Q: Which formula is used to calculate Free Cash Flow (FCF)?

$$FCF = EBIT \times (1 - T) - CAPEX - \Delta NWC$$

Q: A firm has the following values: market value of equity ($$E$$) = $$500$$ million, market value of debt ($$D$$) = $$300$$ million, cost of equity ($$r_e$$) = $$10\%$$, cost of debt ($$r_d$$) = $$5\%$$, and tax rate ($$T$$) = $$30\%. $$What is the Weighted Average Cost of Capital (WACC)?

$$WACC = \frac{500}{800} \times 0.10 + \frac{300}{800} \times 0.05 \times (1 - 0.30) = 0.0625 + 0.013125 = 0.075625 or$$ $$7.56\%$$

Q: Given the following information: $$D_0 = 1.50$, g = 5$$\%$$, forecast the dividend for year 3 (D_3$) using the formula D_t$$ = $$D_0(1 + g)^t$.

$$D_3 = 1.50$$ \times $$(1.05)^3 = 1.50$$ \times 1.157625 = 1.736$$

Q: A company has $$FCF_n = 10$$ million, $$g = 3\%$$, and $$WACC = 8\%. $$What is the terminal value ($$TV) at $$the end of the forecast period?

$$TV = \frac{10 \times (1 + 0.03)}{0.08 - 0.03} = \frac{10.3}{0.05} = 206$$

Question 1

Which of the following best describes the purpose of the Discounted Cash Flow (DCF) model in valuation?

Accepted Answer

To calculate the present value of all forecasted future free cash flows of a firm.

Question 2

A company has a projected dividend ($$D_1) of$$ $$2.50$$, a required rate of return ($$r) of$$ $$8\%$$, and a projected growth rate ($$g) of$$ $$4\%. $$Using the constant growth Dividend Discount Model (DDM), what is the intrinsic value ($$V_0) of $$the stock?

Accepted Answer

$$V_0$$ = \frac{2.50}{0.08 - 0.04} = 62.50$$

Question 3

Which macroeconomic factor would most likely decrease the present value of future cash flows in a valuation model?

Accepted Answer

Higher interest rates

Question 4

In the Capital Asset Pricing Model (CAPM), which variable represents the stock's sensitivity to market movements?

Accepted Answer

$$\beta$$

Question 5

A utility company has a beta ($$\beta) of$$ $$0.6. $$What does this indicate about its stock compared to the market?

Accepted Answer

It is less volatile than the market.

Question 6

Which formula is used to calculate Free Cash Flow (FCF)?

Accepted Answer

$$FCF = EBIT 	imes (1 - T) - CAPEX - \Delta NWC$$

Question 7

When using the DCF model, what is the purpose of the terminal value (TV)?

Accepted Answer

To estimate the value of cash flows beyond the explicit forecast period.

Question 8

Which of the following is NOT a component of Porter's Five Forces?

Accepted Answer

Market capitalization

Question 9

A firm has the following values: market value of equity ($$E$$) = $$500$$ million, market value of debt ($$D$$) = $$300$$ million, cost of equity ($$r_e$$) = $$10\%$$, cost of debt ($$r_d$$) = $$5\%$$, and tax rate ($$T$$) = $$30\%. $$What is the Weighted Average Cost of Capital (WACC)?

Accepted Answer

$$WACC = \frac{500}{800} 	imes 0.10 + \frac{300}{800} 	imes 0.05 	imes (1 - 0.30) = 0.0625 + 0.013125 = 0.075625 or$$ $$7.56\%$$

Question 10

Which relative valuation multiple is most appropriate for comparing early-stage or low-profit companies?

Accepted Answer

EV/Revenue

Question 11

If a company's intrinsic value ($$V_0) $$calculated using DCF is less than its current market price ($$P_0$$), what is the recommended action?

Accepted Answer

Sell the stock

Question 12

Which of the following is a limitation of the Dividend Discount Model (DDM)?

Accepted Answer

It only works reliably for mature, stable dividend payers.

Question 13

Given the following information: $$D_0 = 1.50$, g = 5$$\%$$, forecast the dividend for year 3 (D_3$) using the formula D_t$$ = $$D_0(1 + g)^t$.

Accepted Answer

$$D_3 = 1.50$$ 	imes $$(1.05)^3 = 1.50$$ 	imes 1.157625 = 1.736$$

Question 14

Which industry phase is characterized by minimal or negative growth?

Accepted Answer

Decline

Question 15

A company has $$FCF_n = 10$$ million, $$g = 3\%$$, and $$WACC = 8\%. $$What is the terminal value ($$TV) at $$the end of the forecast period?

Accepted Answer

$$TV = \frac{10 	imes (1 + 0.03)}{0.08 - 0.03} = \frac{10.3}{0.05} = 206$$

Question 16

Which of the following best describes the sector rotation strategy during an economic trough?

Accepted Answer

Invest in capital goods, construction, and transportation.

Question 17

Which of the following statements about the DDM and DCF models is correct?

Accepted Answer

DDM only works reliably for mature, stable dividend payers, while DCF can be used for firms with reliable cash flow forecasts.

Question 18

If a company's retention ratio is $$0.60$$ and its Return on Equity (ROE) is $$12\%$$, what is the estimated dividend growth rate ($$g$$)?

Accepted Answer

$$g = 0.60 	imes 0.12 = 0.072 or$$ $$7.2\%$$

Question 19

Which of the following is a key limitation of relative valuation using market multiples?

Accepted Answer

It depends heavily on peer selection and market mood.

Valuation Methods in Financial Accounting: DDM, DCF, and Relative Valuation

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