3d Financial Management - Financial Valuation Methods

Which one of the following is most important to a successful budgeting effort?

Top management support

Which of the following is a cornerstone investment philosophy in developing an investment portfolio?

Understanding human nature and how it relates to the investment process

Income approach to valuation

Uses the company's ability to create earnings or cash inflows

Joan CPA has been engaged to do some estate planning for a client. As part of that estate planning, Joan is expected to do a valuation of the client's small business. In the process of performing this engagement, Joan will be determining the ________ of the small business.

Value

Weak-form efficency

Weak-form efficiency suggests that information about past prices would not be of use in predicting future performance.

Which of the following rates is most commonly compared to the internal rate of return to evaluate whether to make an investment?

Weighted average cost of capital

Under which one of the following conditions is the internal rate of return method less reliable than the net present value technique?

When both benefits and costs are included, but each is separately discounted to the present

Which of the following observations regarding the valuation of bonds is correct?

When the market rate of return is less than the stated coupon rate, the market value of the bond will be more than its face value, and the bond will be selling at a premium.

Everything else being equal, a noncallable bond will be priced in comparison to a callable bond so that the noncallable bond will provide:

a lower yield.

Everything else being equal, a noncallable bond will be priced in comparison to a callable bond so that the noncallable bond will provide:

a lower yield. Less Risky than callable

Black-Scholes ModelWhich of the following inputs would be most beneficial to consider when management is developing the capital budget?

a price variation model of financial instruments that can be used to determine the price of a European call option

An income-based approach for valuation is used when:

a reliable benefit stream projection such as cash flow or income is available.

Treynor Index Ratio

(Portfolio Return - Risk Free Rate) / Beta

Sharpe Measure Calc

(Portfolio Return - Risk Free Rate) / Standard Deviation

Premise of Value (3)

1. An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject 2. A company will be expected to continue operations into the future. 3. The premise of value must be translated into estimates of future inflows and outflows.

Fair value assumes a value determination for all of the following?

1. Assets 2. Liabilities 3. Equity Ownership NOT retained earnings

4 Time Value of Money Concepts

1. Cash received at different points in time has different values. 2. Money held today has a greater value than money received tomorrow. 3. The time value of money is determined by the interest and length of time. 4. The future value of money is adjusted for time and interest.

When valuing a business or business segment, it is important to identify various risks that could have negative impacts on the subject of the valuation. All of the following are examples of business risk (3)

1. Competitive Risk 2. Labor Efficiency 3. Supplier Risk NOT Global Risk - this is a made up term

3 Basic Valuation Approaches

1. Cost 2. Market 3. Income

All of the following are the rates used in net present value analysis:

1. Cost of Capital 2. Hurdle Rate 3. Required Rate of Return

Black-Scholes Model 5 inputs

1. Current Stock Price 2. Option exercise strike price 3. Time to the options expiration 4. The risk-free rate 5. A risk of measure (volatility)

Which one of the following would have an impact on a firm's beta value?

1. Debt to equity ratio 2. Industry Characteristics 3. Operating Leverage

Market Approach to Valuation (key assumptions 11)

1. Diversification of Operations 2. Markets Served 3. Geographic diversification 4. Size of organization 5. Operating leverage 6. Comparability of products (services) sold 7. Financial leverage 8. Liquidity 9. Asset and Debt management 10. Profitability 11. Growth

Measures of a firms over profitability (3)

1. Earnings per share 2. Industry average for earnings on sales 3. Return on investment NOT internal rate of return

Which of the following characteristics represent(s) an advantage of the internal rate of return technique over the accounting rate of return technique in evaluating a project?

1. Emphasis on cash flows 2. Recognition of the time value of money

For a portfolio, which of the following measurements a weighted average of the measurements for the securities in that portfolio? (3)

1. Expected return 2. Beta 3. Systematic Risk

The differences between fair market value and fair value

1. Fair market value implies a willing buyer and seller, whereas the buyer and seller under fair value are not necessarily willing. 2. Fair market value defines the seller as hypothetical, whereas there is a specific seller when using fair value (not vice versa). 3. Fair market value takes advantage of an unrestricted market, whereas fair value uses the principal or most advantageous market.

