FIN FINAL
Advanced Chemical Industries is awaiting the verdict from a court case over whether it is liable for the clean-up of wastes on a disused factory site. If it is liable, this will result in a reduction of its free cash flow by $11 million per year for ten years. If it is not liable, there will be no effect. On the close of trading the day before the announcement of the verdict, Advanced Chemicals was trading at $20 per share. Most investors calculate that there is a 100% chance that Advanced Chemicals will have a verdict returned against them. One investor, Jo, has performed extensive research into the outcome of the trial and estimates that there is no chance Advanced Chemicals will have a verdict returned against them. Given that Advanced Chemicals has 40 million shares outstanding and an equity cost of capital of 6% with no debt, Joʹs estimate of the value of a share of Advanced Chemicals would be how much more than the market price?
A) $2.02
Banco Industries expect sales to grow at a rapid rate over the next 3 years, but settle to an industry growth rate of 5% in year 4. The spreadsheet above shows a simplified pro forma for Banco Industries. Banco industries has a weighted average cost of capital of 11%, $40 million in cash, $70 million in debt, and 18 million shares outstanding. If Banco Industries can reduce its operating expenses so that EBIT becomes 12% of sales, by how much will its stock price increase? A) $3.27 B) $3.92 C) $5.72 D) $9.80
A) $3.27
Which of the following statements is FALSE? A) As the enterprise value represents the entire value of a firm before the firm pays its debt, to form an appropriate multiple, we divide it by a measure of earnings or cash flows after interest payments are made. B) We can compute a firmʹs price-earnings ratio by using either trailing earnings or forward earnings with the resulting ratio called the trailing price-earnings or forward price-earnings. C) It is common practice to use valuation multiples based on a firmʹs enterprise value. D) Using a valuation multiple based on comparables is best viewed as a ʺshortcutʺ to the discounted cash flow method of valuation.
A) As the enterprise value represents the entire value of a firm before the firm pays its debt, to form an appropriate multiple, we divide it by a measure of earnings or cash flows after interest payments are made.
He decides to take the company public through an IPO, issuing 2 million new shares. Assuming that he successfully completes the IPO, the net income for the next year is estimated to be $8 million. His banker informs him that the price of shares should be set using average price-earnings ratios for similar businesses, which is 14. What share of the company will David own after the IPO?
A) Cumulative shares = 325,000 + 475,000 + 200,000 + 350,000 + 2 million = 3.35 million; Davidʹs share = 0.325 million / 3.35 million = 10%
Gonzales Corporation generated free cash flow of $88 million this year. For the next two years, the companyʹs free cash flow is expected to grow at a rate of 10%. After that time, the companyʹs free cash flow is expected to level off to the industry long-term growth rate of 4% per year. If the weighted average cost of capital is 12% and Gonzales Corporation has cash of $100 million, debt of $300 million, and 100 million shares outstanding, what is Gonzales Corporationʹs expected terminal enterprise value in year 2?
A) FCF1 = $88 million × (1 + 0.1) = $96.8 million; FCF2 = $88 million × (1 + 0.1)2 = $106.48 million; V2 = ($106.48 million × 1.04) / (0.12 - 0.04) = $1384.24 million
Year 1234 Free Cash Flow $12 million $18 million $22 million $26 million Conundrum Mining is expected to generate the above free cash flows over the next four years, after which they are expected to grow at a rate of 5% per year. If the weighted average cost of capital is 11% and Conundrum has cash of $85 million, debt of $65 million, and 30 million shares outstanding, what is Conundrumʹs expected current share price?
A) FCF5 = $26 million × (1 + 0.05) = $27.3 million; V4 = $27.3 million / (0.11 - 0.05) = $455.00 million; using a financial calculator, V0 = $358.36 million; P0=(358.36 +85-65)/30=$12.61
On a particular date, FedEx has a stock price of $89.27 and an EPS of $7.11 . Its competitor, UPS, had an EPS of $0.38 . What would be the expected price of UPS stock on this date, if estimated using the method of comparables?
A) FedEx P/E = $89.27 / 7.11 = $12.5556 ; UPS stock price = $12.5556 × 0.38 = $4.77
Which of the following should be done by a manager wishing to raise his stockʹs price? I. Focus on maximizing the present value (PV) of the free cash flow. II. Focus on accounting earnings. III. Focus on financial policy.
