Chapter 12—Valuation: Cash-Flow-Based Approaches
If an analyst wants to value a potential investment in the common stock equity of a firm, the analyst should discount the projected free cash flows at the: a. required return on equity capital. b. weighted average cost of capital. c. risk-free rate. d. market risk premium.
ANS: A
Plough Corporation reports the following information: Net cash provided by operating activities $300,000 Average current liabilities 150,000 Average long-term liabilities 100,000 Dividends paid 80,000 Capital expenditures 140,000 Payments of debt 35,000 Plough's free cash flow is: a. $80,000 b. $105,000 c. $45,000 d. $10,000
ANS: A
A disadvantage of the free cash flow valuation method is: a. The terminal value tends to dominate the total value in many cases. b. The projection of free cash flows depends on earnings estimates. c. The free cash flow method is not rigorous. d. The free cash flow method is not used widely in practice.
ANS: A
Continuing free cash flows represent: a. the cash flows remaining after deducting cash flows attributable to debt holders. b. the free cash flows after the point at which the firm has settled into a long-run steady-state growth rate. c. all sustainable free cash flows. d. all after-tax free cash flows.
ANS: B
If a firm's stock returns co-vary identically with returns to a market-wide portfolio, then its market beta from such a regression is: a. equal to zero. b. equal to one. c. less than one d. greater than one
ANS: B
If an analyst wants to value a potential investment in the net operating assets of a division of another firm, the relevant cash flows the analyst should use are: a. free cash flow from operations. b. free cash flows for all debt and equity capital stakeholders. c. free cash flows to common equity shareholders. d. cash flow from operations.
ANS: B
Starting with net cash flow from operations and adjusting for capital expenditures and dividends equals: a. free cash flows for all debt and equity capital stakeholders. b. free cash flow. c. free cash flows to common equity capital shareholders. d. free cash flow from operations.
ANS: B
The conceptual framework for free cash flows separates the balance sheet equation into the following categories: a. CA + LT A = CL + LT L + SE b. OA + FA = OL + FL + SE c. OA + FA = OL + FL + OSE + FSE d. Non-FA + FA = Non-FL + FL + SE
ANS: B
When calculating free cash flows to common equity shareholders, financing activities do not include: a. Debt cash flows b. Adjustments for capital expenditures c. Adjustments for Preferred stock cash flows d. Financial asset cash flows
ANS: B
Which of the following is not a problem with using a dividend-based valuation formula? a. Dividends are arbitrarily established. b. Dividends represent a transfer of wealth to shareholders. c. Some firms do not pay a regular periodic dividend. d. It is a challenge to forecast the final liquidating dividend.
ANS: B
Financial assets include all of the following except: a. excess cash b. short term investments c. intangible assets d. long-term investments
ANS: C
Financial liabilities include all of the following except: a. mortgages payable b. current maturities of long-term debt c. accrued taxes d. bonds payable
ANS: C
If an analyst wants to value a potential investment in the common stock equity in a firm, the relevant cash flows the analyst should use are: a. free cash flow from operations. b. free cash flows for all debt and equity capital stakeholders. c. free cash flows to common equity shareholders. d. cash flow from operations.
ANS: C
If an analyst wants to value a potential investment in the net operating assets of a division of another firm, the analyst should discount the projected free cash flows at the: a. cost of debt capital. b. cost of equity capital. c. weighted average cost of capital. d. risk-free rate.
ANS: C
Steady-state growth in free cash flows could be driven by long-run expectations for growth attributable to: a. interest rates b. national exports c. general economic productivity d. balance of payments
ANS: C
What is Houston's free cash flow for all debt and equity holders for year 2012? a. $564 b. $399 c. $324 d. $202
ANS: C
Net cash flow from operations ________________ dividends equals_______________________
ANS: Capital expenditures, free cash flow
All of the following are logical steps that enable the analyst to determine reliable estimates of value except: a. Understand the economics of the industry b. Assess the particular firm's strategy c. Evaluate the quality of the firm's accounting d. Derive a single point estimate of value for a share's current price
ANS: D
An equity security with systematic risk equal to the average amount of systematic risk of all equity securities in the market: a. has a market beta equal to one. b. should expect to earn the same rate of return as the average stock in the market portfolio. c. gives no insight into the risk premium of stock. d. Both a and b are correct.