Which of the following are key assumptions in using the market approach for valuation? (3)

1. Financial Leverage 2. Liquidity 3. Profitability

Advantages of ST Credit

1. Funds can be obtained quickly 2. Financing with this credit usually results in lower interest costs 3. There are some spontaneous sources of funds such as trade credit. 4. Some of this debit is "interest free", such as wages payable

When predicting future cash flow, which of the following needs to be examined carefully to predict the estimated value? (3)

1. Historical growth patterns 2. Expectation as to future economic conditions 3. Expected capacity

Disadvantages of ST Credit

1. Interest rates tend to vary quickly 2. This type of debt is more risky

An asset management firm does which one of the following?

1. Manages various securities and assets 2. Works to meet specified investment goals of the client 3. Has access to a broad range of financial instruments and/or vehicles

The valuator may make adjustments for (4)

1. Nonrecurring 2. Nonopearting 3. Comparability 4. Discretionary items

Screening Methods

1. Payback Method 2. Time-adjusted rate of return 3. Accounting rate of return

4 Basic Assumptions for the Income Approach to valuation

1. Prediction of the future benefit stream 2. The number of period in the project 3. The terminal value at the end of the projection 4. The discount capitalization rate

Which of the following includes all of the appropriate basic value assumptions?

1. Price 2. Value 3. Worth

The capital asset pricing model (CAPM) is a function of each of the following: (3)

1. Required rate of return on the portfolio 2. Risk-free rate of return 3. Volatility of asset returns 4. Beta 5. Market Risk Premium You do not need the exact rate of return

3 Components of the Capital Asset Pricing Model

1. Risk-free rate of interest 2. Market risk premium 3. Beta Coefficient

Which of the following is part of the cost-volume-profit analysis (CVP) formula? (3)

1. Sales equals number of units sold times sales prices per unit 2. For the breakeven point, desired profit equals zero 3. Margin of safety is the excess sales over the breakeven sales point.

Which of the following items are examples of a question that can be addressed through the use of capital budgeting?

1. Should a new product or market be added? 2. Should existing debt be retired or refinanced? 3. Should machinery be replaced by more efficient models?

Which of the following is considered an assumption of valuation using the rules of thumb? (3)

1. Show the valuator is knowledgeable about the subject company's industry 2. Support valuation arrived at using another method with similar results 3. Support valuation arrived at using another method with different results along with arguments as to why the subject company is not average within the industry

Which one of the following statements concerning cash flow determination for capital budgeting purposes is correct?

1. Tax depreciation must be considered since it affects cash payments for taxes. 2. Sunk costs are not incremental flows and should not be included. 3. Net working capital changes should be included in cash flow forecasts.

Advantages of using the NPV method for decision making (4)

1. The TVM is considered (compounding of returns) 2. Given a perfect market, correct decision advice will be obtained 3. A correct ranking will be obtained for mutually exclusive projects given similar lives and investments 4. An absolute value is obtained

When calculating fair value, which of the following should be used as a value determination? (3)

1. The age and condition of the object 2. Attributes for the valuation of the object 3. Location of the object

The cost approach to valuation is appropriate to use when: (5)

1. The company is in liquidation 2. The company is worth more in liquidation than as a going concern 3. The company's value is basically related to the assets held 4. The company has had no income in recent years 5. Future benefit streams cannot be adequately predicited

Disadvantages of using the NP method (2)

1. The discount rate is difficult to determine 2. Assumptions related to cash flows have to be made that may or may not be correct

Which of the following statements are an assumption of the dividend discount model? (3)

1. The dividend growth rate is constant 2. The required rate of return is greater than the dividend growth rate 3. The stock price will grow in perpetuity NOT TRUE: Dividends can be calculated for multiple years beyond the year in which the stock price is being determined.