A) I only
Which of the following statements is FALSE? A) The process of selling stock to the public for the first time is called a seasoned equity offering (SEO). B) Public companies typically have access to much larger amounts of capital through the public markets. C) By going public, companies give their private equity investors the ability to diversify. D) The two advantages of going public are greater liquidity and better access to capital.
A) The process of selling stock to the public for the first time is called a seasoned equity offering (SEO).
Which of the following best describes a firm commitment IPO?
A) The underwriter purchases the entire issue at a small discount and then resells it at the offer price.
Which of the following statements is NOT true regarding angel investors? A) They are typically arranged as limited partnerships. B) For many start-ups, the first round of outside private equity financing is often obtained from them. C) Because their capital investment is often large relative to the amount of capital already in place at the firm, they typically receive a sizable equity share in the business in return for their funds. D) These investors are frequently friends or acquaintances of the entrepreneur.
A) They are typically arranged as limited partnerships.
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 2 million shares of stock. Since then, you have sold an additional 1 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $4 million and would receive 2 million newly issued shares in return. The post-money valuation of your firm is closest to ________.
A) Total shares outstanding = 2 million + 1 million + 2 million = 5 million shares The venture capitalist would be paying $4 million = $2 per share 2 million shares Therefore, post-money valuation = $2 × 5 million shares = $10.0 million.
Natureʹs Bounty, an organic seed company, is seeking to grow from a small company selling seeds in local markets into a company that sells seeds across several states. The funding for this expansion comes from a wealthy individual who uses his considerable inherited wealth to fund a variety of eco-friendly businesses. Which of the following best describes the individualʹs relationship with Natureʹs Bounty?
A) an angel investor
The relative proportions of debt, equity, and other securities that a firm has outstanding constitute its ________.
A) capital structure
Which of the following best describes those shares sold when a company goes public which raise new capital?
A) primary offering
If you want to value a firm but do not want to explicitly forecast its dividends, the simplest model for you to use is ________.
A) the discounted free cash flow model
A study of trading behavior of individual investors at a discount brokerage found that individual investors ________.
A) trade very actively, despite the fact that their performance is actually worse because of trading costs
Which of the following best describes a limited partnership that specializes in raising money to invest in the private equity of young firms?
A) venture capital firms
In its IPO, Jillianʹs Imprints, a small publishing house, offered stock at a price of $10.00 per share. The underwriters of this IPO had a spread of 6.5% per share. If 2 million shares were sold, what funds did Jillianʹs receive from the IPO?
B) $10.00 × 2 million = $20 million; 93.5 % of 20 million = $18.70 million
Year 1234 Free Cash Flow $12 million $18 million $22 million $26 million Conundrum Mining is expected to generate the above free cash flows over the next four years, after which they are expected to grow at a rate of 6% per year. If the weighted average cost of capital is 12% and Conundrum has cash of $80 million, debt of $60 million, and 30 million shares outstanding, what is Conundrumʹs expected terminal enterprise value?
B) FCF5 = $26 million × (1 + 0.06) = 27.6 million; V4 = $27.6 million / (0.12 - 0.06) = $459.3 million
Which of the following statements is FALSE? A) We can estimate the value of a firmʹs shares by multiplying its current earnings per share by the average price-earnings ratio of comparable firms. B) For valuation purposes, the trailing price-earnings ratio is generally preferred, since it is based on actual not expected earnings. C) Forward earnings are the expected earnings over the coming 12 months. D) Trailing earnings are the earnings over the previous 12 months.
B) For valuation purposes, the forward price-earnings ratio is generally preferred, since it is based on the expected earnings.
Which of the following statements is FALSE? A) The more cash a firm uses to repurchase shares, the less it has available to pay dividends. B) Free cash flow measures the cash generated by a firm after payments to debt or equity holders are considered. C) We estimate a firmʹs current enterprise value by computing the present value (PV) of the firmʹs free cash flow. D) We can interpret the enterprise value of a firm as the net cost of acquiring the firmʹs equity, taking its cash, and paying off all debts.
B) Free cash flow measures the cash generated by a firm after payments to debt or equity holders are considered.
On a particular day, a mining company reveals that, due to new extraction technology, the extractable yield from several of its nickel/lead mines has risen by 15%. Which of the following is the LEAST likely consequence of such an announcement?
