M&A Exam 2: Chapters 3-10 Review
Questions and Correct Answers
Intrinsic Value ✅you value an asset based on it's intrinsic characteristics
The Forever Loser Proposition ✅for an asset to have value the expected cash flows
have to be positive some time over the life of the asset
The "It's Okay" Proposition ✅assets that generate cash flows early in their life are
more valuable
What is the difference between equity valuation and firm valuation? ✅Firm valuation
looks at the entire business while equity valuation looks at the value of the equity's
claims on the company's assets or cash flows
For a firm having common and preferred equity as well as debt, common equity value
can be estimated in which of the following ways?
a. By subtracting the book value of debt and preferred equity from the enterprise value
of the firm
b. By subtracting the market value of debt from the enterprise value of the firm
c. By subtracting the market value of debt and the market value of preferred equity from
the enterprise value of the firm
d. By adding the market value of debt and preferred equity to the enterprise value of
the firm
e. By adding the market value of debt and book value of preferred equity to the
enterprise value of the firm ✅C
Discounting Consistency Principle ✅Never mix and match cash flows and discount
rates
Firm Adjusted CAPM ✅ke= Rf+ ß(Rm-Rf) + FSP
Levered Beta ✅beta with the impact of financial leverage
Unlevered Beta ✅beta WITHOUT the impact of financial leverage
Unlevered Beta Formula ✅ßu= ßl/ (1 + (1-t) (D/E))
Zero Growth Model ✅Assumes no growth in Cash Flow: simply CF/r
Constant Growth Model ✅Assumes Constant Growing Perpetuity: CF/r-g
, What are the implications of D/E on beta and the risk of a company? ✅Increasing D/E
raises firm's breakeven and increases shareholder risk that firm will be unable to
generate future cash flows sufficient to pay their minimum required returns.
Free Cash Flow to Equity (FCFE) ✅represents cash flow available for paying
dividends or repurchasing common equity, after taxes, debt repayments, new debt and
preferred stock issues, and all reinvestment requirements.
Free Cash Flow to Firm (FCFF/Enterprise Cash Flow) ✅is cash flow available to repay
lenders and/or pay common and preferred dividends and repurchase equity, after taxes
and reinvestment requirements but before debt repayments.
Which one of the following factors is not considered in calculating the firm's cost of
equity?
a. risk free rate of return
b. beta
c. interest rate on corporate debt
d. expected return on equities
e. difference between expected return on stocks and the risk free rate of return ✅C
Which one of the following factors is not considered in calculating the firm's cost of
capital?
a. cost of equity
b. interest rate on debt
c. the firm's marginal tax rate
d. book value of debt and equity
e. the firm's target debt to equity ratio ✅D
Which of the following factors is excluded from the calculation of free cash flow to the
firm?
a. Principal repayments
b. Operating income
c. Depreciation
d. The change in working capital
e. Gross plant and equipment spending ✅A
Which of the following is not true about the constant growth valuation model?
a. The firm's free cash flow is assumed to be unchanged in perpetuity
b. The firm's free cash flow is assumed to grow at a constant rate in perpetuity
c. Free cash flow is discounted by the difference between the appropriate discount rate
and the expected growth rate of cash flow.
d. The constant growth model is sometimes referred to as the Gordon Growth Model.
Questions and Correct Answers
Intrinsic Value ✅you value an asset based on it's intrinsic characteristics
The Forever Loser Proposition ✅for an asset to have value the expected cash flows
have to be positive some time over the life of the asset
The "It's Okay" Proposition ✅assets that generate cash flows early in their life are
more valuable
What is the difference between equity valuation and firm valuation? ✅Firm valuation
looks at the entire business while equity valuation looks at the value of the equity's
claims on the company's assets or cash flows
For a firm having common and preferred equity as well as debt, common equity value
can be estimated in which of the following ways?
a. By subtracting the book value of debt and preferred equity from the enterprise value
of the firm
b. By subtracting the market value of debt from the enterprise value of the firm
c. By subtracting the market value of debt and the market value of preferred equity from
the enterprise value of the firm
d. By adding the market value of debt and preferred equity to the enterprise value of
the firm
e. By adding the market value of debt and book value of preferred equity to the
enterprise value of the firm ✅C
Discounting Consistency Principle ✅Never mix and match cash flows and discount
rates
Firm Adjusted CAPM ✅ke= Rf+ ß(Rm-Rf) + FSP
Levered Beta ✅beta with the impact of financial leverage
Unlevered Beta ✅beta WITHOUT the impact of financial leverage
Unlevered Beta Formula ✅ßu= ßl/ (1 + (1-t) (D/E))
Zero Growth Model ✅Assumes no growth in Cash Flow: simply CF/r
Constant Growth Model ✅Assumes Constant Growing Perpetuity: CF/r-g
, What are the implications of D/E on beta and the risk of a company? ✅Increasing D/E
raises firm's breakeven and increases shareholder risk that firm will be unable to
generate future cash flows sufficient to pay their minimum required returns.
Free Cash Flow to Equity (FCFE) ✅represents cash flow available for paying
dividends or repurchasing common equity, after taxes, debt repayments, new debt and
preferred stock issues, and all reinvestment requirements.
Free Cash Flow to Firm (FCFF/Enterprise Cash Flow) ✅is cash flow available to repay
lenders and/or pay common and preferred dividends and repurchase equity, after taxes
and reinvestment requirements but before debt repayments.
Which one of the following factors is not considered in calculating the firm's cost of
equity?
a. risk free rate of return
b. beta
c. interest rate on corporate debt
d. expected return on equities
e. difference between expected return on stocks and the risk free rate of return ✅C
Which one of the following factors is not considered in calculating the firm's cost of
capital?
a. cost of equity
b. interest rate on debt
c. the firm's marginal tax rate
d. book value of debt and equity
e. the firm's target debt to equity ratio ✅D
Which of the following factors is excluded from the calculation of free cash flow to the
firm?
a. Principal repayments
b. Operating income
c. Depreciation
d. The change in working capital
e. Gross plant and equipment spending ✅A
Which of the following is not true about the constant growth valuation model?
a. The firm's free cash flow is assumed to be unchanged in perpetuity
b. The firm's free cash flow is assumed to grow at a constant rate in perpetuity
c. Free cash flow is discounted by the difference between the appropriate discount rate
and the expected growth rate of cash flow.
d. The constant growth model is sometimes referred to as the Gordon Growth Model.