Which of the following disclosures is are needed when using fair value on a recurring basis? (3)

1. The fair value measurement as of the reporting date 2. The valuation method(s) 3. A discussion of any changes in valuation techniques

Which of the following statements describes the discounted payback method? (4)

1. The investment alternative with the shortest payback period is considered the most desirable. 2. The chief limitation is that the method emphasizes liquidity and disregards profitability. 3. The method is simple to compute and easy to understand and explain. 4. The discounted payback period is the length of time required to recover the initial cash investment using a sum of the discounted future cash flows

Black-Scholes 6 Major Assumptions

1. The options are European 2. The risk-free rate is fixed 3. Volatility is fixed 4. No dividends are paid 5. Markets follow a random walk 6. Option exercise occurs at expiration regardless of the exercise period.

Which are the implications of income tax on capital budgeting?

1. The reduction in taxes payable due to depreciation is a cash inflow item that must be included in the analysis. 2. Cash flows in the form of revenue are taxable and must be computed net of tax. 3. Cash outflows in the form of expenses are deductible in computing taxes payable and must be computed net of tax.

When determining fair value measurements on a nonrecurring basis, which of the following need to be disclosed? (3)

1. The valuation method 2. The fair value measurement as of the reporting date 3. Reconciliation of the beginning and ending balances when using unobservable inputs

5 Criteria For Sales-Type Lease

1. Title (ownership) transfers to the lessee by the end of the lease term. 2. The lease contains a purchase option that the lessee is reasonably certain to exercise. 3. The lease term is for the major part of the remaining economic life of the underlying asset. 4. The present value of the sum of the lease payments and any lessee guaranteed residual value not already in the lease payments equals or exceeds substantially all of the fair value of the underlying asset. 5. The underlying asset is specialized and is not expected to have an alternative use to the lessor at the end of the lease term.

Portfolio Measures that adjust for risk

1. Treynor Index 2. Sharpe Measure 3. Jensen Measure

Two Types of Business Valuation Engagements

1. Valuation Engagement 2. Calculation Engagement

3 forms of Market Beliefs

1. Weak-form efficient 2. Semi-strong efficient 3. Strong-form efficient

Considerations when choosing between a lease and a loan (3)

1. Whether the lessor has a higher cost of capital than the lease 2. Whether the lessor and lessee have different tax reduction opportunities 3. The residual value of the property NOT the capacity of the equipment

As part of a valuation engagement, it may be necessary to adjust the financial statements for the subject company in all cases (3)

1. comparing non-GAAP statements to GAAP statements. 2. items that are not considered to be part of normal operations are included in the financial statements. 3. discretionary items that are not considered to be normal business expenses are included in the financial statements.

If management: believes too many proposals are being rejected: Hurdle Rate?

A lower hurdle rate would be used

The Sharpe Measure

A measure for portfolio performance

Which of the following assumptions applies to the basic theory underlying the capital asset pricing model?

A single risk-free rate exists.

Which of the following situations is an income-based approach appropriate for valuation?

A substantial amount of goodwill appears to exist. The use of an income-based approach for a valuation is appropriate when a reliable benefit stream projection such as cash flow or income is available

What is an internal rate of return?

A time-adjusted rate of return from an investment

Which of the following statements that relate to capital budgeting is true?

Accelerated methods of depreciation provide tax shields that are advantageous from a present-value point of view.

Accrual "Accounting" rate of return

Accounting Income / Investment

All of the following are the rates used in net present value analysis except for the:

Accounting Rate of Return This method disregards TVM

Which one of the following provide a spontaneous source of financing for a firm?

Accounts payable Because trade credit arises automatically from purchase transactions, it provides a spontaneous source of financing for the firm.

What type of covenant requires a corporation to maintain, at all times, some minimum level of working capital?

Affirmative covenant

Which of the following is the correct definition of premise of value?

An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject of the valuation

Accrual "Accounting Income" based on investment calc

Annual Saving - Depreciation

Which of the following areas of decision policy-making should the financial manager consider when balancing risk and profitability?

Asset portfolio, liquidity position, use of debt

Which one of the following statements concerning cash flow determination for capital budgeting purposes is incorrect?