B) Investors would determine that the estimates of the firmʹs value on the date prior to the announcement were too high.
A firmʹs founder sells equity to outside investors for the first time in the form of preferred stock. In what way is this preferred stock most likely to differ from the preferred stock issued by an established public firm?
B) It will most likely not pay cash dividends.
The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry. Another newspaper publishing firm (not shown) had sales of $620 million, EBITDA of $81 million, excess cash of $62 million, $11 million of debt, and 120 million shares outstanding. If the firm had an EPS of $0.41 , what is the difference between the estimated share price of this firm if the average price-earnings ratio is used and the estimated share price if the average enterprise value/EBITDA ratio is used?
B) Price using price-earnings ratio = 11.33 × $0.41 = $4.6453 ; using enterprise value / EBITDA ratio = 6.44 × $81 million = $521.64 million; P0 = ($521.64 million + $62 million - $11 million) / 120 million = $4.77 ; difference = $-0.13
Which of the following statements is FALSE? A) Underwriters appear to use the information they acquire during the book-building stage to intentionally underprice the IPO, thereby reducing their exposure to losses. B) The green shoe option restricts an underwriter to issue more stock at the IPO offer price. C) The lead underwriter usually makes a market in the stock by matching buyers and sellers and assigns an analyst to cover it. D) In most cases, the existing shareholders are subject to a 180-day lockup; they cannot sell their shares for 180 days after the IPO. Once the lockup period expires, they are free to sell their shares.
B) The green shoe option restricts an underwriter to issue more stock at the IPO offer price.
Which of the following statements is FALSE? A) The preferred stock issued by young companies typically does not pay regular cash dividends. B) The preferred stock issued by young companies usually gives the owner an option to convert it to common stock on some future date, so it is often called callable preferred stock. C) If a company runs into financial difficulties, the preferred stockholders have a senior claim on the assets of the firm relative to any common stockholders. D) Preferred stock issued by mature companies such as banks usually has a preferential dividend and seniority in any liquidation and sometimes special voting rights.
B) The preferred stock issued by young companies usually gives the owner an option to convert it to common stock on some future date, so it is often called callable preferred stock.
Which of the following statements is FALSE? A) After deciding to go public, managers of the company work with an underwriter, an investment banking firm that manages the offering and designs its structure. B) The shares that are sold in the IPO may either be new shares that raise new capital, known as a secondary offering, or existing shares that are sold by current shareholders (as part of their exit strategy), known as a primary offering. C) Many IPOs, especially the larger offerings, are managed by a group of underwriters. D) In an IPO, a firm offers a large block of shares for sale to the public for the first time.
B) The shares that are sold in the IPO may either be new shares that raise new capital, known as a secondary offering, or existing shares that are sold by current shareholders (as part of their exit strategy), known as a primary offering.
Which of the following statements regarding firm commitment IPOs is FALSE? A) If the entire issue does not sell out, the remaining shares must be sold at a lower price and the underwriter must take the loss. B) The underwriter purchases the entire issue (at an offer price) and then resells it at a slightly higher price to interested investors. C) It is the most common underwriting arrangement. D) The underwriter guarantees that it will sell all of the stock at the offer price.
B) The underwriter purchases the entire issue (at an offer price) and then resells it at a slightly higher price to interested investors.
Jeremy founded a company. He issues 100,000 shares of series A stock for his own $100,000 investment. He then goes through three further rounds of investment, as shown below: Which of the following is closest to the percentage of the company owned by the series D investors?
B) Total shares = 500,000 + 300,000 + 500,000 + 100,000 = 1.4 million; Series D ownership = 0.5 million / 1.4 million = 36%
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 3 million shares of stock. Since then, you have sold an additional 2 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $4 million and would receive 2 million newly issued shares in return. Assuming that this is the venture capitalistʹs first investment in your firm, what percentage of the firm will the venture capitalist own?
B) Total shares outstanding = 3 million + 2 million + 2 million = 7 million shares The venture capitalist ownership percentage = 2 million shares 7 million shares = 29%
Aerelon Airways, a commercial airline, suffers a major crash. As a result, passengers are considered to be less likely to choose Aerelon as their carrier, and it is expected free cash flows will fall by $15 million per year for five years. If Aerelon has 55 million shares outstanding, an equity cost of capital of 10%, and no debt, by how much would Aerelonʹs shares be expected to fall in price as a result of this accident?
