etc. These activities are those that are needed to run the business. ____ refers to raising and repaying debt and equity. These are funding-related activities. ____ include redundant assets that are not necessary to the daily business activities, e.g., renting out unused property. These are also called the non-operating activities.

OPERATING ACTIVITIES refers to the daily tasks of a company: buying/ selling goods, investing, etc. These activities are those that are needed to run the business. FINANCING ACTIVITIES refers to raising and repaying debt and equity. These are funding-related activities. SURPLUS ACTIVITIES include redundant assets that are not necessary to the daily business activities, e.g., renting out unused property. These are also called the non-operating activities.

The rationale for reorganization of financial statements is to show the most meaningful metrics that support cashflow calculations and therefore allows us to execute a more accurate valuation. TRUE/ FALSE

TRUE

A contingent liability is when the firm has evaluated that in the years to come, an event will very likely happen, which will result in a cash outflow of a certain amount. From an accrual base, this amount must be recorded as an expense. What is this contingent liability referred to as?

A risk provision (liability)

In a restated balance sheet; tangible assets, intangible assets (patents, brand, etc.), capitalized leasing assets and goodwill are all categorized under which underlying category of capital employed (assets)? A) Noncash (non-debt) working capital B) Fixed assets C) Surplus assets & liabilities

B) Fixed assets: basically, it is equivalent to the non-operating assets in the as-reported balance sheet. These are the assets employed to run the business for a longer period of time. Usually, there is no liabilities associated with these assets. This category Incl. tangible assets, intangible (patents, brands…), capitalized leasing assets, goodwill.

Which of the following statements are NOT TRUE about non-cash (net) working capital (a subcategory of capital employed in restated balance sheet): A) NWC represents the outstanding assets net outstanding liabilities that are necessary to perform the ordinary daily activities in the business cycle. B) NWC is is calculated as the amount of outstanding assets less amount of outstanding liabilities from daily activities C) The higher NWC, the better liquidity of the company D) Typically, the firms in the supermarket sector have low or negative NWC

WRONG: C) The higher NWC, the better liquidity of the company A lower the NWC is better, since it means that all equal, the firm is are getting its return with less cash employed - it reflects that the firm is better at getting cash inflows from its receivables fast, and/or has longer time to pay its payables - which accumulates to better liquidity and cash flow management. NWC can also be negative (e.g., in the supermarket sector: no trade receivables and huge market power compared to suppliers; therefore long maturity before payable must be paid). A low working capital is often associated with a very low net debt = better for the firm.

Surplus assets and liabilities are non-essential to the business' core operations. Which of the following would DEFINITELY NOT be classified as a surplus asset/liability in the restated balance sheet? Choose 1-7 A) the firm's ownership of shares of other firms (must be non-controlling: <50%) or "interests in associates" B) pension liabilities (employee servance) C) financial assets/ investments: "financial receivables" D) other non-current assets: in this case illiquid and non-marketable E) exceptional provisions: a substantial gain/ loss that is unlikely to repeat itself in the future F) property of business operation G) assets and liabilities held for sale: e.g., old production equipment no longer useful to the firm's business operation

F) property = fixed asset, since it is crucial to the daily operation of the firm. All the other items are considered surplus assets in restate balance sheet.

The "financing sources"/ financing activities category in a restated balance sheet includes net debt and equity. Are the following statements true? A) net debt includes interest-bearing loans and bonds, convertible securities, financial leasing debt, etc. These items are easily identifiable and distinguishable from short-term account payables due to the presence of interest expenses. It is called net debt because it is the amount net the excess cash and cash equivalents. B) equity stated in the as-reported BS is equivalent to equity in the restated BS. The equity category includes share capital, reserves, and minority interest.

YES - both statements are true

``` Deferred tax asset/liability in the as-reported balance sheet is USUALLY categorized as ____ in the restated B/S A) non-cash working capital B) fixed assets/ liabilities C) surplus asset D) equity E) net debt ```

A) non-cash working capital Deferred tax assets: usually, tax-related assets and liabilities are considered working capital. Exceptions may occur if the tax asset is significant and occurring due to a non-normal event (e.g., covid-19), where it may be treated as a surplus asset.

``` Non-marketable and illiquid "non-current assets" in the as-reported balance sheet should be categorized as ____ in the restated B/S A) non-cash working capital B) fixed assets/ liabilities C) surplus asset D) equity E) net debt ``` What if they were liquid and marketable?

C) surplus asset: provided that the non-current asset is illiquid and non-marketable. If it instead the non-current assets were liquid and marketable, it would have been categorized under cash and equivalents, which is incorporated as a deduction in "Net Debt" (-).

In multiples valuation, the numerator should always be the most updated price (market cap or EV) possible. However, the denominator can be either (i) actual/historical, (ii) forward, or (iii) trailing. Which of the following descriptions does NOT fit the forward multiple description? A) From a theoretical perspective, this time fra is more correct, because the current actual price (market cap) is based on expected results, which means that the nominator and denominator would be more comparable if the denominator also is forward-looking. B) uses the current (most recent) market cap or EV as nominator and the last historically reported value driver as the denominator C) The problem is, however, that such estimates are not always available nor necessarily correct since they are based on assumption about the future.