Book depreciation is relevant since it affects net income. Depreciation itself is not a cash outflow. Only the income which taxes must be assessed

When determining fair market value, characteristics for both the buyer and seller would include all except which of the following?

Buyers and sellers are related parties. There should be no related parties in determining FMV

Which of the following statements is correct regarding financial decision making?

Capital budgeting is based on predictions of an uncertain future.

Net present value as used in investment decision-making is stated in terms of which of the following options?

Cash flow

A limitation of using the discounted payback method to evaluate a project is that it ignores which of the following?

Cash flows after the payback period

When predicting future cash flow, which of the following does not need to be examined carefully to predict the estimated value?

Changes in technology

IRR vs NPV investment choice

Choose the investment with the highest Net Present Value

As part of a valuation engagement, it may be necessary to make some adjustments. The valuator may make normalization adjustments for which of the following?

Comparability adjustments

If a factory were to be replaced, which of the following cost approaches would be best for determining fair value?

Cost approach The cost approach determines fair value on what it would cost to replace the item.

Cost Approach to valuation

Cost to replace

An accountant using the Black-Scholes model to value stock options has input the exercise price of the options, time to expiration for the options, and an interest rate. Which of the following variables also is required for the model?

Current stock price

How would the following ratios or measures be affected if a company issued additional capital stock for cash? 1. Debt to Assets 2. Working Capital

Debt to Assets: Decrease Working Capital: Increase

Portfolio management determines which assets to include in a given portfolio. Which of the following is not a characteristic of portfolio management?

Deciding the degree of risk for the investor Only the investor should decide the degree of risk with which they are comfortable

Which of the following events would decrease the internal rate of return of a proposed asset purchase?

Decrease tax credits on the asset

The calculation of depreciation is used in the determination of the net present value of an investment for which of the following reasons?

Depreciation increases cash flow by reducing income taxes.

Which of the following has implications for income taxes on capital budgeting but does not have relevance for standard present value calculations?

Depreciation on equipment purchased in prior years

Which of the following best describes the income approach to determine fair value?

Determining fair value using the company's ability to create earnings or cash flow

Which of the following capital budgeting techniques uses the time value of money to screen potential projects?

Discounted payback

Company-specific risk can be reduced or eliminated in investment management through which of the following?

Diversification

Which of the following is the correct formula for the cost of equity?

Dividend paid / (Market price of the stock + Growth rate)

Why is the price-earnings (P/E) ratio so widely used as a multiple to value equity securities?

Earnings are believed to be the primary driver of stock prices.

Which of the following methods is best suited for evaluating the performance of a firm's capital in any given year?

Economic value added

Which of the following is an accurate comparison of fair value and fair market value?

Fair market value defines the seller as hypothetical, whereas fair value assumes a specific seller.

Which of the following types of bonds is most likely to maintain a constant market value?

Floating rate Rates follow the market

Neu Co. is considering the purchase of an investment that has a positive net present value based on Neu's 12% hurdle rate. The internal rate of return would be:

Greater than 12%

Which of the following is not considered an assumption of valuation using the rules of thumb?

Hire an industry expert to give a detailed, thorough report on valuation

The rankings of two mutually exclusive investments determined using the internal rate of return (IRR) method and the net present value (NPV) method may be different in which of the following situations?

If the two projects have unequal lives and the size of the investment for each project is different

What happens to bond prices, in general, when interest rates decline?

In general, bond prices increase when interest rates decline because the stated rate of interest on the bond is more attractive relative to the market interest rate.

The net present value (NPV) of a project has been calculated to be $215,000. Which one of the following changes in assumptions would decrease the NPV?

Increase the discount rate.

When evaluating assumptions used in a valuation of a particular asset, business segment, or business, which of the following is an attribute of due diligence?

Inquiries should be made to determine that the physical assets are suited to their intended use. A physical inspection should always be performed

Advantages of LT Credit

Interest rates tend to be more stable

Which of the following decision-making models equates the initial investment with the present value of the future cash inflows?