B) Using a financial calculator, PV of 15 million for 5 years at 10% = $56.86 million; per share fall = $56.86 million / 55 million = $1.03
Which of the following statements is FALSE? A) A venture capital firm is a limited partnership that specializes in raising money to invest in the private equity of young firms. B) Venture capitalists typically control about three-quarters of the seats on a startupʹs board of directors, and often represent the single largest voting block on the board. C) The initial capital that is required to start a business is usually provided by the entrepreneur and her immediate family. D) Individual investors who buy equity in small private firms are called angel investors.
B) Venture capitalists typically control about three-quarters of the seats on a startupʹs board of directors, and often represent the single largest voting block on the board.
Which of the following statements is FALSE? A) The most common valuation multiple is the price-earnings ratio. B) You should be willing to pay proportionally more for a stock with lower current earnings. C) A firmʹs price-earnings ratio is equal to the share price divided by its earnings per share. D) The intuition behind the use of the price-earnings ratio is that when you buy a stock, you are in a sense buying the rights to the firmʹs future earnings, and differences in the scale of firmsʹ earnings are likely to persist.
B) You should be willing to pay proportionally more for a stock with higher current earnings.
At what stage of the IPO process do senior management and the lead underwriters travel to promote the company and explain their rationale for the offer price to the underwritersʹ largest customers?
B) after initial price range is established
What is the major reason that underwriters tend to offer stocks in an IPO at a price that is below that which the market will pay?
B) to reduce their exposure to losses from unsold stock
The proceeds from the IPO be if Luther is selling 1.25 million shares is closest to ________. A) $18.9 million B) $22.1 million C) $21.0 million D) $20.0 million
By looking at cumulative demand, we see that a cumulative demand of 1.25 million shares corresponds to a price of $16.80 . So, proceeds = $16.80 × 1,250,000 = $21,000,000 (TOP DOWN CUMULATIVE)
What will the offer price of these shares be if Luther is selling 1 million shares? A) $17.15 B) $17.60 C) $17.35 D) $16.75
C (TOP DOWN CUMULATIVE)
Banco Industries expect sales to grow at a rapid rate over the next three years, but settle to an industry growth rate of 5% in year 4. The spreadsheet above shows a simplified pro forma for Banco Industries. If Banco industries has a weighted average cost of capital of 11%, $50 million in cash, $80 million in debt, and 18 million shares outstanding, which of the following is the best estimate of Bancoʹs stock price at the start of year 1? A) $6.52 B) $11.74 C) $13.04 D) $23.48
C) $13.04
Simone founded her company using $200,000 of her own money, issuing herself 200,000 shares of stock. An angel investor bought an additional 100,000 shares for $150,000 . She now sells another 500,000 shares of stock to a venture capitalist for $1.5 million. What is the post-money valuation of the company?
C) 500,000 shares at $1.5 million leads to a valuation of $3 per share; Total shares = 500,000 + 200,000 + 100,000 = 0.8 million; Company valuation = 0.8 million × $3 = $2.4 million
Which of the following statements is FALSE? A) In recent years, the investment banking firm of WR Hambrecht + Company has attempted to change the IPO process by selling new issues directly to the public using an online auction IPO mechanism called Open IPO. B) The lead underwriter is the primary banking firm responsible for managing the deal. The lead underwriter provides most of the advice and arranges for a group of other underwriters, called the syndicate, to help market and sell the issue. C) Because of the potential conflict of interest, the underwriter will not make a market in the stock after the issue. D) The SEC requires that companies prepare a registration statement, a legal document that provides financial and other information about the company to investors, prior to an IPO. Company managers work closely with the underwriters to prepare this registration statement and submit it to the SEC.
C) Because of the potential conflict of interest, the underwriter will not make a market in the stock after the issue.
Which of the following is the best statement of the efficient markets hypothesis?
C) Competition between investors works to make the net present value (NPV) of all trading opportunities zero.
Felicity Industries is selling 2 million shares of stock in an auction IPO. At the end of the bidding period it has received the bids shown above. Which of the following is closest to the price at which the shares will be offered?
C) Cumulative shares = 225,000 + 300,000 + 700,000 + 775,000 = 2 million; hence, $5.75 is the price at which there is sufficient demand to sell the entire issue.
