Deck 18: Business Formation, Growth and Valuation

Question 1

An important thing to remember in valuing a business is that the value of a business changes over time.

Answer 1

True

Question 2

The two tools that are particularly useful in understanding the cash requirements of a business and in estimating how much financing a new business will require are cash flow break-even analysis and the cash budget.

Answer 2

True

Question 3

For sole traders, the owners pay tax on business profits when they file their personal tax returns.

Answer 3

True

Question 4

Partnerships are more costly to form than sole proprietorships because the partners must hire a lawyer to draw up and maintain the partnership agreement.

Question 5

A financial investor is one who is interested in the financial performance of the company.

Question 6

The downside of being able to raise equity capital from other people is that the entrepreneur must inevitably share control with other investors.

Question 7

The business plan presents the results from a strategic planning process that focuses on how the business will be developed over time.

Question 8

A business plan includes a detailed discussion of the marketing and sales activities that will enable the business to achieve the sales and margin levels reflected in the financial forecasts.

Question 9

The cash flow break-even analysis helps identify how much money will be needed to launch a new product or business.

Question 10

A company can have no more than 50 shareholders.

Question 11

Companies are no more costly to form than sole proprietorships.

Question 12

The founder of a company has to make many critical decisions but not any related to strategies to sell the company's products.

Question 13

Companies, which are "legal persons" under law, automatically have a finite life.

Question 14

Businesses do not fail because of management's inability to estimate correctly how much money it will take to get their businesses up and running.

Question 15

A strategic investor is interested in buying the company and not just its financial performance.

Question 16

Two advantages of a company structure are: it gives unlimited liability for managers; and the tax advantages of a limited partnership for investors.

Question 17

A business has a better chance to succeed if one takes calculated risks.

Question 18

The cash budget summarises the cash flows into and out of a company over a period of time.

Question 19

Cost approaches include replacement cost and multiples analysis.

Question 20

Starting a business is less risky than buying and growing a business that someone else has already established.

Question 21

The adjusted book value approach is useful in valuing holding companies whose main assets are publicly traded or other investment securities but is generally less applicable for operating businesses.

Question 22

Starting a business is _________ risky than buying and growing a business that someone else has already established.

A) more
B) less
C) equally
D) none of the above

Question 23

In valuing a business, analysts must also consider whether it is appropriate to adjust the estimated value of the business for the likelihood that these "key people" may not remain with the company as long as expected.

Question 24

Which of the following organisational form offers protection for personal liability?

A) sole trader
B) trust
C) association
D) company

Question 25

Differences in marketability can result in premiums of 30 per cent or more for shares of private companies.

Question 26

All of the following are organisational forms are easy to dissolve EXCEPT

A) company
B) sole trader
C) partnership
D) cooperative

Question 27

An important issue that must be considered when valuing a business is whether a controlling ownership interest or a minority interest is being valued.

Question 28

The founder of a company must start from scratch and make several critical decisions including

A) choosing the product(s) to sell.
B) choosing the best strategy for selling them.
C) raising the money necessary to develop the product(s).
D) All of the above.

Question 29

Which one of the following statements regarding a company is NOT true?

A) must have no more than 100 shareholders.
B) can be set up with only one person.
C) can trade overseas.
D) easy to attract outside investors in the future.

Question 30

The free cash flow from the company (FCFC) approach uses only the portion of the cash flows that are available for distribution to shareholders.

Question 31

Which one of the following statements is NOT true?

A) Setting up a company involves registering with ASIC.
B) The simplest form of business structure is the sole trader.
C) Only a company allows the employment of staff and subcontractors.
D) In a partnership business profits are not taxed at the company tax rate

Question 32

In the transaction approach, analysts use the information on what someone has paid for a comparable company in a merger or an acquisition to estimate a value for the company.

Question 33

Which one of the following statements is true?

A) Partnerships are more costly to form than a trust.
B) For partnerships, all profits flow through to the owners in proportion to their ownership interest.
C) The lives of partnerships are not flexible.
D) A partnership is limited to two owners.

Question 34

In contrast to the FCFE approach, which values cash flows that are available for distribution to shareholders, the DDM approach values the stream of cash flows that shareholders expect to receive through dividend payments.

Question 35

A business's chances of success improve if you do all EXCEPT

A) not jump into a business without careful thought.
B) not overanalyse opportunities to the point where you are just convincing yourself not to proceed.
C) Take no risks.
D) not think that failure will ruin your chances of ultimately achieving business success.

Question 36

Which one of the following statements is NOT true?

A) Two tools are particularly useful in understanding the cash requirements of a business and in estimating how much financing a new business will require-cash flow break-even analysis and the cash budget.
B) The cash flow break-even point calculation focuses on the importance of maximising a product's per unit contribution.
C) The cash flow break-even point does not tell one how much money will be needed to launch a new product or business.
D) The cash flow break-even point estimates how long it will take for a product to reach the break-even point.