Internal rate of return

Which of the following metrics equates the present value of a project's expected cash inflows to the present value of the project's expected costs?

Internal rate of return

An entity is examining potential investments and notes that 1-year maturity yields are higher than those for 10-year maturities. Which of the following explanations for this occurrence is best?

Investors are expecting reduced inflation in the future as reflected in the lower long-term returns.

Which of the following is an advantage of net present value modeling?

It accounts for compounding of returns.

Which of the following best describes the net present value method?

It adjusts for the time value of money.

Which of the following statements is true regarding the payback method?

It does not consider the time value of money.

Which of the following is a strength of the payback method?

It is easy to understand.

Which of the following is a limitation of the profitability index?

It requires detailed long-term forecasts of the project's cash flows.

Prepayment penalties are generally associated with:

LT credit

A multiperiod project has a positive net present value. Which of the following statements is correct regarding its required rate of return?

Less than the project's internal rate of return

Fair Value Hierarchy Level 1

Level 1 inputs are the most desirable and consist of observable inputs such as active market prices of identical assets.

Fair Value Hierarchy Level 2

Level 2 inputs are middle level when determining fair value and include prices of assets or liabilities that can be either directly or indirectly observed but do not include the Level 1 quoted market prices. Often market values of similar assets or liabilities are used to determine fair value.

Fair Value Hierarchy Level 3

Level 3 inputs are unobservable, are considered to be the lowest and least desirable level when determining fair value, and include exit prices.

Which of the following approaches is used most often by real estate agents in determining a reasonable market price for a home?

Market approach

Market Approach to valuation

Market approach uses comparisons of identical or comparable assets or liabilities to determine fair value.

Hurdle Rate

Minimum acceptable rate of return (set by management) for an investment.

Payback period calc

Net Investment / Avg expected annual cash inflow

The discount rate is determined in advance for which of the following capital budgeting techniques?

Net Present Value

The profitability index is a variation on which of the following capital budgeting models?

Net Present Value

If internal rate of return equals the hurdle rate:

No excess return will occur, so net present value will be zero

In fair value hierarchy, which of the following is the most desirable?

Observable inputs

Which of the following statements is correct when a corporation is earning excess profits?

Participating preferred stock acts more like equity than cumulative preferred stock.

A client wants to know how many years it will take before the accumulated cash flows from an investment exceed the initial investment, without taking the time value of money into account. Which of the following financial models should be used?

Payback period

Which of the following is a valid method of calculating the internal rate of return?

Plot three or four combinations of net present value (NPV) and discount rate on a graph, connect the points with a smooth line, and locate the discount rate at which NPV = 0.

Which of the following covenants obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded?

Poison put clause

What is the formula for calculating the profitability index of a project?

Present value of the annual after-tax cash flows / original cash invested in the project

CVP formula

Profit = Sales - Variable Costs - Fixed Costs

Which of the following inputs would be most beneficial to consider when management is developing the capital budget?

Profit center equipment requests Capital budgeting involves management making decisions about spending money on long-term assets.

Capital budgeting methods are often divided into two classifications: project screening and project ranking. Which one of the following is considered a ranking method rather than a screening method?

Profitability Index

Which of the following methods should be used if capital rationing needs to be considered when comparing capital projects?

Profitability index. This allows the comparison of projects with differing investment amounts.

Project A and B each require an investment of $11,000. Project A returns annual cash inflows of $4,000 for three years. Project B returns annual cash inflows of $3,500 for four years.

Project A is superior to Project B in payback but not profitability.

Which of the following is not a key assumption in using the market approach for valuation?

Reputation and standing among peers

Fair value assumes a value determination for all except which of the following?

Retained earnings

Disadvantages of LT Credit

Retirement will probably contain a prepayment penalty

Variance and standard deviation can be used in measuring which of the following?

Risk

What is a primary objective of diversification in portfolio management?

Risk reduction

What is the basic objective of combining investment assets into portfolios?

Risk reduction

Which can you get quicker LT or ST credit

ST

The price-to-sales ratio is based on what assumption?