He decides to take the company public that he successfully completes the IPO, million. His banker informs him that the price of shares should be set using average price-earnings ratios for similar businesses, which is 14. What will be the IPO price per share?
C) Cumulative shares = 375,000 + 400,000 + 250,000 + 400,000 + 2 million = 3.425 million; EPS = $9 million / 3.425 million; IPO price = $14 × $9 million / 3.425 million = $36.79
On a particular date, the above information concerning Office Depot, Incorporated, was given on Google Finance. Its competitor, Staples Incorporated, had a stock price of $24.33 . Which of the following is closest to the EPS of Staples Incorporated if it is estimated using valuation multiples based on price-earnings ratios?
C) EPS Staples = $24.33 / $9.26 = $2.63
The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry. Another newspaper publishing firm (not shown) had sales of $600 million, EBITDA of $84 million, excess cash of $68 million, $18 million of debt, and 120 million shares outstanding. If the average enterprise value to sales for comparable businesses is used, which of the following is the best estimate of the firmʹs share price?
C) Enterprise Value = 1.35 × $600 million = $810 million; P0 = ($810 + $68 - $18) / 120 = $7.17
The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry. Which of the following ratios would most likely be the most reliable in determining the stock price of a comparable firm?
C) Enterprise Value/Sales
Gonzales Corporation generated free cash flow of $86 million this year. For the next two years, the companyʹs free cash flow is expected to grow at a rate of 10%. After that time, the companyʹs free cash flow is expected to level off to the industry long-term growth rate of 4% per year. If the weighted average cost of capital is 11% and Gonzales Corporation has cash of $100 million, debt of $275 million, and 100 million shares outstanding, what is Gonzales Corporationʹs expected current share price?
C) FCF1 = $86 million × (1 + 0.1) = $94.6 million; FCF2 = $86 million × (1 + 0.1)2 = $104.06 million; FCF3 = 104.06 million × (1 + 0.04) = $108.2224 million V2 = $108.2224 million / (0.11 - 0.04) = $1546.03 million using a financial calculator, V0 = $1424.48 million P0 = (1424.48 million - 275 million + 100 million) / 100 million = $12.49
Valuation models use the relationship between share value, future cash flows, and the cost of capital to estimate these quantities for a given firm. Realistically, for a publicly traded firm, what can we reliably use such models to determine? I. the firmʹs future cash flows II. the firmʹs cost of capital III. thefirmʹsmarketprice
C) III only
Which of the following statements is FALSE? A) The long-run growth rate gFCF is typically based on the expected long-run growth rate of a firmʹs revenues. B) Since a firmʹs free cash flow is equal to the sum of the free cash flows from the firmʹs current and future investments, we can interpret the firmʹs enterprise value as the total net present value (NPV) that the firm will earn from continuing its existing projects and initiating new ones. C) If a firm has no debt, then rwacc equals the risk-free rate of return. D) When using the discounted free cash flow model, we forecast a firmʹs free cash flow up to some horizon, together with some terminal (continuation) value of the enterprise.
C) If a firm has no debt, then rwacc equals the risk-free rate of return.
Which of the following is NOT a reason why an IPO is attractive to the managers of a private company?
C) It reduces the complexity of requirements regulating the companyʹs management.
Carbondale Oil announces that a well that it has sunk in a new oil province has shown the existence of substantial oil reserves. The exploitation of these reserves is expected to increase Carbondaleʹs free cash flow by $100 million per year for eight years. If investors had not been expecting this news, what is the most likely effect on Carbondaleʹs stock price upon the announcement, given that Carbondale has 80 million shares outstanding, no debt, and an equity cost of capital of 11%?
C) PV of 100 million for 8 years at 11% = $514.6123 million per share = $514.6123 million / 80 million = $6.43
Which of the following statements is FALSE? A) Once a company goes public, it must satisfy all of the requirements of public companies. B) Organizations such as the Securities and Exchange Commission (SEC), the securities exchanges (including the NYSE and the NASDAQ), and Congress (through the Sarbanes-Oxley Act of 2002) adopted new standards that focused on more thorough financial disclosure, greater accountability, and more stringent requirements for the board of directors. C) The major advantage of undertaking an IPO is also one of the major disadvantages of an IPO: When investors diversify their holdings, the equity holders of the corporation become more concentrated. D) Several high profile corporate scandals during the early part of the twenty-first century prompted tougher regulations designed to address corporate abuses.