WRONG B) uses the current (most recent) market cap or EV as nominator and the last historically reported value driver as the denominator - this is a historical/ actual multiple. Forward multiples: uses curret market cap or EV as nominator and forward (estimated) value driver in the denominator

It is important to be consistent when using multiples of different time frames (current/ forward/ trailing). E.g., when using actual/historical EV/EBITDA multiple, you must use historical/actual EBITDA of the firm under evaluation. Consistently, if you use forward multiples (e.g., P/E), you must use forward (estimated) net income of the company under evaluation. TRUE/ FALSE

TRUE

In the following statements, choose the options that are highlighted with /: 1. High growth firms will have HIGHER/LOWER P/E multiple provided that the return on equity is higher than the cost of equity. If this is not the case, the multiple will be impacted POSITIVELY/NEGATIVELY by growth. 2. High risk firms will have a HIGHER/LOWER P/E 3. Firms with lower reinvestment needs (as inversely measured by the payout ratio) will have a HIGHER/LOWER P/E ratio

1. High growth firms will have HIGHER P/E ratio provided that the return on equity is higher than the cost of equity. If this is not the case, the multiple will be impacted NEGATIVELY by growth. 2. High risk firms will have a LOWER P/E ratios - the ratio is inversely correlated to risk. 3. Firms with lower reinvestment needs (as inversely measured by the payout ratio) will have a HIGHER P/E ratio - the ratio is inversely correlated with reinvestment needs because it decreases the payout ratio to investors

The P/E is much more sensitive to changes in expected growth rates when interest rates are low. TRUE/ FALSE

TRUE - see graph page 61 in CV lecture notes - this you should just remember by hard

Which of the following is NOT true about the P/BV multiple? Choose 0-6 A) The P/BV multiple is less used, since it does not link directly to profitability B) The P/BV multiple is useful when valuing a firm with negative earnings C) Book values can vary across firms with different accounting standards, posing a disadvantage to this multiple D) The P/BV multiple is influenced by the cost of equity: the higher the cost of equity, the lower the P/BV multiple E) Book values can be negative after several years of negative profits, posing a disadvantage to this multiple F) The P/BV multiple is strongly influenced by the return on equity (ROE)

All of the statements are correct about the P/BV multiple

EV/sales is a multiple that: (choose 0-8) A) is mostly used in industries where we can assume a fixed cost structure (such as fashion industries) B) takes into account a company's profitability C) allows to directly asses the market value of shareholder's equity D) is appropriate for mature businesses E) is appropriate for banks F) can be used for firms with negative earnings G) less impacted by accounting standards H) can lead to high multiples even for firms that are generating losses

EV/sales is a multiple that: A) is mostly used in industries where we can assume a fixed cost structure (such as fashion industries) - that is because the multiple does not take into account the company's profitability - which means that if cost structures in an industry were very variable - it would be difficult to compare firms. D) is appropriate for mature businesses F) can be used for firms with negative earnings G) (sales or revenue) is less impacted by accounting standards H) can lead to high multiples even for firms that are generating losses - recall, it is not linked to profitability but sales

The EV/EBITDA multiple is frequently used because: select 0-5 A) there is a strong link between EBITDA and cash flows, which is of interest to investors B) only very few (very distressed) firms show negative EBITDA, which makes the valuation process easier C) it is unaffected by different depreciation policies D) Frequently, potential acquirers consider an EV multiple because debt will be refinanced after a takeover E) It can be compared more easily among firms with different leverage

All are true

The Relationship between P/E in a Steady State and Leverage is that: as D/E (leverage) increaes, the P/E multiple INCREASES/DECREASES

As leverage increases, the P/E DECREASES. This is because leverage increases risk, which increase the cost of equity levered (required return for investors). So, since the price is equal to: 1/k_EL in a steady state scenario (no growth), leverage decreases the P/E multiple. (See graphs on pp. 67 in CV lecture notes)

``` Increasing the average dimension of a company by acquiring competitors in order to obtain higher margins, profitability, and to exploit economies of scale and scope etc. is called: A) Market consolidation B) Vertical integration C) Conglomerate consolidation D) Leveraged finance E) Industry consolidation ```

A) Market consolidation

``` When companies try to exploit improved profitability (higher economies of scale/scope) through the acquisition/merger of companies in the same industry that make products required at different stages of the supply chain (either upstream or downstream) is called: A) Market consolidation B) Vertical integration C) Conglomerate consolidation D) Leveraged finance E) Industry consolidation ```

B) Vertical integration

``` The strategy to acquire companies in other industries with the aim of reducing the industry-specific risk and therefore enhance its portfolio diversification whilst reducing the overall company risk is called: A) Market consolidation B) Vertical integration C) Conglomerate consolidation D) Leveraged finance E) Industry consolidation ```

C) Conglomerate consolidation Note: this strategy may be risky for companies because in order for such an acquisition to be fruitful, the acquirer must have a certain degree of insight and understanding of the sector of which the target company operates.

``` During a crisis, the winners and losers of industries are determined, and after the recession, the winners tend to acquire the losers (firms in very difficult situations of near bankruptcy). This tendency is called: A) Market consolidation B) Vertical integration C) Conglomerate consolidation D) Leveraged finance E) Industry consolidation ```

E) Industry consolidation

The maximum price that the acquirer is willing to pay can be found by setting the NPV for the buyer equal to 0. The minimum price that the seller is willing to sell at can be determined by setting the NPV for seller equal to 0. The difference between the max and min is the value creation area. TRUE/ FALSE

TRUE

Which of the following are sources of "value creation" in an M&A? Choose 1-4 A) Value of financial/ capital restructuring B) Value of positive cash flow change after transaction from synergies C) Value of managerial control for the acquirer D) Value from change of risk profile of consolidated entity

A) Value of financial/ capital restructuring: change in the D/E composition of the target after acquisition, with the benefit of increasing debt and exploit higher tax shield can create value. B) Value of positive cash flow change after transaction from synergies: if the new entity is able to exploit synergies with respect to the FCF of entity A and B separately, it is value creating. D) Value from change of risk profile of consolidated entity: the new entity may be able to reduce the overall company risk with respect to the two separate entities, it is value creating due to decrease of cost of equity (unlevered).