Sales are less likely to be manipulated by management than earnings.

Which of the following is not an implication of income tax on capital budgeting?

Salvage value at book value resulting in a gain must be computed net of tax.

Semi-strong efficiency

Semi-strong efficient markets suggest that all publicly available information is incorporated in market prices.

More flexible LT or ST credit

Short-term; can renew more often

Which of the following items is not an example of a question that can be addressed through the use of capital budgeting?

Should production be outsourced? Outsourcing is not a capital budget decision.

For a portfolio, which of the following measurements is not a weighted average of the measurements for the securities in that portfolio?

Standard Deviation Standard deviation is a statistical measure of variability or tightness of a distribution of outcomes around a central measure, the expected return. Thus, it is not an average measurement.

What is the calculation for the interest payment on a bond?

Stated rate of interest × Par value

When analyzing the capital asset pricing model, which of the following risks can be diversified away?

Stock Price

When analyzing the capital asset pricing model, which of the following risks can be diversified away?

Stock price

Beta Coefficient Measures

Stock's Volatility (how much a stock's price increases or decreases compared to movement in the stock market.

Strong-form efficient

Strong-form efficient markets suggest that all available information is incorporated in current market prices.

What term is used to represent unavoidable past costs that cannot be changed no matter what action is taken?

Sunk Costs

Which of the following is a description of the internal rate of return (IRR)?

The IRR is the rate of interest that equates the present value of the net cash flows to zero.

How does the price-to-book (P/B) ratio differ from the price-to-sales ratio model?

The P/B ratio focuses on the balance sheet rather than the income statement.

Upper-level managers routinely provide margin of safety information to profit center managers. What does this information provide?

The amount by which revenue can drop before a loss is incurred

Which of the following best describes the accounting rate of return (ARR)?

The annual accounting income divided by investment

Beta Coefficient

The beta coefficient is a measure of individual stock volatility. A larger coefficient indicates more risk. If the beta coefficient is 1.0, then the individual stock has risk equal to the general market.

An individual holds a 10-year fixed-rate bond as an investment. Three years of its life remain. When the bond was issued, interest rates were much higher than they are now. Interest rates are expected to be stable for the next three years. Which of the following statements is correct regarding the bond?

The bond is currently selling at a premium.

Which of the following is an example of when an asset-based (cost) approach is appropriate for valuation?

The company is worth more in liquidation than as a going concern.

Which of the following phrases defines the internal rate of return on a project?

The discount rate at which the net present value of the project equals zero

Fair Value Measurement Assumptions (3)

The fair value measurement assumes that the best use for the object is not determined by its current holder, but by its future owner. The value of the object is physically possible, legally permissible, and financially feasible.

The discount rate used when preparing a business valuation when employing an income approach is critical. Which of the following statements about discount rates is true?

The higher the risk, the higher the discount rate, and the lower the present value of the subject company.

When calculating fair value, which of the following should not be used as a value determination?

The owner's value

IRS Revenue Ruling 68-608 provides guidance as to the form of the financial statement when used in a valuation process. This guidance can be summarized as which of the following?

The past earnings used in the valuation process should fairly reflect the probable future earnings.

Which of the following statements is correct regarding the payback method as a capital budgeting technique?

The payback method provides the years needed to recoup the investment in a project.

Which of the following statements about investment decision models is true? Payback period

The payback rule ignores all cash flows after the end of the payback period.

Which of the following best defines fair market value?

The price expressed in terms of the cash equivalent at which the property would change hands between a buyer and seller in which neither is compelled to buy and both buyer and seller acknowledge that it is relevant to the transaction

Beta Coefficient of 1

The price of the stock or security moves with the market

Which of the following is a characteristic of the profitability index?

The profitability index is often used to compare two or more mutually exclusive projects.

Profitability Index

The profitability index is the present value of the cash flows after the initial investment divided by the amount of that investment. Net Present Value / Investment Required

Internal Rate of Return (IRR)

The rate of return that causes the present value of the net cash flows to equal the initial investment

Which of the following is a way to measure portfolio performance?