C) The major advantage of undertaking an IPO is also one of the major disadvantages of an IPO: When investors diversify their holdings, the equity holders of the corporation become more concentrated.
An entrepreneur founded his company using $200,000 of his own money, issuing himself 200,000 shares of stock. An angel investor bought an additional 100,000 shares for $150,000 . The entrepreneur now sells another 400,000 shares of stock to a venture capitalist for$2 million. What is the post-money valuation of the company?
C) Total shares = 200,000 + 100,000 + 400,000 = 700,000 ; 400,000 shares for $2 million leads to a share price of $5.00 per share; Company valuation = 5.00 × 700,000 = $3,500,000
Which of the following statements concerning the valuation of firms using the method of comparables is FALSE? A) If two different firms generate identical cash flows, the Law of One Price will imply that both firms have the same value. B) Comparables adjust for scale differences when valuing similar firms. C) Valuation multiples take into account differences in the risk and future growth between the firms being compared. D) Two firms that sell very similar products or offer very similar services will have different values if they are of different sizes.
C) Valuation multiples take into account differences in the risk and future growth between the firms being compared.
Which of the following statements is FALSE? A) The general partners work for and run the venture capital firm; they are called venture capitalists. B) An important consideration for investors in private companies is their exit strategyhow they will eventually realize the return from their investment. C) When a company founder decides to sell equity to outside investors for the first time, it is common practice for private companies to issue common stock rather than preferred stock to raise capital. D) Institutional investors such as pension funds, insurance companies, endowments, and foundations manage large quantities of money.
C) When a company founder decides to sell equity to outside investors for the first time, it is common practice for private companies to issue common stock rather than preferred stock to raise capital.
A large publishing firm specializing in college textbooks wishes to expand into online delivery of its materials. In order to facilitate this, it invests in a number of small start-up companies that deliver college courses online and uses these companies to start diversifying the delivery of its content. Which of the following best describes the role of the publishing firm as described above?
C) a corporate investor
The Ontario Teachersʹ Pension Plan is a pension fund for public school teachers in the province of Ontario. It has a large and diverse portfolio of investments, both in Canada and internationally, and had net assets in December 2007 of C$108.5 billion. Which of the following best describes the Ontario Teachersʹ Pension Plan?
C) an institutional investor
If you want to value a firm that consistently pays out its earnings as dividends, the simplest model for you to use is the ________.
C) dividend-discount model
Individual investorsʹ tendency to trade too much based on the mistaken belief that they can pick winners and losers better than investment professionals is known as ________.
C) the investor overconfidence hypothesis
Which of the following is NOT a common name for a corporation that invests in private companies?
C) venture partner
The founder of a company currently holds 12 million of the 15 million shares in that company. She considers an IPO where she sells a mix of primary shares and 2 million of her own secondary shares for $16 per share. If she wants to retain a 70% ownership of the company, how much money can she raise in this IPO?
D) 70% of 15 million shares = 0.7 × 15 million shares = 10.5 million shares; Thus, the founder can sell 12 million - 10.5 million = 1.5 million shares; The amount of money the owner can raise = 1.5 million × $16 = $24 million
Which of the following statements is FALSE? A) Even two firms in the same industry selling the same types of products, while similar in many respects, are likely to be of different size or scale. B) In the method of comparables, we estimate the value of a firm based on the value of other, comparable firms or investments that we expect will generate very similar cash flows in the future. C) Consider the case of a new firm that is identical to an existing publicly traded company. If these firms will generate identical cash flows, the Law of One Price implies that we can use the value of the existing company to determine the value of the new firm. D) A valuation multiple is a ratio of some measure of a firmʹs scale to the value of the firm.
D) A valuation multiple is a ratio of some measure of a firmʹs scale to the value of the firm.
The owners decide to take the company public through an IPO, issuing 1 million new shares. Assuming that they successfully complete the IPO, the net income for the next year is estimated to be $5 million. The price of shares is set using average price-earnings ratios for similar businesses of 16. What will be the IPO price per share?