Which of the following is NOT true about divisible synergies? Select 0-4 A) all shareholders of the new entity benefit from divisible synergies B) includes better managerial capabilities amid acquisition/ merger C) includes development of new and better strategies for the company amid acquisition/ merger D) only the controlling shareholders of the new entity (acquirer) benefit from divisible synergies

WRONG: D) only the controlling shareholders of the new entity (acquirer) benefit from PRIVATE BENEFITS (NOT DIVISIBLE SYNERGIES). All other options are correct characteristics of divisible synergies

Which are the potential reasons behind the current high level of M&A activities?

1. Low interest rates: making financing of strategic decisions such as M&A less expensive to execute through partly financing through leverage. Meanwhile, from the POV of equity investors, the current negative yield environment, in the context of bank deposits, makes the demand for investment in general more attractive, which perhaps reduces the required return (cost of equity). 2. Industry consolidation: amid covid and the corresponding bankruptcies and financial distress that have followed, we might have seen a rise in M&A activity in this regard. 3. Private equity activity accelerating: also amid low interest rates, making LBO much more competitive in regard to financing through leverage.

The _____ value is the minimum valuation of a company in the context of M&A where no synergies are expected. The ______ is the value that eventually becomes the negotiation price of the transaction, and is determined by the specific conditions and the corresponding value that each part (buyer and seller) will potentially obtain from the transaction. The ____ does not represent a specific possible transaction price, but rather, it represents an average firm market value in the context of M&A. Plug in the following three concepts in the right places: Acquisition value; stand-alone value; fair market value

The STAND-ALONE value is the minimum valuation of a company in the context of M&A where no synergies are expected. The ACQUISITION VALUE is the value that eventually becomes the negotiation price of the transaction, and is determined by the specific conditions and the corresponding value that each part (buyer and seller) will potentially obtain from the transaction. The FAIR MARKET VALUE does not represent a specific possible transaction price, but rather, it represents an average firm market value in the context of M&A.

Following statement about the concept of "fair market value" is NOT true: Choose 0-5 A) fair market value = stand-alone value B) fair market value = acquisition value B) it does not represent a specific possible transaction price, but rather, it represents an average firm market value in the context of M&A. C) the maximum fair market value is the sum of the stand-alone value and the value of synergies. D) the estimation of synergies is not related to a specific potential acquirer (which is the case with acquisition value), but rather, the average level of synergy that the selling company is able to exploit when ownership changes. I.e., the level of efficiency that the company is able to reach on average. E) when determining the fair market value, in 80% cases, IBs use multiples (deal multiples or market multiples+acquisition premium), while the DCF method is used as a control-model for verification

WRONG: A + B A) fair market value = stand-alone value The fair market value differs from the stand-alone value in its inclusion of average synergy realization capabilities. B) fair market value = acquisition value The fair market value differs from acquisition value in it not representing a specific possible transaction price (which is the case for acquisition value), but rather, it represents an AVERAGE firm market value in the context of M&A. The estimation of synergies is not related to a specific potential acquirer (which is the case with acquisition value), but rather, the average level of synergy that the selling company is able to exploit when ownership changes. I.e., the level of efficiency that the company is able to reach on average.