Question 37

According to the text, businesses fail for a number of different reasons but not due to

A) poorly thought-out strategy.
B) a very competitive market.
C) poor management skills to properly execute a good strategy.
D) underestimating how much money it will take to get their businesses up and running.

Question 38

Which one of the following statements is NOT true?

A) A sole proprietorship is the least expensive type of business to start.
B) The life of a sole proprietorship is unlimited
C) Sole proprietorships must rely on equity contributions from the proprietor and debt or lease financing.
D) All profits of the sole proprietorship pass directly to the owner and are taxed at the owner's marginal tax rate.

Question 39

In contrast to the financial statements of publicly held companies, private company financials often include personal expenses of the owner and excess compensation expenses.

Question 40

In the free cash flow to equity (FCFE) approach, an analyst values the free cash flows that the assets of the company are expected to produce in the future.

Question 41

The costs associated with non-interest-bearing current liabilities, which are included in the company's cost of sales and other operating expenses,

A) are subtracted in the calculation of free cash flow from the company (FCFC).
B) are added in the calculation of FCFC.
C) are not a factor in the calculation of FCFC
D) none of the above

Question 42

Which one of the following elements is included in a business plan?

A) A detailed description of the product(s) and services the company will sell
B) A detailed discussion of the marketing and sales activities that will enable the business to achieve the sales and margin levels reflected in the financial forecasts.
C) A detailed discussion of capital requirements and uses.
D) All of the above

Question 43

In the free cash flow from the company (FCFC) approach, the total value of the company, V_C, is calculated as the present value of the FCFC,

A) discounted by the company's cost of equity
B) discounted by the company's WACC
C) discounted by the company's cost of debt
D) None of the above.

Question 44

Break-even analysis: Sherwin Furniture makes period pieces. The company has total fixed costs of $632,750. The average piece is sold at a price of $2,125 and involves variable costs of $1,675 per unit. What is the break-even point for this company?

A) 1,406
B) 298
C) 167
D) 378

Question 45

Break-even analysis: Johnstone company wants to break even at 20,000 units on its only product. Its unit variable cost is $63.75, and its fixed cost is $742,000. What should be the company's unit selling price?

A) $37.10
B) $26.65
C) $100.85
D) $63.75

Question 46

The transaction approach is difficult to use because

A) transactions data are not typically as reliable as the data available for multiples analysis, especially when they are associated with a private company.
B) transactions involving the purchase or sale of an entire business in an industry tend to occur relatively infrequently and hence the data is not very timely.
C) the terms of the transactions can be difficult to assess.
D) All of the above.

Question 47

Which one of the following statements is NOT true?

A) A strategic investor is one who has an interest in acquiring the business.
B) The investment value of the company to a strategic investor will take into consideration the benefits that can accrue from the acquisition.
C) The market value of a business is likely to carry a higher value than the strategic value.
D) A financial investor, on the other hand, is only interested in the financial performance of the company and not in acquiring the business.

Question 48

The adjusted book value approach involves

A) restating the value of the individual assets in a business to reflect their fair market values.
B) valuing all tangible and intangible assets.
C) valuing holding companies whose main assets are publicly traded or other investment securities but are generally less applicable for operating businesses.
D) All of the above

Question 49

The key elements in a business plan include all but

A) an executive summary
B) a company overview
C) a dividend policy
D) a market analysis

Question 50

The value of a business changes over time because

A) changes in general economic conditions, industry conditions, and decisions that are made by the managers all affect the value of the cash flows that a business is expected to generate in the future.
B) actions by competitors also affect the value of a business.
C) the investment, operating, and financing decisions made by managers also affect the value of a business.
D) All of the above

Question 51

Which one of the following statements about the free cash flow from the company (FCFC) approach is NOT true?

A) The present value of these cash flows exceeds the total value of the company, or its enterprise value.
B) We do not include the cash necessary to pay short-term liabilities that do not have interest charges associated with them, such as accounts payable and accrued expenses.
C) The costs associated with non-interest-bearing current liabilities, which are included in the company's cost of sales and other operating expenses, are subtracted in the calculation of FCFC.
D) the total value of the company, V_F, is calculated as the present value of the FCFC, discounted by the company's WACC.

Question 52

Break-even analysis: Trident Ltd makes designer gold bracelets. Their annual costs include shop rent of $12,500, salaries for two jewellers of $118,000, design software costs of $10,000, and other overhead costs of $13,000. An average bracelet is priced at $5,500. It costs $2,000 in raw material, $1,250 in labour, and $250 in other expenses. What is the minimum number of bracelets that need to be sold to earn a profit?