The risk-adjusted return on investment Returns must be adjusted for risk before they can be compared meaningfully

Beta Less than 1

The security's returns are less likely to respond to movements in the market

Beta Coefficient greater than 1

The security's returns are more likely to respond to movements in the market and will be more volatile

In capital budgeting, which of the following items is included in the payback model calculation?

The total amount of the initial outlay for the project

Calculation Engagement

The valuator and the client agree upon specific valuation methods or approaches to be used

Valuation Engagement

The valuator is free to use any valuation approach of method deemed to be professionally appropriate

According to the Black-Scholes option pricing model, what effect does increased volatility of a stock have on the value of a call option of the stock?

The value of the call option will increase because increased volatility improves the likelihood that the call option will be in-the-money.

What does beta measure in the capital asset pricing model?

The volatility of a stock relative to the market

Everything else being equal, the internal rate of return (IRR) of an investment project will be lower if:

cash inflows are received later in the life of the project.

The market approach to determining the fair value of a small company is based upon the theory that:

companies within the industry that have similar performance records and structure will have similar value.

If a project has differing required rates of return over its life, i.e., 8% in the first three years and 12% in the second three years, the analyst should:

compute the project's net present value using both rates for the appropriate years and accept the project if the net present value is at least zero.

When performing a fair value valuation, John CPA has found a quoted market price for a similar asset to the one held by the reporting organization. There are some questions, however, related to the condition of the asset being valued in comparison to the similar asset. John should:

consider this a Level 3 fair value measurement if the potential adjustments necessary due to the condition of the assets being valued merit the classification of an unobservable input.

The binomial model of pricing options:

considers the underlying security over a period of time. Similar to Black-Scholes except Black-Scholes looks at a point in time

When the risks of the individual components of a project's cash flows are different, an acceptable procedure to evaluate these cash flows is to:

discount each cash flow using a discount rate that reflects the degree of risk.

The capital budgeting model that is generally considered the best model for long-range decision making is the:

discounted cash flow model. TVM is considered

A disadvantage of the net present value method of capital expenditure evaluation is that it:

does not provide the true rate of return on investment.

The rationale of why the price-to-cash flow (P/CF) ratio might be used rather than the price-earnings (P/E) ratio is that:

earnings are subject to significantly more manipulation than cash flows.

FASB ASC 820 discusses the disclosures that need to be presented in financial statements related to fair value measurements. A basic goal of these disclosures is to provide:

enough information to the user of the financial statements so that the inputs used in the fair value measurement can be assessed.

In capital budgeting, the excess present value index (profitability index) is best used to:

evaluate mutually exclusive investments of different sizes.

Letters of credit are often used to facilitate international trade. The basic purpose of the letter of credit is to reduce risk to the:

exporter. The risk of uncollectibility to the exporter is virtually eliminated

Short-term interest rates are:

generally lower than long-term rates.

A project should be accepted if the present value of cash flows from the project is:

greater than the initial investment.

The net present value of a proposed investment is negative; therefore, the discount rate used must be:

greater than the project's internal rate of return.

If a firm identifies (or creates) an investment opportunity with a present value ________ its cost, then the value of the firm and the price of its common stock will ________.

greater than; increase

A financial lease:

has a duration that corresponds to the useful life of the asset and payments that amortize the cost of the asset while providing the lessor an interest return.

Diversification in portfolio management should:

increase income while reducing risk.

The use of an accelerated method instead of the straight-line method of depreciation in computing the net present value of a project has the effect of:

increasing the present value of the depreciation tax shield.

Preferred stock and long-term bonds are similar from the standpoint of the issuing firm because:

interest and dividend payments are fixed.

The payback reciprocal can be used to approximate a project's:

internal rate of return if the cash flow pattern is relatively stable. Payback Reciprocal = 1/Payback Period Payback = Net Cash Invested / Annual Cash Inflow

An agreement between a small firm and a bank that permits the firm to borrow varying amounts of funds as needed over a specified time period is called a:

line of credit.