Which of the following is NOT a limitation from using deal multiples in valuation? A) it is often difficult to obtain a robust subset of previous similar transactions in order to build the deal multiple. Comparability may be limited B) the price of the transactions that have taken place are not always publicly accessible, since there is no obligation for disclosure if the company under transaction is not listed. C) deal multiples are not representative for M&A in the case of majority buyout, since it does not include control premium. D) many companies have negative EBITDA due to the stage of the company lifecycle, making EV/EBITDA difficult to use.

``` WRONG: C) deal multiples are not representative for M&A in the case of majority buyout, since it does not include control premium - this is the case for Market Multiples (comparable comp. multiples) Deal multiples (comparable transactions) ARE representative in the case of majority buyout because earlier M&A transactions DO include control premium. ```

Given a friendly takeover which is initiated by the seller, the financial advisor prepares the business plan, evaluates the company and hand-over this material to sell-side. Then, the advisor sends to business plan and their take on the valuation to the counterparty; buy-side. In this way, the two parties can compute their own internal valuation based on the same data (the business plan). This is one way to reduce the uncertainty in the evaluation. TRUE/ FALSE

Given a friendly takeover which is initiated by the seller, the financial advisor prepares the business plan, evaluates the company and hand-over this material to sell-side. Then, the advisor sends to business plan to the counterparty; buy-side (NOT THE VALUATION). In this way, the two parties can compute their own internal valuation based on the same data (the business plan). This is one way to reduce the uncertainty in the evaluation.

Dubious motives refers to irrational reasons for M&A that do not typically increase value, whilst it leads to negative cumulative abnormal returns. Which of the following is NOT considered a "dubious" motive for M&A from the buy-side POV? A) tax consideration & optimization B) managment's personal incentives C) following clients D) diversification

C) following clients is NOT considered a dubious motive for M&A from the buy-side POV. If a client is of significant importance for the performance of a company, this may create an incentive for consolidation if the client chooses a different supplier. Explanation of D): diversification is not considered a rational motive for M&A if this is the only driver behind the transaction. The point is that this will not decrease cost of equity, because it is assumed that investors can diversify themselves without the firm having to do so.

The payment method (stock versus cash) in M&A deals is NOT influenced by: A) availability of cash at hand for the acquirer B) the perceived value of the stock of the acquirer C) debt capacity of both target and acquirer and interest rate levels D) tax factors influencing the target firm shareholders E) the relationship between target and buyer: hostile vs. friendly takeover F) all the options are determinants for the payment method (acquisition currency)

F) all the options are determinants for the payment method (acquisition currency)

The perceived value of the acquirer's stock is a determinant of the acquisition currency. Which of the following is NOT an effect of the acquirer stock value on the payment method? A) managers who believe their stock is trading at a price significantly below its value should not use stock as currency on acquisitions- B) firms that believe their stocks are overvalued are more likely to use stock as currency in deals C) both statements (A+B) are correct

C) both statements (A+B) are correct

Tax factors influence the payment method of M&A deals because when an acquisition is through a stock swap, the stockholders in the target firm may be able to defer capital gains taxes on the exchanged shares. Thus, target shareholders might be willing to accept a lower price given a stock swap rather than a cash payment. TRUE/ FALSE

TRUE

Whether an M&A deal is through a friendly versus hostile takeover influences the acquisition currency (payment method). In the event of a hostile takeover, the transaction currency is typically exclusively cash (e.g., with tender offer), since the target shareholders in this case do not agree on the transaction. TRUE/ FALSE

TRUE

The exchange ratio given stock as acquisition currency depends on the level of synergies (value of flow differences) amid the transaction. That is, the higher the synergies estimated, the higher the uncertainty of realization, and the higher the gap between the maximum exchange ratio from the POV of the acquirer and the minimum exchange ratio from the POV of the target. TRUE/ FALSE

TRUE

The exchange ratio is, besides the level of synergies estimated, also affected by the possibility to exploit private benefits. If all synergies were divisible, it would disrupt part of the value that controlling shareholders perceive is connected to the transaction - decreasing the max. exchange ratio acquirer shareholders are willing to offer. TRUE/ FALSE

TRUE

A hostile takeover has which of the following risks/disadvantages for the acquiring firm? Select 0-3 A) During a merger agreement, all the relevant information is disclosed by the target company. This helps the bidder or acquirer in making viable decisions that will prove beneficial. In case of a hostile takeover, there is no access to non-public information or data room, which gives rise to the risk of a wrong valuation for the acquirer (recall bank consortium case with Santander B) The bidder risks in the context of a tender offer, if all (more) minority shareholders were to accept the bid, the acquirer would have to acquire an even larger number of stocks than necessary to get control. C) Sometimes the hostile company can lose some prominent key players because of hostility and can change the working dynamics. It can prove costly in the immediate scenario.

All three options reflect risks/ disadvantages of hostile takeovers for the acquiring firm.

The equity capital market may be divided into two sub-divisions: primary and secondary equity market, each having a sub-division in debt and equity. The primary equity market helps corporates issue NEW instruments (debt or equity). In this primary equity market division, we have the private placement market and primary public market. Which of the following is NOT true about the private placement market? A) transactions in this category are typically negotiated privately, and it is done directly with a few exclusive clients. B) a typical example is when the government issues a new debt, where only institutional investors have access to the primary option. C) private placements offer the possibility to acquire the newly issued instrument (bond or stock) to the public market, where all potential investors can participate. A typical example is an IPO. D) The reason why only a few large investors can participate in a private placement is that especially when issuing a large amount of debt, (bond) the issuer needs the guarantee that the counterparty will be able to cover the supply.

WRONG: C) private placements offer the possibility to acquire the newly issued instrument (bond or stock) to the public market, where all potential investors can participate. A typical example is an IPO. This is the definition of a primary public market.

The equity capital market may be divided into two sub-divisions: primary and secondary equity market, each having a sub-division in debt and equity. About the secondary equity market, which of the following is NOT true? A) in the secondary market, exchange of already-issued instruments takes place B) the two underlying categories of the secondary equity market are (i) stock exchange and (ii) over-the-counter. C) the stock exchange is a regulated market where financial products such as debt, bonds, and stocks can be exchanged. D) the over-the-counter (OTC) market differs from the stock exchange market in its presence of counter-party risk. E) private placement is a service offered by IBs in the secondary equity market.

WRONG: E) private placement is a service offered by IBs in the secondary equity market.

About the over-the-counter (OTC) market, the following does NOT hold: A) It is a sub-division of the investment bank's secondary equity market in the equity capital market division. Equity cap. mark --> secondary equity mark --> OTC mark. B) Even in highly developed OTC markets with high liquidity and large numbers of supply and demand operators, there is counterparty risk. There is no guarantee that the counterparty will be able to fulfill their obligation (deliver the product/ pay the price). Every trader in the OTC market face counter-party risk. C) It is considered a private market placement - a sub-division in the investment bank's primary equity market division. D) In the OTC market, investors can choose tailor-made products, both on the supply and demand side. You may choose the quantity for physical commodities (e.g., agricultural products), the delivery time of the product, a delivery point (e.g., physical), etc. Thus, the investor can in the OTC market modify the characteristics of the product traded.

WRONG: C) It is considered a private market placement - a sub-division in the investment bank's primary equity market division. The OTC related services are offered in the OTC sub-division in an IB's SECONDARY EQUITY MARKET - not primary.

When a listed company wants to raise new capital, it can choose to (i) ask current shareholders to inject additional equity capital, (Iii) issue additional "plain" shares, or (iii) perform a right issuance. Which of the following is NOT true about rights issuance? Select 0-5 A) this instrument allows the company to raise large amounts of additional capital needed, whilst the amount to be raised can be guaranteed by a third party: typically, underwriting banks guarantee the success of the operation. B) this instrument gives investors the possibility to either (i) exercise the right(s) to buy a new share(s), paying the subscription price, or (ii) liquidate the right and get a cash payout. C) At the announcement date of the right issuance, the stock price of the firm will be split between the value of the right, and the ex-right price (price without the right). From this day to the maturity (the subscription period), the stock (without the right) and the right (without the stock) can be traded separately. D) this instrument is relatively quick to implement (approval is needed from the BoD and shareholders of the issuing firm), but the implementation is easy and not time-demanding. E) All the actual current shareholders will receive a right for each of the shares they hold (they choose to either exercise the right and get more shares or liquidate the right and get cash)

All the statements correctly sum up the characteristics of a rights issuance.

There is a risk connected to the success of raising funds through rights issuance. If the issuing firm's share price goes below subscription price: in the event that the ex-right price after the detachment during the period goes below the subscription price, the shareholder has no incentive to exercise the right. That is, the shareholder wanting to obtain additional shares can simply buy them directly from the secondary market at a cheaper price than the subscription price. In this case, there is no incentive to buy the right. TRUE/ FALSE

TRUE

The announcement of rights issuance can lead to downward pressure on share price due to dilution of actual shareholders: like all other types of equity issuance. When new equity capital is raised, we also tend to see a negative market reaction, because. Which of the following statements are NOT correct in the context of market reaction to rights issuance? A) signals to the market that the company believes it is overvalued - and that it aims at correcting the price by issuing additional shares B) pecking-order theory C) rights/ equity issuance does not necessarily have to be negative, given that the firm wants to pursue new investments, in which context it needs additional investable capital. D) signals to the market that it is in financial distress and at the edge of bankruptcy, making it difficult to obtain financing through leverage

WRONG: D) signals to the market that it is in financial distress and at the edge of bankruptcy, making it difficult to obtain financing through leverage All other statements are correct

The ______ theory states that whenever a company is in need of additional financing, it prefers raising funds through DEBT rather than EQUITY because the former is typically less expensive. I.e., the expected return of equity holders tends to be higher than the cost of debt. Therefore, the market reacts negatively whenever the firm aims to raise capital through equity (e.g., right issuance), since it may indicate that the firm is not able to raise (constrained in raising) its leverage. What is the name of this theory?

Pecking-order theory

In the context of rights issuance underwriting - is the statement following true? High underwriting and advisory fees: typically, an IB is given the mandate to underwrite the transaction, i.e., to guarantee that the total amount of right issues will be exercised on the last day of the transaction period. This often entails a rather large risk for the investment bank, and therefore requires high advisory and underwriting fees. TRUE/ FALSE

TRUE

