Finance Flashcards
5-10%
A mature company is looking to complete a tax reorganization and has asked you to estimate its value. The company has had stable operating cash flow after taxes for the last three years and expects similar results in the future with no growth. Which valuation approach would be most relevant to use in this circumstance?
a)
Adjusted net asset
b)
Capitalized cash flow
c)
Liquidation
d)
Discounted cash flow
B - The company has a track record of stable positive cash flows to capitalize, and future results are expected to be similar.
A troubled company has growing liabilities and the owner does not believe it can continue to operate. You are asked to estimate the value of the company. Which valuation approach would be most relevant to use in this circumstance?
a)
Adjusted net asset
b)
Capitalized cash flow
c)
Liquidation
d)
Discounted cash flow
C - The company is not operating under the going-concern assumption, and there is indication from the owner that the business should be liquidated.
The definition of fair market value for valuation purposes includes which of the following terms:
a)
Acting at arm’s length
b)
Closed and restricted market
c)
Lowest price available
d)
Under a compulsion to act
A - Acting at arm’s length is part of the definition of fair market value.
A new startup company is looking to go public and has asked you to estimate what the price of its shares should be. The company has yet to achieve profitability and expects a high-growth period for the next five years. Which valuation approach would be most relevant to use in this circumstance?
a)
Capitalized earnings
b)
Capitalized cash flow
c)
Liquidation
d)
Discounted cash flow
D - By using the discounted cash flow approach, you can model the financial statements during the high-growth period and then calculate a terminal value when the business reaches maturity.
You have been hired by a lawyer to prepare an independent valuation of a holding company in Bermuda in relation to a divorce case. The company has no active operations but is considered a going concern. Which valuation approach would be most relevant to use in this circumstance?
a)
Adjusted net asset
b)
Capitalized cash flow
c)
Liquidation
d)
Discounted cash flow
A - The company does not have active operations but is considered a going concern with investments that can be valued.
The objective of business valuations is to determine the fair market value of the enterprise, and several different approaches can be used. Which of the following is correct with regard to business valuations?
a)
The only theoretically correct value of a going-concern enterprise is the discounted present value of its future cash flows.
b)
Fair market value is the highest price available in an open and unrestricted market.
c)
Income statements are normalized to adjust net earnings to the highest amount possible.
d)
The adjusted net asset approach is used to determine the multiple to be used for the market approach.
B - Fair market value is the highest price that an arm’s length purchaser would be willing to pay in order to complete the transaction in an open and unrestricted market.
Which of the following statements concerning business valuations is true?
a)
The capitalized earnings approach uses earnings and a capitalization rate to determine value.
b)
The liquidation approach determines the value of a business by estimating the fair market value of the assets.
c)
The adjusted net asset approach uses the net book value of operating assets and liabilities to determine the value of a business.
d)
The market-based approach uses the entity’s current share price and number of shares outstanding to determine the value.
A - The liquidation approach uses the net realizable value of the assets less liabilities less taxes to determine the value of a business. Answer a) is correct. In the capitalized earnings approach, earnings are divided by a capitalization rate to determine value.
You are discussing valuation concepts with Colin, another associate at your firm. Colin is confused over some of the concepts in business valuation and has made a series of statements. Which of the following statements is true?
a)
When you are using the capitalized earnings approach, past earnings are used with no adjustments.
b)
The adjusted net asset approach will calculate a “floor” selling price for the vendor.
c)
When you are using the capitalized earnings approach, higher risk gives rise to a higher capitalization multiple.
d)
Using a market-based approach, an appropriate multiple times the earnings before interest, tax, depreciation, and amortization (EBITDA) of a business will give a good approximation of its equity value.
B - The adjusted net asset approach usually determines the “floor” value of a business.
You are discussing the valuation of business interests with Denise, another associate at your firm. You have made a number of general statements about valuation. Which of the following statements about business valuation is true?
a)
The adjusted net asset approach provides a maximum price for the assets of a business.
b)
If Company A is found to have a higher risk than Company B, then Company A will have the higher multiplier.
c)
Both the discounted cash flow and the capitalized earnings approaches should be adjusted for unusual items.
d)
A valuation approach based on a multiple of net earnings estimates the enterprise value of a business.
