Corporate Valuation
Question Bank
Course Introduction
Corporate Valuation is a comprehensive course that delves into the techniques and methodologies used to determine the economic value of a business. Students explore various valuation approaches, including discounted cash flow (DCF), comparable companies analysis, precedent transactions, and asset-based valuation methods. The course examines the underlying financial statements, market trends, and strategic factors that influence a company's worth, enabling students to critically assess both intrinsic and relative valuations. Through case studies and real-world applications, participants gain practical skills in evaluating mergers and acquisitions, investment opportunities, and financial reporting, making the course essential for careers in investment banking, corporate finance, and consulting.
Recommended Textbook
Corporate Finance 2nd Edition by Jonathan Berk
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Chapter 1: The Corporation
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Q1) You own 100 shares of a "C" Corporation.The corporation earns $5.00 per share before taxes.Once the corporation has paid any corporate taxes that are due,it will distribute the rest of its earnings to its shareholders in the form of a dividend.If the corporate tax rate is 40% and your personal tax rate on (both dividend and non-dividend)income is 30%,then how much money is left for you after all taxes have been paid?
A) $210
B) $300
C) $350
D) $500
Answer: A
Q2) A sole proprietorship is owned by
A) one person.
B) two of more persons.
C) shareholders.
D) bankers.
Answer: A
Q3) Explain the difference between a sub-chapter "S" corporation and a sub-chapter "C" corporation.
Answer: 11ea7e54_8b72_55d2_ba34_77ea3b53de7f_TB1620_00
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) For the year ending December 31,2009 Luther's cash flow from operating activities is ?
Answer: Operating cash flow = NI + Depreciation - chg in AR + chg in AP - chg in INV
Operating cash flow = 10.6 + 3.6 - (55.5 - 39.6)+ (87.6 - 73.5)- (45.9 - 42.9)= 9.4
Q2) If ECE reported $15 million in net income,then ECE's Return on Equity (ROE)is:
A) 5.0%
B) 7.5%
C) 10.0%
D) 15.0%
Answer: D
Q3) Luther's Net Profit Margin for the year ending December 31,2008 is closest to:
A) 1.8%
B) 2.7%
C) 5.4%
D) 16.7%
Answer: A
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Chapter 3: Arbitrage and Financial Decision Making
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Q1) Suppose you will receive $500 in one year and the risk-free interest rate (r<sub>f</sub>)is 5%.The equivalent value today is closest to:
A) $475
B) $476
C) $500
D) $525
Answer: B
Q2) When we express the value of a cash flow or series of cash flows in terms of dollars today,we call it the ________ of the investment.If we express it in terms of dollars in the future,we call it the ________.
A) present value; future value
B) future value; present value
C) ordinary annuity; annuity due
D) discount factor; discount rate
Answer: A
Q3) The price per share of the ETF in a normal market is:
Answer: Value of ETF = = 2 × 121.57 + 3 × 36.59 + 3 × 3.15 = $362.36
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Chapter 4: The Time Value of Money
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Q1) You are saving for retirement.To live comfortably,you decide that you will need $2.5 million dollars by the time you are 65.If today is your 30th birthday,and you decide,starting today,and on every birthday up to and including your 65th birthday,that you will deposit the same amount into your savings account.Assuming the interest rate is 5%,the amount that you must set aside each and every year on your birthday is closest to:
A) $71,430
B) $27,680
C) $26,100
D) $26,260
Q2) If the appropriate interest rate is 8%,then present value of $500 paid at the end of each of the next 40 years is closest to:
A) $23
B) $5,962
C) $6,439
D) $20,0000
Q3) Draw a timeline detailing the cash flows from investment "B."
Q4) The future value at retirement (age 65)of your savings is:
Q5) In terms of present value,how much will Joe receive for selling the family business?
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Chapter 5: Interest Rates
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Q1) The NPV of an investment that costs $2700 and pays $1000 certain at the end of one,three,and five years is closest to:
A) 21.47
B) $1665.62
C) -100.26
D) -71.38
Q2) The total amount of interest that Dagny will pay during the first month of her mortgage is closest to:
A) $1,110
B) $1,785
C) $1,800
D) $2,245
Q3) Which alternative offers you the lowest effective rate of return?