``` According to Vontobel’s valuation approach, how is a company’s ESG score affecting the final valuation? I.e., mechanically – how is it incorporated in a DCF? A) in the cost of debt B) in the market risk premium C) in the cost of equity D) all of the above ```

C) Vontobel’s approach is simple and intuitive: they use 15 equal-weighted factors to determine how a company scores in terms of ESG. Each factor is relevant and material. Analysts score each metric on a five-point scale. The company’s cost of equity is then adjusted for the sum of the scores. NOTE: Not Vontobel-related, but banks have increasingly incorporated climate change considerations when assessing the risk profile of clients - translating into higher cost of debt for companies with poor ESG-performances.

In the context of rights issues, which of the following statements are NOT true? A) The cum right price (p) is price before seasonal equity offering (SEO=increase in capital happening after IPO) announcement. B) The ex-right price is share price before the detachment of the right (ERP) but after announcement of share right issuance. C) The subscription right is the financial instruments that entitles the holder to subscribe new shares. D) The subscription price (P) is price of new share issued, set in advance, typically at discount. This is the price of which shareholders can buy new shares given the rights. Like a exercise price for a call option. E) The subscription period is period during which subscription of new shares can be made paying the subscription price. After this period, the right becomes worthless. F) Ex-right date is the first date of share traded without the right

WRONG: B) Ex-right price: share price AFTER detachment of the right (ERP). When the right is detached from the stock, and the two products are traded separately in the market, we have the ex-right price.

Subscription price (P): price of new share issued, set in advance, typically at discount. This is the price of which shareholders can buy new shares given the rights. For every share there is in the market, there is one right. However, there might be different exchange ratios: typically, you need more than 1 right to obtain 1 additional share. TRUE/ FALSE

TRUE

TERP: theoretical price of stock at ex-right date (TERP). This reflects the estimated (theoretical) impact of this transaction on the actual stock market price. This is the ex-right price at the day of the announcement. TRUE/ FALSE

TRUE

The ex-right price evolves throughout the trading period. However, it is in the firm's interest to set the subscription price strictly lower than the ex-right price in the entire period. Why?

If we are in a situation where the subscription price is higher than the ex-right price, the shareholders have no incentive to exercise their right. Meanwhile, there is no demand in the market to buy the right, because it is out of money.