XYZ Lawn Care Services provides a variety of lawn care supplies such as seed and fertilizer. In addition, the firm provides lawn care services on a customer requested basis. Sales and services vary greatly by season and are affected by changes in weather conditions. The financing method that would likely result in meeting XYZ's cash needs at the lowest cost is:

line of credit. gives flexibility

When evaluating capital budgeting analysis techniques, the payback period emphasizes:

liquidity.

Price multiple ratios are all based on an assumption that:

management's behavior has an influence on the ratios.

The price-earnings ratio:

measures the price investors are willing to pay for each dollar of earnings the company generates.

Under fair value assumptions, the hypothetical transaction is considered to have occurred in either the principal market for the subject transaction or, in the absence of such a market, in the ______________ for that transaction.

most advantageous market

The method that recognizes the time value of money by discounting the after-tax cash flows over the life of a project, using the company's minimum desired rate of return is the:

net present value method.

In a business combination, the valuation of goodwill is a calculation:

of the residual paid above the fair value of the identifiable net assets. The acquisition of a major part or all of another enterprise may result in the recognition of the intangible asset known as goodwill.

A measure of project risk is provided by the capital budgeting technique of:

payback. The payback capital budgeting technique indicates how soon a project will recover its cost. The sooner the cost is recovered, the less risky the project—returns are less knowable the further in the future they are.

A project's net present value, ignoring income tax considerations, is normally affected by the:

proceeds from the sale of the asset to be replaced.

An effective assessment of how a company can increase the profit it generates out of each sales dollar is to assess:

profit margin.

The recommended technique for evaluating projects when capital is rationed and there are no mutually exclusive projects from which to choose is to rank the projects by:

profitability index.

By using a rule of thumb, a practitioner can:

provide support for a valuation estimate arrived at using another method with similar results.

A secured bond issue is one that:

provides bondholders with a pledge against certain assets.

If the net present value of a capital budgeting project is positive, it would indicate that the:

rate of return for this project is greater than the discount percentage rate used in the net present value computation.

The expertise of financial managers is called into play most often when issues of ________ are involved.

risk and return

When valuing options under the Black-Scholes model, it is assumed that:

risk-free rates are constant over the life of the option.

The use of an asset-based (cost) approach for valuation is appropriate when:

the company is in liquidation or is worth more in liquidation than a going concern.

Hurdle Rate

the cost of capital or cost of borrowing

In determining cash flows from a proposed investment, the amount of the investment's depreciation tax savings (shield) in a given year is equal to:

the depreciation times the tax rate.

In the definition of fair value as presented in FASB ASC 820, the principal market is considered to be a market where:

the holder of the asset or liability could find the greatest volume of asset sales or liability transfers of items similar to the one being valued.

Joe CPA has been retained to determine the fair value of the capital assets of the warehousing division of the Trinket Company. In doing so, Joe will assume that:

the hypothetical sale occurred in an orderly fashion.

If the time-adjusted rate of return, or internal rate of return, is higher than the rate of return required by the company, then:

the net present value of the project is positive.

When evaluating projects, the discounted breakeven period is best described as:

the point where discounted cumulative cash inflows on a project equal discounted total cash outflows.

Essex Corporation is evaluating a lease that takes effect on March 1, 20X7. The company must make eight equal payments, with the first payment due on March 1, 20X7. The concept most relevant to the evaluation of the lease is:

the present value of an annuity due.

Hat Haven's common stock has a beta of 1.3. This beta indicates that:

the return of the Hat Haven stock varies more than the market returns.

The cost approach to valuation is appropriate to use when:

the value of the firm is basically related to the assets held.

Future payments must be discounted in a bond valuation in order to take into account the:

time value of money.

One limitation of the Black-Scholes model is that:

trading has no associated fees. Assumes that any trades have a zero-cost option; this is not practical given that fees are assessed for all trade transactions

When estimating cash flow for use in capital budgeting, depreciation is:

utilized in determining the tax costs or benefit.

For capital budgeting purposes, management would select a high hurdle rate of return for certain projects because management:

wants to factor risk into its consideration of projects.