BIWS DCF TESTED EXAM QUESTIONS
WITH VERIFIED ANSWERS LATEST
UPDATE
What is a flaw in the Multiples Method of finding terminal value? - Answer-The median
multiples may change greatly in the next 5 - 10 years so they terminal value may no
longer be accurate by the end of the period you're looking at. This is why a range of
multiples is considered in the valuation.
Why is the terminal value not just the enterprise value of the company? - Answer-The
terminal value is essentially the approximate enterprise value at the end of the "near
future" period - 5 to 10 years. Assuming that would be saying that prior to that period the
company has no value which makes no sense, so you have to take into account the PV
of the FCF's from this period.
How do you know if a DCF is too dependent on future assumptions? - Answer-A
general standard is that if over 50% of a company's value comes from the PV of
terminal value then the DCF is too dependent on future assumptions. The problem is
that in practice this is true in almost all DCF's. So if the Terminal Value accounts for
something like 80% - 90% of the company's value then maybe the assumptions should
be reconsidered.
How do you get cost of debt or preferred stock? - Answer-You typically look at the yields
of preferred stock and interest rates on debt of comparable companies to get your
figures. You could alternatively calculate a firm's cost of debt by doing interest/total
debt, and use the firm's own yield on preferred shares
How do you calculate cost of equity? - Answer-Risk-Free Rate + Equity Risk Premium *
Levered Beta
Depending on your bank and group you may also add a size premium or industry
premium to account for additional risk and expected returns from these
What is Risk-Free Rate? - Answer-Usually you would use the yield of a 10 or 20 year
US Treasury Bond, but can change to a different "safe" bond based on the country you
are looking at
What is Beta? - Answer-the volatility of an investment compared with the market as a
whole. The market has a beta of 1, while investments that are more volatile than the
market have a beta greater than 1 and those that are less volatile have a beta of less
than 1.
, What is equity risk-premium? - Answer-the difference between how stocks are expected
to perform and the risk-free rate of return, typically pulled from a publication called
Ibbotson's
Why do we not factor in dividends into the calculation for cost of equity? - Answer-
Because dividends are already accounted for in the firm's beta - beta describes returns
in excess of the market as a whole which includes dividends
What is a DCF? - Answer-Based off the idea that the intrinsic value of an asset (in this
case a company) is equal to the present value of its future cashflows (free cash flows)
You divide a firm's future cashflows into a "near future" period of 5-10 years and a "far
future" period for everything beyond that which is too far to project accurately but can be
approximated using various methods
The sum of these future cashflows is then discounted back to today's value to give an
approximate value of the company
Time Value of Money - Answer-The idea that money today is worth more than money in
the future because today you could invest that money, earn interest on it, and end up
with more tomorrow
Walk me through a DCF - Answer-1. Project the companies financials and use them to
calculate free cash flows for 5 to 10 years in the future, depending on the stability and
nature of the company
2. Calculate the firm's WACC and use it to discount the near-future cashflows to their
present value
3. Determine the terminal value of the company by either using the Multiples method or
the Gordon Growth method
4. Use the WACC again to discount the terminal/far future value back to present value
5. Add up the present value of the near-future cashflows and the terminal value to find
an enterprise value.
6. Subtract Net Debt (or add cash, subtract debt, subtract preferred stock, subtract non-
controlling interest, subtract any other debt-like items) to find an equity value, then
divide by diluted shares outstanding to find an implied share price
How do you find Free Cash Flow from Revenue? - Answer-ASK IF THEY ARE
LOOKING FOR UNLEVERED FREE CASH FLOW (FCF to Firm)
(Unlevered)
WITH VERIFIED ANSWERS LATEST
UPDATE
What is a flaw in the Multiples Method of finding terminal value? - Answer-The median
multiples may change greatly in the next 5 - 10 years so they terminal value may no
longer be accurate by the end of the period you're looking at. This is why a range of
multiples is considered in the valuation.
Why is the terminal value not just the enterprise value of the company? - Answer-The
terminal value is essentially the approximate enterprise value at the end of the "near
future" period - 5 to 10 years. Assuming that would be saying that prior to that period the
company has no value which makes no sense, so you have to take into account the PV
of the FCF's from this period.
How do you know if a DCF is too dependent on future assumptions? - Answer-A
general standard is that if over 50% of a company's value comes from the PV of
terminal value then the DCF is too dependent on future assumptions. The problem is
that in practice this is true in almost all DCF's. So if the Terminal Value accounts for
something like 80% - 90% of the company's value then maybe the assumptions should
be reconsidered.
How do you get cost of debt or preferred stock? - Answer-You typically look at the yields
of preferred stock and interest rates on debt of comparable companies to get your
figures. You could alternatively calculate a firm's cost of debt by doing interest/total
debt, and use the firm's own yield on preferred shares
How do you calculate cost of equity? - Answer-Risk-Free Rate + Equity Risk Premium *
Levered Beta
Depending on your bank and group you may also add a size premium or industry
premium to account for additional risk and expected returns from these
What is Risk-Free Rate? - Answer-Usually you would use the yield of a 10 or 20 year
US Treasury Bond, but can change to a different "safe" bond based on the country you
are looking at
What is Beta? - Answer-the volatility of an investment compared with the market as a
whole. The market has a beta of 1, while investments that are more volatile than the
market have a beta greater than 1 and those that are less volatile have a beta of less
than 1.
, What is equity risk-premium? - Answer-the difference between how stocks are expected
to perform and the risk-free rate of return, typically pulled from a publication called
Ibbotson's
Why do we not factor in dividends into the calculation for cost of equity? - Answer-
Because dividends are already accounted for in the firm's beta - beta describes returns
in excess of the market as a whole which includes dividends
What is a DCF? - Answer-Based off the idea that the intrinsic value of an asset (in this
case a company) is equal to the present value of its future cashflows (free cash flows)
You divide a firm's future cashflows into a "near future" period of 5-10 years and a "far
future" period for everything beyond that which is too far to project accurately but can be
approximated using various methods
The sum of these future cashflows is then discounted back to today's value to give an
approximate value of the company
Time Value of Money - Answer-The idea that money today is worth more than money in
the future because today you could invest that money, earn interest on it, and end up
with more tomorrow
Walk me through a DCF - Answer-1. Project the companies financials and use them to
calculate free cash flows for 5 to 10 years in the future, depending on the stability and
nature of the company
2. Calculate the firm's WACC and use it to discount the near-future cashflows to their
present value
3. Determine the terminal value of the company by either using the Multiples method or
the Gordon Growth method
4. Use the WACC again to discount the terminal/far future value back to present value
5. Add up the present value of the near-future cashflows and the terminal value to find
an enterprise value.
6. Subtract Net Debt (or add cash, subtract debt, subtract preferred stock, subtract non-
controlling interest, subtract any other debt-like items) to find an equity value, then
divide by diluted shares outstanding to find an implied share price
How do you find Free Cash Flow from Revenue? - Answer-ASK IF THEY ARE
LOOKING FOR UNLEVERED FREE CASH FLOW (FCF to Firm)
(Unlevered)
