DCF Basic Exam Quiz with Accurate
Solution and Explanations.
1. Conceptually, a DCF analysis consists of a "near future" value (over 5-10
years) and a "far future" value (the company's value past that period), both
of which are discounted back to their present values and summed up.
a. True
b. False
##i. Explanation: The correct answer choice is A. The "near future" value
consists of the projected Free Cash Flows over the next 5 to 10 years, until
the company reaches a steady state. The "far future" value represents the
Free Cash Flows generated in the final year of the projection until perpetuity,
and is approximated by the Terminal Value, which can be calculated using
two differed approaches. Both values are discounted back to present and
added together to determine Enterprise (or Equity) value, depending on
which type of Free Cash Flows is projected.
2. Which of the following steps do you complete in a DCF analysis?
a. Project cash flows in the "near future" period
b. Project cash flows in the "far future" period
c. Determine the appropriate discount rate to discount cash flows by
d. Add together all the discounted cash flows to determine the NPV
##Explanation: All of the above entail the steps necessary in
completing a DCF analysis. As mentioned before, the value of the company
consists of two components: 'near future' period cash flows and 'far future'
,period cash flows. For the former we can project these cash flows within a 5
to 10 year period. For the latter, we need to approximate these cash flows by
estimating the Terminal Value. Once both 'near future' and 'far future' cash
flows are estimated, we calculate the appropriate discount rate to
determine their present values. Finally, once everything is discounted to
present value we add together the two figures to obtain Enterprise (or
Equity) value, depending on which type of FCF we projected.
3. How
Cash Flow analysis?
is a Dividend Discount Model different from a conventional Discounted
a. Dividends are discounted instead of Free Cash Flow
b. Cost of Equity is used as the discount rate instead of WACC
c. Terminal Value is based on a P / BV or P / E multiple instead of
EV/EBITDA
d. None of the above
##Explanation: All of the statements above are correct differences
when doing a DDM instead of a DCF. Answer choice A is correct as dividends
are used in place of Free Cash Flow (dividends are assumed to be a proxy for
FCF for some types of companies, such as banks and insurance firms).
Answer choice B is correct because in a DDM we only discount cash flows at
Cost of Equity, NOT the overall WACC - since dividends only go to equity
investors, we're calculating Equity Value and using Cost of Equity. Answer
choice C is correct because we want to use an Equity Value-based multiple,
such as P / E or P / BV, as opposed to an Enterprise Value-based multiple
when using a DDM.
4. All of the following equations below are the correct definition of
Unlevered Free Cash Flow (Free Cash Flow to Firm) EXCEPT:
, a. EBIT * (1 - Tax Rate) + Non-Cash Charges - Change in Operating Assets and
Liabilities - CapEx
b. CFO + Net Interest Expense * (1 - Tax Rate) - CapEx
c. Net Income + Net Interest Expense * (1 - Tax Rate) + Non-Cash
Charges - Change in Operating Assets and Liabilities - CapEx
d. Net Income + Non-Cash Charges - Change in Operating Assets and
Liabilities - CapEx - Mandatory Debt Repayments
e. None of the above (i.e. these are all correct)
##Explanation: The correct answer choice is D. Unlevered Free
Cash Flow can be defined in more than one way, and answer choices A, B,
and C are all correct definitions of unlevered FCF. Answer choice D, on the
other hand, is NOT the definition of Unlevered FCF but rather is the correct
formula for Levered free cash flow (since it includes interest payments and
debt repayment).
5. Which sections of the Cash Flow Statement do we generally exclude when
calculating Free Cash Flow?
a. Cash Flow from Operations (CFO)
b. Cash Flow from Investing (CFI), except for CapEx
c. Cash Flow from Financing (CFF)
d. None of the above - we need all these sections when calculating FCF
##Explanation: When calculating Unlevered FCF we only take CapEx from
CFI and exclude everything else in that section as well as CFF. The idea is
that we are trying to only include recurring, predictable items. And in the
case of Levered FCF, we still exclude almost everything from CFI and CFF
sections (with the exception of CapEx in FI and mandatory debt repayments
in CFF). Most other items in CFI and CFF are usually one-time, non-recurring
Solution and Explanations.
