Financial Valuation Methods Part 2

Question 1

What are the variables required for the Black-Scholes model?

Answer 1

the current price of the underlying stock, the option exercise price, the risk-free interest rate, the time until expiration, and a measure of risk tied to the underlying stock

Question 2

Assumptions of Black-Scholes option-pricing model?

Answer 2

• There are NO transaction costs for buying the stock or option
• Uses the European options method (only exercised at expiration)
• This option-pricing model assumes a constant risk-free interest rate over the option’s term in the calculation.
• The Black-Scholes-Merton option-pricing model assumes that expected dividends remain constant rather than fluctuate over the option term. The expected dividends are determined on the date the options are granted.

Question 3

The binomial (Cox-Ross-Rubinstein) model is actually a variation of the Black-Scholes option pricing model. There are two primary differences with the
Black-Scholes model including:

Answer 3

The consideration of the option over a period of time using American-style options and
it can be used for stocks that pay periodic dividends without modifying the model (which would be necessary using the Black-Scholes model).

Question 4

Acme Co. issues a $1,000 face value bond that pays an annual coupon rate of 6.5 percent
and matures in four years. Assuming a market interest rate of 6.0 percent at time of issuance, the bond’s price is closest to:

A. $965.84
B. $1,000.00
C. $1,017.33
D. $1,197.39

Answer 4

Choice “C” is correct. The answer was derived as follows:

$65/1.06 + $65/(1.06)^2 + $65/(1.06) + $1,065/(1.06)^3
= $61.32 + $57.85 + $54.58 + $843.58 =

$1.017.33

Question 5

What is the formula for pricing cash flows of a bond?

Answer 5

SUM OF:
coupon payment / (1 + mkt rate of interest at time of issuance) ^ [# of yrs].

Question 6

Bond Valuation based on face value?

Answer 6

The price of a bond at issuance will either be less than face value (a discount bond), more than face value (a premium bond), or equal to face value (a
par value bond). A bond is issued at a discount whenever the coupon rate (or stated rate) is less than the prevailing market rate at the time of issuance. A bond is issued at a premium whenever the coupon rate is more than the prevailing market rate at the time of issuance. Par value bonds have coupon rates equal to the market rate.
If this bond was issued at a discount and the coupon rate is 6 percent, it must be a case that market rates at the time of issuance were higher than 6 percent.

Question 7

In a scenario in which limited intangible asset transactions exist and there are no reliable estimates of income/cash flows, which valuation method is best?

Answer 7

The cost approach

Question 8

What is the methodology for using the market (median value) approach for valuation of an intangible?

Answer 8

Remove the outliers and average the values in the middle.

Ex/ With 4 values, remove the highest and lowest values and average the 2 values in the middle.

Question 9

When using the replacement cost approach, all costs are considered except __________________.

Answer 9

general administration (allocation) costs, which is a back-office, period expense not tied
directly to the creation of the property.

Question 10

Using ___________________________ pertaining to fixed assets would be the least acceptable method for estimating depreciation and salvage value
given that these fixed assets are unique to each company such as condition, degree of
use, repairs, and maintenance.

Answer 10

industry consensus information

Question 11

Using the _______________________ would be a questionable methodology for using estimates on the company’s balance sheet. An
acceptable approach is to use an estimate of probable future losses pertaining to that
specific lawsuit settlement.

Answer 11

outcome of similar litigation settlements

Question 12

The controller of Theme Parks Inc. is involved with initially approving accounting estimates
for critical balance sheet accounts. On a TIME PERMITTED basis, the controller’s group will
then review a sample of accounting estimates each fiscal year for accuracy based on supporting documentation. The procedure in place for accounting estimates at the company
would be best described as

Answer 12

Inadequate due to a lack of approval on estimate reviews and no regular review
periods.

Based on the scenario facts, the company does not review accounting estimates on a periodic basis (ad hoc basis only). When the estimates are reviewed, they are traced to supporting documentation but are not approved by a manager from the controller’s group.