Midterm: G3: Cash Flow Valuation Techniques

Question 1

The way to determine the value of an investment opportunity is by

Answer 1

Determining the actual cash generated by a particular asset

Question 2

can be done by determining the present value of the net cash flows of the investment opportunity.

Answer 2

Discounted Cash Flows Analysis

Question 3

refers to the amount of cash available for distribution to both debt and equity claims of the business or asset. This is calculated from the net cash generated from operations and for investment over time.

Answer 3

Net Cash Flows

Question 4

NCF is used as basis of valuation if any of the following conditions are present:

Answer 4

● Company does not pay dividends
● Company pays dividends but the amount paid out significantly differs from its capacity to pay dividends
● Net Cash Flows and profits are aligned within a reasonable forecast period
● Investor has a control perspective. If an investor can exert control over a company, dividends can be adjusted based on the decision of the controlling investor.

Question 5

Analysts find analyzing cash flows and its sources helpful in understanding the following:

Answer 5

1. Source of financing for needed investment - The best case for firms is to fund its investments wholly or partly
   through cash from operations.
2. Reliance on debt financing - Debt financing is an excellent financing strategy especially for expanding companies.
3. Quality of earnings - Significant disparities between cash flows and income may indicate earnings does not get converted to cash easily, suggesting low quality.

Question 6

The best case for firms is to find its investments, wholy or partly through cash from operations

Answer 6

Source of financing for needed investments

Question 7

Debt financing is an excellent financing strategy especially for expanding companies

Answer 7

Reliance on debt financing

Question 8

Significant disparities between cash flows and income may indicate earnings does not get converted to cash easily, suggesting low quality

Answer 8

Quality of earnings

Question 9

Two levels of Net cash flows

Answer 9

Net cash flow to the firm
Net cash flows to equity

Question 10

Is the amount made available to both debt and equity claims against the company

Answer 10

Net cash flows to the firm

Question 11

Refers to the cash flow available to the parties who supplied capital after paying all operating expenses, including taxes and investing in capital expenditures and working capital as required by business needs

Answer 11

Net cash flows to the firm

Question 12

Cash flows generated from operating activities which is intended to pay required return of fund providers. It only capture items that are directly related to the operating and investing activities of the business.

Answer 12

Net cash flows to the firm

Question 13

Basic measure of a firms profitability which refers to the bottom line figure in an income statement. This is the amount left for the common shareholders after deducting all costs, expenses, depreciation, amortization interest, taxes, and dividends to preferred shareholders.

Answer 13

Net income available to common shareholders

Question 14

Pertains to non-cash items that are included in the computation of net income

Answer 14

Non-cash charges (net)

Question 15

Common noncash items

Answer 15

Depreciation and amortization
Restructuring charges
Provisions for doubtful accounts

Question 16

This interest expense is a cash flow intended for the debt providers. It is added back to net income, since the objective of NCF is the measure of the cash flow’s associated with operating activities of the business.

Answer 16

After-tax interest expense

Question 17

Net investment in current assets, such as receivables and inventory, is reduced by current liabilities like liable. The amount captured is based on the movements in these accounts from prior periods

Answer 17

Working capital adjustments

Question 18

Pertains to cash outflows made to purchase or pay for capital expenditures that are required to support existing and future operating needs.

Answer 18

Investment in fixed capital

Question 19

Assumes that the price financed is acceptable, and has positive net present value

Answer 19

Investment in fixed capital

Question 20

Represents how much cash is a company generated from its operations. This shows how much cash is received from customers, and how much cash outflows are paid to vendors

Answer 20

Cash flow from operating activities

Question 21

Represents how much cash is disbursed (received) for investments in (sale of) long-term assets, like property plant and equipment and strategic investments in other companies

Answer 21

Cash flow from investing activities

Question 22

Represents how much cash was raised (or paid) to finance the company. This is not considered when computing NCFF.

Answer 22

Cash flow from financing activities

Question 23

Pertains to income before deducting interest, taxes, depreciation, and amortization expenses, net of taxes

Answer 23

EBITDA earnings before interest, taxes, depreciation, and amortization

Question 24

Non-cash charges are not typically adjusted if NCF starts with EBITDA. However, it is important that analysts should check whether non-cost charges were already deducted in computing for EBITDA or not.

Answer 24

Tax savings on non-cash charges

Question 25

Represents the amount of cash flows made available to the equity stockholders after deducting, the net debt, or the outstanding liabilities to the creditors less available cash balance of the company

Answer 25

Net cash flows to equity

Question 26

Refers to cash available for common equity, participants or shareholders, only after being expenses, satisfying operating and fixed capital requirements and settling cash flow transactions involving debt providers and preferred shareholders

Answer 26

Net cash flows to equity

Question 27

This refers to the amount of cash, received by the company as a result of borrowing of long-term debt

Answer 27

Proceeds from borrowing

Question 28

This is the total amount used to service the loans or debt financing. This is the total amount of loan repayment and the interest expenses, net of income tax benefit.

Answer 28

Debt service

Question 29

Same with the debt, preferred shares as another form of financing, other than the issuance of ordinary, equity, must also be factored in the calculation of the net cash flows available to equity

Answer 29

Proceeds from issuance of preferred shares

Question 30

Since payments made to preferential shareholders in the form of dividends are outflows

Answer 30

Dividends on preferred shares

Question 31

Discounted cash flow analysis is most applicable to use when the following are available

Answer 31

Validated operational and financial information
Reasonable appropriated cost of capital or required rate of return
New quantifiable information

Question 32

It’s a financial method of valuation, and it is widely used to assess any investment value or estimate the valuation of a company or project

Answer 32

DCF model formula

Question 33

This calculation is done based on the cash flow’s projected for the future

Answer 33

DCF model formula

Question 34

The value of the cash flows in the future will be less than it is today, because of the effect of the —

Answer 34

Time value of money

Question 35

Steps

Answer 35

1. Projections of the financial statements
2. Calculating free cash flow to firm
3. Calculating the discount rate
4. Calculating the terminal value
5. Present value calculations
6. Adjustments
7. Sensitivity analysis

Question 36

If the value reached through discounted cash flow analysis is higher than the current cost of the investment opportunity would be —

Answer 36

Attractive

Question 37

Entails thinking through factors that affect a firm, like future revenue growth and profit margins, cost of equity and debt, and a discount rate that largely depends on the risk free rate

Answer 37

DCF model