D) Cumulative shares = 100,000 + 225,000 + 375,000 + 1 million = 1.7 million; EPS = $5 million / 1.7 million; price = 16 × $5 million / 1.7 million = $47
Gonzales Corporation generated free cash flow of $81 million this year. For the next two years, the companyʹs free cash flow is expected to grow at a rate of 9%. After that time, the companyʹs free cash flow is expected to level off to the industry long-term growth rate of 4% per year. If the weighted average cost of capital is 11% and Gonzales Corporation has cash of $100 million, debt of $300 million, and 100 million shares outstanding, what is Gonzales Corporationʹs expected free cash flow in year 2?
D) FCF1 = 81 × (1 + 0.09 ) = 88.29 ; FCF2 = $81 million × (1 + 0.09)2 = $96.2361 million
Which of the following statements regarding best efforts IPOs is FALSE? A) For smaller IPOs, the underwriter commonly accepts the deal on this basis. B) The underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price. C) Often these arrangements have an all-or-none clause: either all of the shares are sold in the IPO, or the deal is called off. D) If the entire issue does not sell out, the underwriter is on the hook.
D) If the entire issue does not sell out, the underwriter is on the hook.
Which of the following statements is FALSE? A) Once the issue price (or offer price) is set, underwriters may invoke another mechanism that allows them to sell extra shares of more successful offeringsthe over-allotment allocation. B) Before the offer price is set, the underwriters work closely with the company to come up with a price range that they believe provides a reasonable valuation for the firm. C) Before an IPO, the company prepares the final registration statement and final prospectus containing all the details of the IPO, including the number of shares offered and the offer price. D) In a cash offer, a firm offers the new shares only to existing shareholders.
D) In a cash offer, a firm offers the new shares only to existing shareholders.
Why do most people launching a start-up company acquire their funds through the venture capital industry rather than through angel investors?
D) Most entrepreneurs do not have any relationships with individuals with substantial capital to invest.
On a certain date, Kastbro has a stock price of $37.50, pays a dividend of $0.64, and has an equity cost of capital of 8%. An investor expects the dividend rate to increase by 6% per year in perpetuity. He then sells all stocks that he owns in Kastbro. Given Kastbroʹs share price, was this a reasonable action?
D) No, since the difference between his calculated stock price and the actual stock price most likely indicates that his estimate of dividend growth rate was incorrect.
Which of the following is the appropriate way to calculate the price of a share of a given company using the free cash flow valuation model?
D) P0 = (V0 + Cash0 - Debt0) / (Shares Outstanding0)
Praetorian Industries will pay a dividend of $2.50 per share this year and has an equity cost of capital of 8%. Praetorianʹs stock is currently trading at $84 per share. By comparing Praetorian with similar firms, an investor expects that its dividends will grow by up to 5% per year. What is the best next step that the investor should take regarding Praetorianʹs stock?
D) Revise her estimate of Praetorianʹs dividend growth.
Which of the following statements regarding exit strategies is FALSE? A) An alternative way to provide liquidity to its investors is for the company to become a publicly traded company. B) An important consideration for investors in private companies is their exit strategy, or how they will eventually realize the return from their investment. C) Often large corporations purchase successful start-up companies. In such a case, the acquiring company purchases the outstanding stock of the private company, allowing all investors to cash out. D) Roughly 25% of venture capital exits from 2001-2005 occurred through mergers or acquisitions.
D) Roughly 25% of venture capital exits from 2001-2005 occurred through mergers or acquisitions.
Which of the following is NOT a reason why an investor would choose to invest in new and growing firms as a limited partner in a venture capital firm rather than making those investments directly by themselves?
D) The investor will have a direct say in how the companies that the venture capital firm funds will be run.
Which of the following statements is NOT true regarding venture capitalists? A) They can provide substantial capital for young companies. B) Firms offer limited partners a number of advantages over investing directly in start-ups themselves as angel investors. C) They use their control to protect their investments, so they may therefore perform a key nurturing and monitoring role for the firm. D) They might invest for strategic objectives in addition to the desire for investment returns.
D) They might invest for strategic objectives in addition to the desire for investment returns.
Jeremy founded a company. He issues 100,000 shares of series A stock for his own $100,000 investment. He then goes through three further rounds of investment, as shown below: What is the post-money valuation for the series D funding round?