A) Investment A
B) Investment B
C) Investment C
D) Investment D
Q4) Can the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.
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Chapter 6: Investment Decision Rules
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Q1) Which of the following statements is false?
A) In general, the IRR rule works for a stand-alone project if all of the project's positive cash flows precede its negative cash flows.
B) There is no easy fix for the IRR rule when there are multiple IRRs.
C) The payback rule is primarily used because of its simplicity.
D) No investment rule that ignores the set of alternative investment alternatives can be optimal.
Q2) Larry should
A) reject the offer because the NPV < 0.
B) accept the offer even though the IRR < 10%, because the NPV > 0.
C) reject the offer because the IRR < 10%.
D) accept the offer because the IRR > 0%.
Q3) The number of potential IRRs that exist for Rearden's mining operation is equal to:
A) 0
B) 1
C) 2
D) 12
Q4) If the discount rate for project B is 15%,then what is the NPV for project B?
Q5) If the discount rate for project A is 16%,then what is the NPV for project A?
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Chapter 7: Fundamentals of Capital Budgeting
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Q1) The free cash flow from Shepard Industries project in year two is closest to:
A) $345
B) $455
C) $275
D) -$5
Q2) The NPV for Galt Motors of manufacturing the armatures in house is closest to:
A) 1,095,000
B) 1,215,000
C) 1,225,000
D) 1,250,000
Q3) Which of the following statements is false?
A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our NPV analysis for the project.
B) To compute the NPV for a project, you need to estimate the incremental cash flows and choose a discount rate.
C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty.
D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
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Chapter 8: Valuing Bonds
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Q1) Which of the following statements is false?
A) Prices of bonds with lower durations are more sensitive to interest rate changes.
B) When a bond is trading at a discount, the price increase between coupons will exceed the drop when a coupon is paid, so the bond's price will rise and its discount will decline as time passes.
C) Coupon bonds may trade at a discount, at a premium, or at par.
D) The sensitivity of a bond's price changes in interest rates is the bond's duration.
Q2) Assume that the YTM increases by 1% for each of the four bonds listed.Rank the bonds based upon the sensitivity of their prices from least to most sensitive.
Q3) Assuming the appropriate YTM on the Sisyphean bond is 9.0%,then the price that this bond trades for will be closest to:
A) $946
B) $919
C) $1,086
D) $1,000
Q4) What is the relationship between a bond's price and its yield to maturity?
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Chapter 9: Valuing Stocks
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Q1) You expect KT Industries (KTI)will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend.KTI's return on new investments is 15% and their equity cost of capital is 12%.The value of a share of KTI's stock is closest to:
A) $39.25
B) $20.00
C) $33.35
D) $12.50
Q2) Von Bora Corporation (VBC)is expected to pay a $2.00 dividend at the end of this year.If you expect VBC's dividend to grow by 5% per year forever and VBC's equity cost of capital is 13%,then the value of a share of VBS stock is closest to:
A) $25.00
B) $40.00
C) $15.40
D) $11.10
Q3) Suppose you plan to hold Von Bora stock for only one year.Calculate your total return from holding Von Bora stock for the first year.
Q4) Calculate the enterprise value for DM Corporation.
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Chapter 10: Capital Markets and the Pricing of Risk
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Q1) Common risk is also called
A) diversifiable risk.
B) correlated risk.
C) uncorrelated risk.
D) independent risk.
Q2) Which of the following statements is false?
A) The expected return is the return is the return that actually occurs over a particular time period.
B) If you hold the stock beyond the date of the first dividend, then to compute you return you must specify how you invest any dividends you receive in the interim.
C) The average annual return of an investment during some historical period is simply the average of the realized returns for each year.
D) The realized return is the total return we earn from dividends and capital gains, expressed as a percentage of the initial stock price.