The issuer, when finding the right discount in the context of right issuance subscription price, must balance between two components: 1. To set the discount high enough to make sure that the ex-right price is strictly above the subscription price in the entire trading period. This determines the success of raising the needed capital (S). 2. To set the discount low enough to avoid any negative signaling to the market. TRUE/ FALSE

TRUE

The discount to TERP determines the subscription price of rights issued. Which of the following are NOT one of the areas to be considered when setting the discount? A) Size of offering: if a very large amount of equity is needed, the discount would probably be larger in order to increase demand for the right, increasing the changes of raising the needed capital. B) Market environment: if there is high economic activity and growth in the general macroeconomy, discounts would probably be lower due to excess cash in the market and higher demand on investments by investors. C) Previous offering (track record): if the previous right issuance transactions have been successful, it increase the attractiveness of the right, and the discount required to reach target S would be smaller. The track record shows whether prior shareholders have been satisfied with the return. D) All of the above are important considerations when setting the discount to TERP

D) All of the above are important considerations when setting the discount to TERP

The discount to TERP determining the subscription price of the right is constrainted. Following is NOT true about this constraint: A) the discount must be above 0, but lower than the pre issuance market cap over the ex-right market cap: n*p / (n*p)+S B) the subscription price (P) must be lower than the TERP in order to maximize the probability to obtain success (or else the right/option is out of the money). C) the discount rate that we set must be high enough to minimize the risk of having a subscription price higher than the ex-right price, yet low enough to maximize the probability of success in raising the needed capital. D) in practice, when determining the right discount, we base this on the amount of capital to be raised in the rights issuance: S and E) all of the statements are correct

E) all of the statements are correct

TERP is a weighted average between the subscription price and the cum-right price, over the total number of shares (current + new shares issued). TERP = n*p+N*P/ (n+N) TRUE/ FALSE

TRUE

In the following scenarios, determine weather the discount to TERP should be high or low: 1. If the valuation of the issuing company is unattractive relative to peers, the discount to TERP should be high/low 2. If the timeframe for the right issuance (the subscription period) is long, the discount set to TERP should be high/low 3. if the right issue size as a percentage of total market cap is low, the discount to TERP should be high/low 4. if the historical/ implied volatility of the stock market or the specific firm stock is very high, the TERP should be high/low 5. if the market sentiment on the company and sector is very negative, the TERP should be high/low

1. If the valuation of the issuing company is unattractive relative to peers, the discount to TERP should be HIGH 2. If the timeframe for the right issuance (the subscription period) is long, the discount set to TERP should be HIGH: because this increases the risk for the ex-right price to decrease below subscription, which increases the required discount for investors. 3. if the right issue size as a percentage of total market cap is low, the discount to TERP should be LOW 4. if the historical/ implied volatility of the stock market or the specific firm stock is very high, the TERP should be HIGH - due to higher risk 5. if the market sentiment on the company and sector is very negative, the TERP should be HIGH - to increase demand from investors

The decision of subscription price and discount (and by default the TERP) has a direct impact on the current shareholders' net-worth due to the dilution effect this issuance creates. TRUE/ FALSE

FALSE The decision of subscription price and discount (and by default the TERP) has no direct impact on the shareholder net-worth. However, the discount and subscription price decisions (and subsequently the TERP) affect the market reaction, which affects the actual shareholder wealth through their ownership of the company’s shares (the stock price fluctuation).

In the context of right issuance. At the ex-right date, from the POV of a new investor (who currently owns no shares), in an efficient market, there is no arbitrage condition. This means that it is exactly equivalent to purchase one share without the right at ex-right price, and to purchase the amount of rights allow you to buy one share at subscription price. TRUE/ FALSE

TRUE

The subscription ratio is calculated as the cum-right number of shares outstanding (n) divided by new shares issued (N). TRUE/ FALSE

TRUE

On the ex-right date, rights are detached from existing shares, and start to trade separately on the same stock exchange. The ex-right price will evolve from its theoretical value (TERP) during the subscription period as a result of new information flowing to the market. Which of the two following statements in this regard is NOT correct? Select 0-3 A) The subscription price is pre-set and cannot be modified during the subscription period. Thus, any change in the ex-right price relative to TERP will be reflected in the value of the right (VR) and number of rights needed to purchase one share at subscription price (R) B) An increase in the ex-right value will determine an increase in the value of the right (VR) and number of rights needed to purchase 1 new share (R), and vice versa C) The following equation must be satisfied throughout the period in which rights are trading, since arbitrage would otherwise be possible: Ex Right Price (ERP) = Rights needed for 1 stock at subscription price (R) * Value of Right (VR) + Subscription price (P) --> VR = (ERP - P) / R

All statements are correct

A tail-swallowing strategy entails that the pre-right issuance shareholder not needing to invest additional cash to maintain its current stock of the company. The shareholder is given a number of rights at right issuance, and he/she then decides to finance the purchase of new shares through the sale of rights. I.e., the constant ownership stake is achieved by selling just enough rights, so that the net sales proceeds of the rights exactly cover the cost of exercising the remaining rights. TRUE/ FALSE

TRUE

A higher discount to TERP (lower subscription price) reduces the risk borne by the underwriters (IB). This in turn likely translates into lower underwriting fees paid by the issuer. TRUE/ FALSE

TRUE: The higher the discount (the lower the subscription price), the higher the chance that the right issue will allow the issuer to obtain the financing intended. That is, the higher the possibility of successful right issuance - which decreases the risk borne by underwriters (IB) - therefore lower underwriting fees.

(In the context of climate change economices), US withdrawing from the Paris accord reduces transition risk, but increase physical risk. TRUE/ FALSE

TRUE

In terms of strategies that can be implemented to tackle climate change and the consequences hereof, we can classify such strategies into two categories: adaptation strategy and mitigation strategy. Which of the following statements in this regard are true? Select 0-2 A) Mitigation aims at reducing the climate change causes (the source of risk), whereas adaption works on reduction of the climate change impact on the firm (accepting that the risk will happen). B) Adaptation strategy is extremely difficult for governments to incentivize for firms, since it typically entails immense costs. Firms are not incentivized to increase short-term costs significantly to avoid long-term risks.

Both statements are correct.