C - Both income-based approaches require cash flows or earnings to be normalized and adjusted for unusual items.
You have been asked to value a business by an owner who intends to shut the business down due to lack of productivity. The owner still has control over the assets and is not being forced to sell them immediately. Which valuation approach should you use?
a)
Capitalized cash flow
b)
Adjusted net asset
c)
Orderly liquidation
d)
Forced liquidation
C - The company is not a going concern, but the owner is not being forced to sell the assets.
You have been asked to value a company with ongoing operations that are expected to continue into the future. You have valued the company a number of different ways and arrived at the following values:
· capitalized cash flow approach: $300,000
· market approach: $305,000
· adjusted net asset approach: $250,000
· liquidation approach: $200,000
What is considered the “floor” value of the company?
a)
$200,000
b)
$250,000
c)
$300,000
d)
$305,000
B - When an operating company is a going concern, the adjusted net asset approach is often used to determine a “floor” value.
You have been asked to value Moneky Inc. using an asset-based approach. Moneky’s primary business is the manufacturing of plastic bottles. Below are some of Moneky’s assets:
· accounts receivable · inventories · marketable securities · prepaid expenses · goodwill
Which of the following represents a redundant asset?
a)
Goodwill
b)
Prepaid expenses
c)
Marketable securities
d)
Inventories
C - Answer a) is incorrect. Goodwill is not separable from the assets of the company and therefore does not represent a redundant asset. Answer c) is correct. Marketable securities are a redundant asset because they are not used in the normal operations. A redundant asset can be sold without impacting the operations of the company.
You have been asked to value a company using the adjusted net asset approach. The company has:
· cash of $100,000
· accounts receivable of $50,000
· marketable securities with a book value of $30,000 (fair market value [FMV] of $60,000 and latent taxes and selling costs of $7,500)
· fixed assets with a book value of $100,000 (FMV of $150,000 and latent taxes and selling costs of $20,000)
· long-term debt of $75,000
What is the value of the company?
a)
$205,000
b)
$257,500
c)
$285,000
d)
$332,500
B - The value of the company under the adjusted net asset approach = cash ($100,000) + accounts receivable ($50,000) + FMV securities ($60,000) – latent taxes and selling costs ($7,500) + FMV fixed assets ($150,000) – latent taxes and selling costs ($20,000) – long-term debt ($75,000) = $257,500.
You have been asked to value a holding company using the liquidation approach. The key assets and liabilities of the company are:
· $50,000 in cash
· $30,000 in accounts receivable
· a piece of land acquired for $100,000 with a FMV of $200,000
· short-term liabilities of $50,000
The company pays taxes at 20% on taxable capital gains. Selling costs of the land are estimated at 5%.
What is the amount distributable to shareholders?
a)
$161,000
b)
$211,000
c)
$220,000
d)
$230,000
B - Cash ($50,000) + accounts receivable
($30,000) + FMV land ($200,000) – selling costs on land ($200,000 × 0.05 = $10,000) – taxes on land ($200,000 – $10,000 = $190,000 – $100,000 = $90,000 / 2 × 20% = $9,000) – short-term liabilities ($50,000) = $211,000. Note: The sale of the land would be a capital disposition, so the gain is only taxable at 50%.
You are valuing a company using a capitalized cash flow approach. You have determined that the company has the following:
· maintainable earnings before interest, tax, depreciation, and amortization (EBITDA) of $200,000
· sustaining capital reinvestment net of taxes of $50,000
· a tax rate of 30%
· a capitalization rate of 10%
· a present value (PV) of the undepreciated capital cost (UCC) tax shield on existing assets of $20,000
· interest-bearing debt of $130,000
What is the equity value of the company?
a)
$1,290,000
b)
$920,000
c)
$790,000
d)
$770,000
C - The equity value of the company = EBITDA after tax [$200,000 × (1 – 30%)] – sustaining capital reinvestment ($50,000) = $90,000 / capitalization rate (10%) = $900,000 + PV of UCC tax shield ($20,000) – interest-bearing debt ($130,000) = $790,000.