Q3) Suppose that you want to use the 10 year historical average return on the Market to forecast the expected future return on the Market.Calculate the 95% confidence interval for your estimate of the expect return.
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Q1) The Sharpe ratio for the value stock portfolio is closest to:
A) .53
B) .58
C) .61
D) .79
Q2) The expected return of a portfolio that is consists of a long position of $10000 in Wal-Mart and a short position of $2000 in Microsoft is closest to:
A) 21%
B) 12%
C) 27%
D) 18%
Q3) The beta for the risk free investment is closest to:
A) 1
B) 0
C) Unable to answer this question without knowing the risk free rate
D) Unable to answer this question without knowing the markets volatility
Q4) Explain how having different interest rates for borrowing and lending affects the CAPM and the SML.
Q5) Calculate the covariance between Stock Y's and Stock Z's returns.
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Chapter 12: The Capital Asset Pricing Model
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Q1) Rearden Metal has a bond issue outstanding with ten years to maturity,a yield to maturity of 8.6%,and a B rating.The bondholders expected loss rate in the event of default is 50%.Assuming a normal economy the expected return on Rearden Metal's debt is closest to:
A) 0.6%
B) 1.6%
C) 4.6%
D) 6.0%
Q2) Using the average historical excess returns for both Wyatt Oil and the Market portfolio,your estimate of Wyatt Oil's Beta is closest to:
A) 0.75
B) 0.84
C) 1.00
D) 1.19
Q3) Luther's after-tax debt cost of capital is closest to:
A) 4.2%
B) 5.4%
C) 7.0%
D) 9.8%
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Chapter 13: Investor Behavior and Capital Market Efficiency
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Q1) The expected return for the fad follower's portfolio is closest to:
A) -0.9%
B) 0.0%
C) 3.6%
D) 6.0%
Q2) A stock's ________ measures the stock's return relative to that predicted based on its beta,at the time of some event.
A) excessive abnormal return
B) cumulative average return
C) excessive predicted return
D) cumulative abnormal return
Q3) The CAPM does not require investors have homogeneous expectations,but rather that they have
A) rational biases.
B) no biases.
C) heterogenous expectations.
D) rational expectations.
Q4) What does the existence of a positive alpha investment strategy imply?
Q5) Explain why the market portfolio proxy may not be efficient.
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Chapter 14: Capital Structure in a Perfect Market
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Q1) Which of the following statements is false?
A) The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its capital structure.
B) The most common choices are financing through equity alone and financing through a combination of debt and equity.
C) The project's NPV represents the value to the new investors of the firm created by the project.
D) When corporations raise funds from outside investors, they must choose which type of security to issue.
Q2) Two separate firms are considering investing in this project.Firm unlevered plans to fund the entire $80,000 investment using equity,while firm levered plans to borrow $45,000 at the risk-free rate and use equity to finance the remainder of the initial investment.Construct a table detailing the percentage returns to the equity holders of both the levered and unlevered firms for both the weak and strong economy.
Q3) Based upon the three comparable firms,what asset beta would you recommend using for your firm's new project?
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Chapter 15: Debt and Taxes
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Q1) After the recapitalization,the value of KD's levered equity is closest to:
A) $670 million
B) $400 million
C) $330 million
D) $470 million
Q2) In 2005,assuming an average dividend payout ratio of 50%,the effective tax advantage for debt ( *)was closest to:
A) 24%
B) 18%
C) 35%
D) 15%
Q3) The value of Shepard Industries with leverage is closest to:
A) $64 million
B) $100 million
C) $135 million
D) $114 million
Q4) Raceway Products has a market debt-to-equity ratio of .60,a corporate tax rate of 40%,and pays 8% interest on its debt.The interest tax shield on Raceway's debt lowers its WACC by what amount?
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Q1) Which of the following firms is likely to maintain low levels of debt?
A) An electric utility
B) A tobacco company
C) An Internet firm
D) A mature restaurant chain
Q2) Which of the following statements is false?
A) One disadvantage of using leverage is that it does not allow the original owners of the firm to maintain their equity stake.
