University of California, Los Angeles MGMT 120AFSA3e Test Bank _Mod13_091712. Module 13 Cash-Flow-Based Valuation

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Module 13 Cash-Flow-Based Valuation Learning Objectives – coverage by question True/False Multiple Choice Exercises Problems Essays LO1 – Identify equity valuation models and explain the inf... ormation required to value equity securities. 1, 2 1, 2 1 1, 2 LO2 – Describe and apply the discounted free cash flow model to value equity securities. 1-6 3-10 3-12 2-7 3 ©Cambridge Business Publishers, 2013 Test Bank, Module 13 13-1Module 13: Cash-Flow-Based Valuation True/False Topic: Discounted Cash Flow (DCF) Valuation Model LO: 2 1. One advantage of the DCF model is that it only recognizes value evidenced by cash flow, which is less easily manipulated by accrual accounting practices. Answer: True Rationale: The DCF model is based on accrual accounting principles. In fact, free cash flow is defined as NOPAT – change NOA. Cash flow is not affected by accrual accounting practices, which recognize revenue when earned and the matching of expenses when incurred. Topic: Free Cash Flow LO: 2 2. Firms can increase free cash flow to the firm (FCFF) in the short run by cutting back on investment in fixed assets. Answer: True Rationale: Capital expenditures are a deduction in the computation of FCF. As a result, firms can increase FCF in the short run by cutting back on CAPEX. Long-run FCFF may be lessened by the failure to invest in PPE. Topic: Terminal Value LO: 2 3. The higher the expected growth rate of the terminal free cash flow to the firm, the lower the present value of the terminal value becomes. Answer: False Rationale: The terminal value is given by FCF/(r-g) where g is the growth rate and r is the discount rate. As g increases, the terminal value increases as well. Topic: Stock Price, Cash Flow and Discount Rate LO: 2 4. The price one is willing to pay for a common stock is positively related to expected free cash flows to the firm (FCFF) and negatively related to the required rate of return. Answer: True Rationale: Higher expected FCFF and lower required rate of return will lead to a higher valuation. ©Cambridge Business Publishers, 2013 13-2 Financial Statement Analysis & Valuation, 3rd EditionTopic: DCF Valuation Model LO: 2 5. The DCF valuation of a firm’s equity involves the following three steps: a. Forecast free cash flows to the firm (FCFF) for the horizon period. b. Forecast discount FCFF for the terminal period. c. Sum the horizon and terminal periods to yield firm value. Answer: False Rationale: To value the firm’s equity, we sum the present values of the horizon and terminal periods. Topic: NOPAT LO: 2 6. Net operating profit after tax (NOPAT) is equal to net income less interest expense incurred during the year. Answer: False Rationale: NOPAT is computed from the income statement and equals operating revenues less operating expenses, all of which is expressed on an after-tax basis. ©Cambridge Business Publishers, 2013 Test Bank, Module 13 13-3Multiple Choice Topic: Equity Valuation Models LO: 1 1. There are many types of equity valuation models. They differ mainly in: A) The choice of length of horizon periods B) The treatment of the terminal period C) The choice of what is forecast D) The interaction of income statement and balance sheet items E) None of the above Answer: C Rationale: Different models forecast different items. Commonly forecasted items include dividends, cash flows, and residual income. Topic: Dividend Discount Model LO: 1 2. The advantage of the dividend discount model is that: A) It is simple B) Dividends are easily observable C) Capital gains can be earned instead of dividends D) Firms publish their dividend policies E) All of the above Answer: A Rationale: many firms do not pay dividends and relying on their observability would mean some firms would have a zero stock price. Capital gains are irrelevant to the dividend discount model. The model is simple. Topic: Projecting Revenue One Year Out (Numerical calculations required) LO: 2 3. Following is information from adidas-Salomon AG for fiscal 2011 (€ in millions). Total 2011 revenue € 13,344 Total revenue growth rate 11.3% Terminal revenue growth rate 6.1% Net operating profit margin (NOPM) 5.4% Net operating asset turnover (NOAT) 2.80 Projected 2012 total revenue would be: A) € 13,344 million B) € 1,507 million C) € 14,158 million D) € 14,852 million E) None of the above Answer: D Rationale: € 13,344 million × 1.113 = € 14,852 million ©Cambridge Business Publishers, 2013 13-4 Financial Statement Analysis & Valuation, 3rd EditionTopic: Projecting Revenue Two Years Out – Numerical calculations required LO: 2 4. Following is information from Williams Engineering for 2012. Total 2012 revenue $159,110 Projected revenue growth rate, for next five years -1.3% Terminal revenue growth rate, after year 5 5.2% Net operating profit margin (NOPM) 6.6% Net operating asset turnover (NOAT) 1.11 Projected 2014 total revenue would be: A) $157,042 B) $161,178 C) $163,274 D) $155,000 E) None of the above Answer: D Rationale: $159,110 × 0.987 × 0.987 = $155,000 Topic: Terminal Period Present Value LO: 2 5. Which of the following represents the present value of a terminal period FCFF if rw is the weighted average cost of capital? A) (FCFFt+1/(rw-g))/(1+rw)t B) (FCFFt+1/(g- rw))/(1+rw)t C) (FCFFt/(rw-g))/(1+g)t D) (FCFFt/(g- rw))/(1+g)t Answer: A Rationale: The present value of a terminal period FCFF is computed as (FCFFt+1/(rw-g))/(1+rw)t ©Cambridge Business Publishers, 2013 Test Bank, Module 13 13-5Topic: Computing Free Cash Flows – Numerical calculations required LO: 2 6. Bundy Manufacturing reported the following information for fiscal 2012 and 2011. What are the company’s free cash flows to the firm (FCFF) for 2012? December 31 2012 2011 Operating assets $50,330 $48,122 Operating liabilities 24,778 26,978 Net cash flow from operations 13,396 11,968 Net operating profit after tax (NOPAT) 11,368 9,794 Discount factor 6.0% 5.8% A) $6,566 B) $6,960 C) $8,988 D) $8,480 E) None of the above Answer: B Rationale: FCFF = NOPAT- increase in net operating assets (NOA) NOA = Operating assets – Operating liabilities 2011 NOA = $21,144 2012 NOA = $25,552 FCFF = $11,368 – ($25,552 – $21,144) = $6,960 Topic: Computing Free Cash Flows – Numerical calculations required LO: 2 7. Catfish Inc. manufactures life-vests for marine use. Based on the following information, what are the company’s free cash flows to the firm (FCFF) for the year ended October 31, 2012? October 31 2012 2011 Cash $8,800 $7,120 Net operating working capital $2,800 $1,400 Net long-term operating assets $4,800 $4,000 Net nonoperating obligations (NNO) $600 $400 Net operating profit after tax (NOPAT) $800 $720 Discount factor 5.4% 5.8% A) -$700 B) $0 C) -$600 D) -$1,400 E) None of the above Answer: D [Show More]

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