1. Conceptually, a DCF analysis consists of a "near future" value (over 5-10
years) and a "far future" value (the company's value past that period), both
of which are discounted back to their present values and summed up.
a. True
b. False
##i. Explanation: The correct answer choice is A. The "near future" value
consists of the projected Free Cash Flows over the next 5 to 10 years, until
the company reaches a steady state. The "far future" value represents the
Free Cash Flows generated in the final year of the projection until perpetuity,
and is approximated by the Terminal Value, which can be calculated using
two differed approaches. Both values are discounted back to present and
added together to determine Enterprise (or Equity) value, depending on
which type of Free Cash Flows is projected.
2. Which of the following steps do you complete in a DCF analysis?
a. Project cash flows in the "near future" period
b. Project cash flows in the "far future" period
c. Determine the appropriate discount rate to discount cash flows by
d. Add together all the discounted cash flows to determine the NPV
##Explanation: All of the above entail the steps necessary in
completing a DCF analysis. As mentioned before, the value of the company
consists of two components: 'near future' period cash flows and 'far future'
,period cash flows. For the former we can project these cash flows within a 5
to 10 year period. For the latter, we need to approximate these cash flows by
estimating the Terminal Value. Once both 'near future' and 'far future' cash
flows are estimated, we calculate the appropriate discount rate to
determine their present values. Finally, once everything is discounted to
present value we add together the two figures to obtain Enterprise (or
Equity) value, depending on which type of FCF we projected.
3. How
Cash Flow analysis?
is a Dividend Discount Model different from a conventional Discounted
a. Dividends are discounted instead of Free Cash Flow
b. Cost of Equity is used as the discount rate instead of WACC
c. Terminal Value is based on a P / BV or P / E multiple instead of
EV/EBITDA
d. None of the above
##Explanation: All of the statements above are correct differences
when doing a DDM instead of a DCF. Answer choice A is correct as dividends
are used in place of Free Cash Flow (dividends are assumed to be a proxy for
FCF for some types of companies, such as banks and insurance firms).
Answer choice B is correct because in a DDM we only discount cash flows at
Cost of Equity, NOT the overall WACC - since dividends only go to equity
investors, we're calculating Equity Value and using Cost of Equity. Answer
choice C is correct because we want to use an Equity Value-based multiple,
such as P / E or P / BV, as opposed to an Enterprise Value-based multiple
when using a DDM.
4. All of the following equations below are the correct definition of
Unlevered Free Cash Flow (Free Cash Flow to Firm) EXCEPT:
, a. EBIT * (1 - Tax Rate) + Non-Cash Charges - Change in Operating Assets and
Liabilities - CapEx
b. CFO + Net Interest Expense * (1 - Tax Rate) - CapEx
c. Net Income + Net Interest Expense * (1 - Tax Rate) + Non-Cash
Charges - Change in Operating Assets and Liabilities - CapEx
d. Net Income + Non-Cash Charges - Change in Operating Assets and
Liabilities - CapEx - Mandatory Debt Repayments
e. None of the above (i.e. these are all correct)
##Explanation: The correct answer choice is D. Unlevered Free
Cash Flow can be defined in more than one way, and answer choices A, B,
and C are all correct definitions of unlevered FCF. Answer choice D, on the
other hand, is NOT the definition of Unlevered FCF but rather is the correct
formula for Levered free cash flow (since it includes interest payments and
debt repayment).
5. Which sections of the Cash Flow Statement do we generally exclude when
calculating Free Cash Flow?
a. Cash Flow from Operations (CFO)
b. Cash Flow from Investing (CFI), except for CapEx
c. Cash Flow from Financing (CFF)
d. None of the above - we need all these sections when calculating FCF
##Explanation: When calculating Unlevered FCF we only take CapEx from
CFI and exclude everything else in that section as well as CFF. The idea is
that we are trying to only include recurring, predictable items. And in the
case of Levered FCF, we still exclude almost everything from CFI and CFF
sections (with the exception of CapEx in FI and mandatory debt repayments
in CFF). Most other items in CFI and CFF are usually one-time, non-recurring