ANS: D
Free cash flow is calculated as net cash provided by operating activities less: a. dividends. b. capital expenditures and depreciation. c. capital expenditures. d. capital expenditures and dividends.
ANS: D
Nonsystematic risk factors would include all of the following except: a. the sustainability of the firm's strategy b. the firm's ability to generate revenue growth c. the firm's ability to control expenses d. unemployment levels
ANS: D
Sun Corporation reports the following information: Net cash provided by operating activities $255,000 Average current liabilities 150,000 Average long-term liabilities 100,000 Dividends paid 60,000 Capital expenditures 110,000 Payments of debt 35,000 Sun's free cash flow is: a. $195,000 b. $145,000 c. $50,000 d. $85,000
ANS: D
The conceptual framework for free cash flows separates all assets and liabilities into the following categories: a. Current and non-current b. Monetary and non-monetary c. Operating and non-operating d. Operating and financial
ANS: D
What is Houston's free cash flow for common equity holders for year 2012? a. $564 b. $399 c. $324 d. $412
ANS: D
__________ is an estimate of systematic risk based on the degree of covariation between a firm's stock returns and an index of stock returns for all firms in the market.
ANS: Market beta
________________________________________ typically include accounts payable, accrued expenses, accrued taxes, deferred taxes, pension obligations and other retirement benefit obligations.
ANS: Operating liabilities
Free cash flows for common equity shareholders are the cash flows specifically available to the common shareholders after making all capital expenditures, _____________________________________________ and ____________________________________________________________.
ANS: debt service payments to lenders, paying dividends to preferred shareholders The risk-adjusted discount rate used to compute the present value of all the projected free cash flows for common equity shareholders equals the _______________________________________________________. < ANS: required rate of return on equity capital
The cash-flow-based valuation approach measures and values the cash flows that are "free" to be ________________________________________ unencumbered by necessary reinvestments in operating assets or required payments to debt holders.
ANS: distributed to shareholders
The present value of future free cash flows valuation method focuses on free cash flows, a base that economists argue has more economic meaning than ____________________.
ANS: earnings
If the objective is to value operating assets net of operating liabilities of a firm then the appropriate free cash flow measure to be used is ______________________________________________________________________.
ANS: free cash flow for all debt and equity capital
Steady-state growth in ___________________________________ could be driven by long-run expectations for growth attributable to economy-wide inflation, general economic productivity, the population, or long-run growth in industry's sales.
ANS: free cash flows
The forecasting and valuation process is particularly difficult for ______________________________ when the near term free cash flows tend to be negative.
ANS: growth firms
If cash flow projections include the effect of inflation then the discount rate used should be a(n) ____________________ rate.
ANS: nominal
For most firms, ______________________________ include cash and short-term investment securities, accounts receivable, inventory, property, plant and equipment, intangible assets and investments in affiliated companies.
ANS: operating assets
Even in relatively efficient securities markets, ______ is observable but ______ is not; therefore, ______ must be estimated.
ANS: price value value
Changes in general price levels due to inflation or deflation cause the ______________________________ of the monetary unit to increase or decrease ______________
ANS: purchasing power, over time
If a firm generates a rate of return on __________________________________________________ equal to the discount rate used by the investor then it does not matter if an analyst uses cash flows to the investor or cash flows to the firm.
ANS: reinvested free cash flow
One advantage of the free cash flow valuation method is cash is the medium of exchange and therefore is a fundamental source of ________________________
ANS: value
The analyst can use expectations of the dividends to be paid to the investor or the free cash flows to be generated by the firm (that will ultimately be paid to the investor) as equivalent approaches to measure the ____________ expected payoffs to shareholders.
ANS: value-relevant