We may distinguish between two classes of climate risk. Transition risk and physical risks. Which of the following options is/are classified as a PHYSICAL risk? Choose 0-6 A) policy-related risks for firms B) liability risk for insurers C) extreme weather events D) social norms and preferences of e.g., consumers E) long-term change in climate patterns

PHYSICAL RISKS: C) extreme weather events E) long-term change in climate patterns All the other options are considered TRANSITION RISKS

In the context of a "mitigation strategy", the government/ policymakers may make use of either administrative and economic instruments. Which of the following is/are example(s) of ADMINISTRATIVE instruments? A) the government implements certificates of emission and subsidies (as a mean to incentives development of low-carbon technologies and processes). B) the government sets limit on the greenhouse gasses of means of transportation such as cars, airplanes, etc. C) the government implements carbon taxes D) the government seting a limit of the emissions that can be utilized to produce a specific product.

B) the government sets limit on the greenhouse gasses of means of transportation such as cars, airplanes, etc. D) the government seting a limit of the emissions that can be utilized to produce a specific product. Administrative instruments are ways of which policy-makers can FORCE an industry change, and adjust the limit periodically to meet the given target. Economic instruments can be implemented by governments to impose INCENTIVES for firms to operate in a more climate-friendly way

``` Which of the following items are NOT part of the NWC calculation in the restated balance sheet? A) accounts payable B) accounts receivable C) inventory D) taxes payable E) other current assets F) other current liabilities G) excess cash H) operating cash ```

G) excess cash is part of the net financial position category, not the NWC. In this course, total cash will be divided into excess cash and operating cash, in which case only the latter will be incorporated into the NWC (as an increase)

Given the following B/S items, calculate the core capital and net capital invested in a restated B/S: NWC, Surplus Assets, Provisions, Fixed Assets

Core capital invested = NWC + Fixed assets | Net capital invested = NWC + Fixed assets + surplus assets - privisions

``` In a restated balance sheet, which of the following B/S items is/are NOT part of the Net Financial Position category? Choose 0-7 A) Short-term debt B) Accounts payable C) Excess cash D) Operating cash E) Long-term debt F) Dividend payable G) Provisions ```

Net Financial Position = short term debt (A) + long-term debt (E) + dividend payable (F) - excess cash (C) WRONG OPTIOS: B) Accounts payable: part of NWC (on net invested capital side) D) Operating cash: part of NWC (on net invested capital side) G) Provisios: part surplus liabilities (on net invested capital side)

``` When calculating the FCFE, a positive change in surplus assets leads to ____ from the FCFO, and a positive change in surplus liabilities leads to _____ from FCFO: A) deduction; addition B) addition; deduction C) addition; addition D) deduction; deduction ```

A) When calculating the FCFE, a positive change in surplus assets leads to DEDUCTION from the FCFO, and a positive change in surplus liabilities leads to ADDITION from FCFO.

When calculating FCFE from FCFO, a positive change in Gross financial debt (comprised of change in the three components: short term debt + long-term debt + dividends payable), leads to a ______ to/from the FCFO. A) deduction B) addition

When calculating FCFE, which of the following components are NOT part of the calculation starting from FCFO? Choose 1-6 A) change in surplus assets B) change in surplus liabilities C) net interest expense D) tax shield E) D&A F) change in gross financial debt: sum of change in dividends payable + change in LT debt + change in ST debt

WRONG: E) D&A is incorporated earlier when calculating the FCFO, and NOT FCFE.

When calculating FCFE, the following components are part of the calculation starting from FCFO. Determine whether each component is added or deducted: A) change in surplus assets B) change in surplus liabilities C) net interest expense D) tax shield E) change in gross financial debt: sum of change in dividends payable + change in LT debt + change in ST debt

A) change in surplus assets: deduct (if positive change -> deduct: like change in NWC) B) change in surplus liabilities: if up, add - opposite treatment of surplus assets C) net interest expense: deduct the sum of interest expense and interest income. Income is higher than expense, the difference is added. D) tax shield: add E) change in gross financial debt: sum of change in dividends payable + change in LT debt + change in ST debt: add (if positive change -> add: reverse of NWC)

In calculating free cash flows, which of the following is/are NOT an investment that should be SUBTRACTED from gross cash flows? A) Change in operating working capital B) Change in debt outstanding C) Net capital expenditures D) Investment in goodwill and acquired intangibles

B) Change in debt (gross financial debt) outstanding is not to be subtracted, but rather ADDED to FCFO to get FCFE. I.e., it is treated oppositely as change in NWC. Explanation for WRONG options: A) Change in operating working capital: deduct to get FCFO C) Net capital expenditures: CAPEX: deduct to get FCFO D) Investment in goodwill and acquired intangibles: part of fixed assets and therefore part of CAPEX Note: divestment in goodwill and intangibles affect CAPEX negatively, which positively affects FCFO.