D) Total shares = 500,000 + 300,000 + 500,000 + 100,000 = 1.4 million; Post-money valuation = $1.75 × 1.4 million = $2.45 million
Which of the following statements is FALSE? A) A firmʹs weighted average cost of capital, denoted rwacc, is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firmʹs equity and debt. B) Intuitively, the difference between the discounted free cash flow model and the dividend-discount model is that in the divided-discount model, a firmʹs cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model. C) We interpret rwacc as the expected return a firm must pay to investors to compensate them for the risk of holding the firmʹs debt and equity together. D) When using the discounted free cash flow model, we should use a firmʹs equity cost of capital.
D) When using the discounted free cash flow model, we should use a firmʹs equity cost of capital.
An investor estimates the value of a firm which manufactures cookware by examining the cash flows of similar firms. Which of the following is assumed to be the same for these firms?
D) all of the above
Which of the following is an activity typically taken by an underwriter during an IPO of a company?
D) all of the above
Which of the following is LEAST likely to be a possible source of funds to finance a growing business?
D) family investors
Disposition effect is the tendency of individual investors to ________.
D) hold on to stocks that have lost value and sell stocks that have risen in value since the time of purchase
As part of the registration statement, the preliminary prospectus circulates to investors before the stock is offered. This preliminary prospectus is also called a(n) ________.
D) red herring
Which of the following is NOT an advantage of the valuation multiple method as compared to the discounted cash flow method?
D) takes into account important differences between different firms
The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry. Another newspaper publishing firm (not shown) had sales of $640 million, EBITDA of $84 million, excess cash of $67 million, $14 million of debt, and 120 million shares outstanding. If the average enterprise value to sales for comparable businesses is used, which of the following is the range of reasonable share price estimates?
Enterprise Value = 1.35 × $640 = $864 million; P0 = ($864 million + $67 million - $14 million) / 120 = $7.64 Range is from 82% to 116% of estimate. $7.64 × 0.82 = $6.27 ; $7.64 × 1.16 = $8.86
Financial managers prefer to choose the same debt level no matter which industry they operate in.
FALSE
If you value a stock using a range of stock valuation methods and these valuations indicate a stock price that is greater than its actual market price, it is most likely that the stock is
FALSE
In a best-efforts IPO, the underwriter guarantees that all stock will be sold.
FALSE
Individual investors trade conservatively, given the difficulty of finding over-valued and under-valued stocks.
FALSE
Equity in a firm with no debt is called unlevered equity.
TRUE
Equity investors in a private company usually plan to realize a return on their investment by selling their stock when that company is acquired by another firm or sold to the public in a public offering.
TRUE
Even if two firms operate in the same industry, they may prefer different choices of debt -equity ratios.
TRUE
In an efficient market, investors will only find positive-NPV trading opportunities if they have some form of competitive advantage over other investors.
TRUE
In the method of comparables, the known values of a firmʹs cash flows are used to estimate the unknown cash flows of a similar firm.
TRUE
Individual investors who grow up and live during a time of high stock returns are more likely to invest in stocks.
TRUE
Several methods should be used to provide an estimate of a stockʹs value since no single method provides a definitive value.
TRUE
The discounted free cash flow model ignores interest income and expense but adjusts for cash and debt directly, if free cash flow is calculated based on EBIT.
TRUE
The firm commitment process is the most common practice for IPOs in the United States.
TRUE
The main advantages for a firm in going public are greater liquidity and better access to capital.
TRUE
When a company founder sells stock to outside investors in order to raise capital, the share of the company owned by the founder and the founderʹs control over the company will be reduced.
TRUE
Simone founded her company using $200,000 of her own money, issuing herself 300,000 shares of stock. An angel investor bought an additional 100,000 shares for $150,000 . She now sells another 400,000 shares of stock to a venture capitalist for $2 million. What percentage of the firm does Simone now own?
Total shares = 400,000 + 300,000 + 100,000 = 0.8 million; Simoneʹs ownership = 300,000 shares / 800,000 shares = 38%
You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 3 million shares of stock. Since then, you have sold an additional 2 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $5 million and would receive 4 million newly issued shares in return. Suppose you sold the2 million shares to the angel investor for $500,000. What was your percentage ownership in the company immediately following the angel investorʹs investment?
Total shares outstanding = 3 million + 2 million = 5 million. Your share is 3 million / 5 million = 60.0 %