B) The separation of ownership and control creates the possibility of management entrenchment; facing little threat of being fired and replaced, managers are free to run the firm in their own best interests.
C) Managers also have their own personal interests, which may differ from those of both equity holders and debt holders.
D) The costs of reduced effort and excessive spending on perks are another form of agency cost.
Q3) List five general categories of indirect costs associated with bankruptcy.
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Chapter 17: Payout Policy
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Q1) The effective dividend tax rate for a buy and hold individual investor in 1999 is closest to:
A) 25%
B) 0%
C) 20%
D) 40%
Q2) Wyatt Oil's current stock price is closest to:
A) $11.00
B) $12.50
C) $14.00
D) $17.50
Q3) If Rockwood is able to repurchase shares prior to the market becoming aware of the new information regarding Rockwood's true value,then the number of shares outstanding following the repurchase is closest to:
A) 92 million
B) 10 million
C) 75 million
D) 90 million
Q4) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Omicron's Unlevered cost of capital is closest to:
A) 8.75%
B) 7.10%
C) 9.60%
D) 7.50%
Q2) Galt's free cash flow to equity (FCFE)is closest to:
A) $19.2 million
B) $20.4 million
C) $21.2 million
D) $24.0 million
Q3) Assume that to fund the investment Taggart will take on $150 million in permanent debt with the remainder of the investment funded by a cut in dividends.Assuming Taggart will incur a 2% underwriting fee on the new debt issue,the NPV of Taggart's new rail line is closest to:
A) $195 million
B) $200 million
C) $235 million
D) $240 million
Q4) Calculate the present value of the interest tax shield provided by Omicron's new project.
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) What is the purpose of the sensitivity analysis?
Q2) Based upon Ideko's Sales and Operating Cost Assumptions,what production capacity will Ideko require in 2009?
A) 1,505 units
B) 1,115 units
C) 1,323 units
D) 1,702 units
E) 1,914 units
Q3) Based upon the average P/E ratio of the comparable firms,Ideko's target market value of equity is closest to:
A) $157 million
B) $155 million
C) $193 million
D) $165 million
E) $191 million
Q4) What range for the market value of equity for Ideko is implied by the range of EV/Sales multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its working capital needs?
21
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Chapter 20: Financial Options
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Q1) In describing Galt's equity as a call option,the strike price of the call option is:
A) $200 million
B) $300 million
C) $500 million
D) $700 million
Q2) Which of the following statements is false?
A) Options also allow investors to speculate, or place a bet on the direction in which they believe the market is likely to move.
B) Options where the strike price and the stock price are very far apart are referred to as deep in-the-money or deep out of-the-money.
C) Call options with strike prices above the current stock price are in-the-money, as are put options with strike prices below the current stock price.
D) European options allow their holders to exercise the option only on the expiration date holders cannot exercise before the expiration date.
Q3) Describe the conditions when it would be optimal to exercise an American Call and an American Put option prior to their expiration.
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Chapter 21: Option Valuation
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Q1) Using risk neutral probabilities,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:
A) $2.00
B) $2.15
C) $1.45
D) $2.40
Q2) Which of the following statements is false?
A) The option delta, , has a natural interpretation: It is the change in the price of the stock given a $1 change in the price of the option.
B) Because a leveraged position in a stock is riskier than the stock itself, this implies that call options on a positive beta stock are more risky than the underlying stock and therefore have higher returns and higher betas.
C) Only one parameter input for the Black-Scholes formula, the volatility of the stock price, is not observable directly.
D) Because a stock's volatility is much easier to measure (and forecast) than its expected return, the Black-Scholes formula can be very precise.
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Chapter 22: Real Options
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Q1) Which of the following statements is false?
A) Traditionally, managers have used the equivalent annual benefit method to choose between projects of different lives.
B) The equivalent annual benefit method ignores the value of any real options because it assumes that the projects will always be replaced at their original terms.
C) If the future costs (or benefits) are certain with mutually exclusive projects, then we must use a real options approach to determine the correct decision.