``` Island Inc is a publicly traded company that has 120 in bank loans on its books, with a stated interest rate of 3% and 165 in publicly traded bonds,, which were issued under par, with a coupon rate of 3,9%. The company currently has a bond rating of BBB, with a default spread of 1,75% over the risk free rate. If the current T-Bill rate is 1%, the ten-year T-Bond rates 4,5% and the marginal tax rate is 40%, what is the pre-tax cost of debt? A) 3,52% B) 6,25% C) 2,75% D) 8,02% ```

B) 6,25% - because rating-based cost of debt = risk free rate + default spread = 1% + 4.5% = 6% T-Bond rate = risk free rate

Free cash flows from operations (FCFO), other things being equal, increase if: A) Shareholders underwrite a capital increase B) Dividends decrease C) Accounts receivables decrease D) Trade liabilities decrease

Free cash flows from operations (FCFO), other things being equal, increase if: C) Accounts receivables decrease: reduces NWC, affecting FCFO positively. Explanation to WRONG options: A) Shareholders underwrite a capital increase: this affects equity capital in B/S, not FCFO B) Dividends decrease: Dividends, share repurchases, and share issuance do not affect FCFF and FCFE, because these are CFs available to investors, while dividends are uses of these cash flows. BUT NOTE, if dividends PAYABLE changes, this is treated as an interest expense - which affects FCFE through gross debt change. D) Trade liabilities decrease: this affects NWC positively, leading to decrease in FCFO

Facebook Inc was the first social network to go through an IPO in 2012. In that year, the company had no debt. It is highly likely that the market valued Facebook with: A) DCF asset side B) Trading multiples C) APV D) All of the above would have worked well

A) DCF asset side Because (B) trading multiples would not be representative due to the lack of comparables. Meanwhile, (C) APV had been more appropriate in the case of leverage with the intend to change the capital structure along the way. Meanwhile, with no debt, there is no value from tax shields.

``` A company generates FCFO of 100 in 2016, 110 in 2017 and 121 in 2018. WACC is 10% and perpetual growth is 0%. How much is enterprise value on 31/12/2016? A) 1.510,0 B) 1.410,0 C) 1.200,0 D) 1.300,0 ```

A company generates FCFO of 100 in 2016, 110 in 2017 and 121 in 2018. WACC is 10% and perpetual growth is 0%. How much is enterprise value on 31/12/2016? C) 1.200,0 ``` EV = (FCFO(2017)/1+WACC) + (FCFO(2018)/(1+WACC)^2)+ (TV/(1+WACC)^2) TV = (FCFO(2018) * (1+g))/ WACC-g TV = (121 *(1+0) / 0.1-0 = 1200 EV = 110/1.1 + 121/(1.1)^2+ 1200/(1.1)^2 = 1200 ```

EV/sales is a multiple: A) That takes into account a company's profitability B) Allows to directly asses the market value of shareholder's equity C) Appropriate for mature businesses D) Appropriate for banks

C) Appropriate for mature businesses Even though it is not usually used for mature businesses, this is the most correct answer of the four options. In reality, we often see EV/sales multiples used from high-growth and young businesses with low or even negative EBITDA and net income, making the profitability-related multiples less useful.

``` A company issues this a business plan including financials for 2018 (last fiscal year), 2019 and 2020, with an EBITDA of respectively 100, 120 and 130, net debt of respectively 300, 350 and 400. Market capitalization on 31/12/2018 is 1000. Comparables average EV/EBITDA multiples are 10x for 2018, 9x for 2019 and 8x for 2020. WACC is 10%. How much is Alfa's equity value as of the end of the last FY with a forward +2 (2020) multiple? A) 740,0 B) 640,0 C) 600,0 D) 528,9 ```

A) 740,0 ``` EV = 8*130=1040 Eqtv = 1040 - 300 = 740 ``` ALWAYS USE CURRENT (TODAY) NET DEBT

Carrefour SA, a supermarket chain, will most likely: A) Have negative noncash working capital B) Not easily get a bank loan C) Have high fixed costs D) Never be a target of a leveraged buyout

Carrefour SA, a supermarket chain, will most likely: A) Have negative noncash working capital Supermarkets typically have little to no accounts receivable, since customers pay immediately at purchase point. Meanwhile, a large chain like Carrefour likely has high bargaining power toward suppliers - making the assumption of high accounts payable (good payment terms) reasonable. Hence low to negative NWC is likely.

``` You are valuing a young business in the hardware industry. Its 2023 forecast FCFO is equal to € 10 million, whose probability of success is equal to 70%. WACC based on similarly young businesses in the industry is equal to 18%, while based on more mature hardware companies it would be equal to 10%. In a DCF model, in 2023 you should consider: A) A FCFO of 7 and a WACC of 18% B) A FCFO of 10 and a WACC of 18% C) A FCFO of 10 and a WACC of 10% D) None of the above ```

B) A FCFO of 10 and a WACC of 18%

With an equity side DCF model, cash flows to shareholders should be discounted using: A) the cost of debt B) the weighted average cost of capital C) the weighted average cost of capital minus the cost of debt D) the cost of equity

D) the cost of equity

``` In determining the levered cost of equity of a company, the market risk premium is weighted by its: A) Variance B) Standard deviation C) Beta D) Alfa ```

C) Beta

Cumulative abnormal returns refers to

The abnormal return (AR) reflects the return of a specific company versus the return of the market. AR = R_Company - R_Market It shows us the firm’s performance relative to a chosen market index (overperform/underperform). The CUMULATIVE abnormal return (CAR) is the sum of the AR of every period. I.e., this reflects whether a stock in a specific period is able to overperform or underperform the market.

The MM method and CAPM method for calculating level cost of equity will only give equivalent outputs and hence constitute to the same WACC in the case that cost of debt is equal to the risk free rate. TRUE/ FALSE

TRUE Recall: the MM2 method incorporates the cost of debt, whilst the CAPM method does not (instead it incorporates the risk free rate) - therefore, they are different if the cost of debt is different from risk-free rate.

If a PE firm is to acquire a majority stake in a company, which is operating in an industry where the PE firms does not have any other investments, which premium is the correct to consider? A) acquisition premium B) control premium C) both

B) Control premium - because the PE firm has no other investments in the industry, it means that it cannot leverage any divisible synergies. Therefore, control premium is to be considered. Control premium = offer price per share/ market stock price after announcement.