D) The equivalent annual benefit method accounts for the difference in project lengths by calculating the constant payment over the life of the project that is equivalent to receiving the NPV today and then selecting the project with the higher equivalent annual benefit.
Q2) Assume that Kinston has the ability to ignore the pilot production and test marketing and to go ahead and build their manufacturing plant immediately.Further assume that the probability of high or low demand is still 50%.Draw a decision tree that details Kinston Industries Mountain Bike project if Kinston goes ahead and builds the plant immediately.
Q3) Describe the two factors that affect the value of an investment timing option?
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Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Which of the following statements is not true regarding Angel Investors?
A) They are typically arranged as limited partnerships.
B) For many start-ups, the first round of outside private equity financing is often obtained from them.
C) Because their capital investment is often large relative to the amount of capital already in place at the firm, they typically receive a sizeable equity share in the business in return for their funds.
D) These investors are frequently friends or acquaintances of the entrepreneur.
Q2) The IRR on the investment of a limited partner into Galt Ventures net of all management fees and expenses is closest to:
A) 7.8%
B) 9.9%
C) 12.4%
D) 14.9%
Q3) The amount of money raised by Nielson Motors is closest to:
A) $144 million
B) $150 million
C) $216 million
D) $219 million
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Chapter 24: Debt Financing
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Q1) What is the Yield to Call (YTC)on this bond?
Q2) Which of the following statements is false?
A) A convertible bond can be thought of as a regular bond plus a special type of call option called a warrant.
B) On the maturity date of the bond, the strike price of the embedded warrant in a convertible bond is equal to the face value of the bond divided by the conversion ratio-that is, the conversion price.
C) Calling a convertible bond transfers the remaining time value of the conversion option from shareholders to bondholders.
D) If the stock price is low so that the embedded warrant is deep out-of-the-money, the conversion provision is not worth much and the bond's value is close to the value of a straight bond-an otherwise identical bond without the conversion provision.
Q3) Which of the following statements regarding the private debt market is false?
A) Private debt has the advantage that it avoids the cost of registration.
B) Bank loans are an example of private debt, debt that is not publicly traded.
C) Private debt has the disadvantage of being illiquid.
D) The public debt market is larger than the private debt market.
Q4) What is the Yield to Maturity (YTM)on this bond?
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Chapter 25: Leasing
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Q1) The lease rate for which Rearden will break even is closest to:
A) $1,110,000
B) $1,130,000
C) $1,150,000
D) $1,160,000
Q2) The lease is treated as a capital lease (financial lease)for the lessee and must be listed on the firm's balance sheet if it satisfies any of the following conditions except:
A) The lease contains an option to purchase the asset at its fair market value.
B) The present value of the minimum lease payments at the start of the lease is 90% or more of the asset's fair market value.
C) The title to the property transfers to the lessee at the end of the lease term.
D) The lease term is 75% or more of the estimated economic life of the asset.
Q3) Is St.Martin's better off leasing the CT scanner or financing the purchase of the CT scanner with a lease-equivalent loan and by how much is St Martin's better off?
Q4) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using an operating lease?
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Chapter 26: Working Capital Management
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Q1) Calculate the number of days in Luther's Operating Cycle.
Q2) The percentage of Wyatt's receivables that are past due is closest to:
A) 20.1%
B) 32.1%
C) 38.3%
D) 42.2%
Q3) Which of the following money market investments is essentially a loan arrangement wherein a securities dealer is the "borrower" and the investor is the "lender." The investor buys securities from the securities dealer,with an agreement to sell the securities back to the dealer at a later date for a specified higher price?
A) Certificates of Deposit (CD)
B) Commercial Paper
C) Banker's Acceptance
D) Repurchase Agreement
E) Treasury Bill
Q4) What is a compensating balance?
Q5) Your firm purchases goods from its supplier on terms of 2/10,net 45.Calculate the effective annual cost to your firm if it chooses not to take advantage of the trade discount offered.
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Chapter 27: Short-Term Financial Planning
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Q1) The effective annual rate for Taggart if they choose alternative #1 is closest to:
A) 13.9%
B) 18.8%
C) 27.0%
D) 27.9%
Q2) The permanent working capital needs for Hasbeen Toys is closest to:
A) $1,100 million
B) $2,435 million
C) $1,275 million
D) $770 million
Q3) The Luther Industries wants to borrow $1 million for two months.Using its inventory as collateral,it can obtain a 10% (APR)loan (compounded monthly).The lender requires that a warehouse arrangement be used.The warehouse fee is $10,000,payable at the end of the two months.Calculate the effective annual rate of this loan for Row Cannery.
Q4) Calculate the temporary working capital needs for each of the four quarters for Hasbeen Toys.
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Chapter 28: Mergers and Acquisitions
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Q1) This period is known for hostile,"bust-up" takeovers,in which the acquirer purchased a poorly performing conglomerate and sold off its individual business units for more than the purchase price:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
Q2) Taggart Transcontinental and Phoenix-Durango have entered into a stock swap merger agreement whereby Taggart will pay a 30% premium over Phoenix-Durango's pre-merger price.If Taggart's pre-merger price per share was $15 and Phoenix-Durango's was $30,then the exchange ratio that Taggart will offer is closest to:
A) 0.4:1
B) 1.8:1
C) 2.0:1
D) 2.6:1
Q3) If Martin pays no premium to acquire Luther,what will the earnings per share be after the merger?
Q4) What is a white knight?
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Page 30
Chapter 29: Corporate Governance
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Q1) Describe the main requirements of the Sarbanes-Oxley Act of 2002.
Q2) Which of the following statements is false?
A) The relationship between managerial ownership and firm value is unlikely to be the same for every firm, or even for different executives of the same firm.
B) Even with the risk benefits of separating ownership and control, there are still examples of corporations in which the top managers have substantial ownership interests.
C) Academic studies do not support the notion that greater managerial ownership is associated with fewer value-reducing actions by managers.
D) While increasing managerial ownership may reduce perquisite consumption, it also makes managers harder to fire-thus reducing the incentive effect of the threat of dismissal.
Q3) A board of directors is said to be captured when
A) a majority of the directors are independent directors.
B) a majority of the directors are outside directors.
C) its monitoring duties have been compromised by connections or perceived loyalties to management.
D) when the CEO also serves as chairman of the board of directors.
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Chapter 30: Risk Management
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Q1) The cash-and-carry strategy consists of all of the following simultaneous trades except
A) borrow euros today using a one-year loan with the interest rate r<sub> .</sub>
B) exchange the euros for dollars today at the spot exchange rate S $/ .
C) purchase a forward contract to convert $ to .
D) invest the dollars today for one year at the interest rate r<sub>$.</sub>
Q2) In December 2005,the spot exchange rate for the British Pound was $1.7188/£.Suppose that at the same time the on-year interest rate in the United States was 4.85% and the one-year interest rate in Great Britain was 3.15%.Based on these rates,what forward exchange rate is consistent with no arbitrage.
Q3) What is the actuarially fair cost of full insurance?
Q4) A currency forward contract specifies all of the following except
A) the amount of currency to exchange.
B) the spot exchange rate.
C) the delivery date on which the exchange will take place.
D) the currencies to be exchanged.
Q5) Assuming that your firm will purchase insurance,what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
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Chapter 31: International Corporate Finance
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Q1) Which of the following statements is false?
A) U.S. tax policy requires U.S. corporations to pay taxes on their foreign income at the same rate as profits earned in the United States.
B) The home government gets an opportunity to tax the income from a foreign project to the domestic firm.
C) The general international arrangement prevailing with respect to taxation of corporate profits is that the home country gets the first opportunity to tax income.
D) The home government must establish a tax policy specifying its treatment of foreign income and foreign taxes paid on that income.
Q2) The present value of Rearden Metal's cash outflow computed by first converting to dollars and then discounting the cash flow at the appropriate Argentine Peso rate is closest to:
A) $469,500
B) $475,000
C) $481,000
D) $484,500
Q3) Calculate the pound denominated cost of capital for Luther's project.
Q4) What is the dollar present value of the project?
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Page 33