A) 28
B) 44
C) 77
D) 17

Question 53

When using the multiples analysis approach to valuing a business, one must be aware

A) of the presence of a marketability discount that can be sizable.
B) that identifying one or more comparable companies is not an easy task.
C) of differences in the capital structures of the companies being compared.
D) All of the above.

Question 54

Which one of the following statements about business valuation is NOT true?

A) The value of a business changes over time.
B) There is a single value for any business.
C) There is no such thing as the value for a business.
D) Actions by competitors also affect the value of a business.

Question 55

Which one of the following statements about business plans is true?

A) A business plan is like a road map for a business.
B) A business plan presents the results from a strategic planning process that focuses on how the business will be developed over time.
C) A well-prepared business plan makes it easier for an entrepreneur to communicate to potential investors precisely what returns an investor might expect to receive.
D) All of the above are true

Question 56

Which one of the following statements is true?

A) The cash budget is also a very useful planning tool for entrepreneurs
B) The cash budget summarises the cash flows into and out of a company over a period of time.
C) Preparing a cash budget helps an entrepreneur better understand where money is coming from, where it is going, and how much external financing is likely to be needed and when.
D) All of the above are true.

Question 57

A business plan is a tool that

A) can help raise capital
B) can help an entrepreneur set the goals and objectives for the company
C) serve as a benchmark for evaluating and controlling the company's performance
D) All of the above

Question 58

Break-even analysis: Jackson Electronics makes circuit boards and markets them to electronic goods manufacturers. The company has non-salary fixed costs of $212,000 and salary costs of $134,250. Each circuit board is sold at a price of $111.50 and involves variable costs of $81.73 per unit. What is the break-even point for Jackson?

A) 3,105
B) 11,631
C) 4,237
D) 3,714

Question 59

Break-even analysis: Triad Electrical Supply Company needs to sell

A) $2,497,250
B) $1,302,000
C) $1,195,250
D) $3,692,500

Question 60

Which one of the following statements is NOT true?

A) Replacement cost and adjusted book value are cost-based valuation approaches.
B) The replacement cost approach involves restating the value of the individual assets in a business to reflect their fair market values.
C) The replacement cost of a business is the cost of duplicating the assets of the business in their present form as of the valuation date.
D) The replacement cost valuation approach is generally used to value individual assets within a business when they are being insured.

Question 61

Adjusted BV: Troy company has cash of $24,250, receivables of $81,700, and inventory of $117,875. In addition, the company has property, plant, and equipment of $152,000. Management has also told you that you can reasonably expect to collect 85 per cent of the receivables, that the inventory could be sold to realise 80 per cent of its book value, and that the sale of the property, plant, and equipment would yield $113,250. What is the liquidation value of this company? Round to the nearest dollar.

A) $375,825
B) $293,695
C) $351,575
D) $301,245

Question 62

Valuing private company: You are interested in investing in a private company. Based on earnings multiples of similar publicly traded companies, you estimate the value of the private company's shares to be $13.44 per share. You plan to acquire a majority of the shares in the company. The expected control premium is 12 per cent, while the marketability discount for such a company is 15 per cent. The discount for the key person, one of the founders who may leave the company upon your control of the company, is 15 per cent. What price should you be willing to pay for these shares?

A) $14.92
B) $16.65
C) $11.80
D) $10.88

Question 63

Income approaches: You are using the FCFC approach to value a business. The estimated FCFC for next year will be $13.6 million, and it will increase at a rate of 6 per cent for each of the following five years. After that point, the FCFC will increase at a rate of 3 per cent forever. If the WACC for this company is 8 per cent, what is it worth?

A) $384 million
B) 354 million
C) $241 million
D) $144 million

Question 64

Income approaches: You are valuing the equity of Cirona Company using the FCFE approach and have estimated that the FCFE in the next three years will grow at an 8 per cent rate from last year's FCFE of $2.1 million. Beginning in year 4, you expect the cash flows to increase at a constant rate of 5 per cent per year for the indefinite future. The cost of equity for the company is10 per cent. What is the value of equity in this company?

A) $42 million
B) $56 million
C) $48 million
D) $6 million

Question 65

The free cash flow to equity (FCFE) approach uses only the portion of the cash flows that are available

A) for distribution to bondholders.
B) for distribution to bondholders and shareholders.
C) for distribution to shareholders.
D) None of the above.

Question 66

Income approaches: Shenandoah company is expected to grow rapidly in the next four years and then have a zero growth rate for the foreseeable future. The company expects free cash flows of $42.5 million, $64.3 million, $77.1 million and $92 million over the next four years, and thereafter its cash flows will stay constant. The company has cash to the tune of $23.4 million. If the appropriate WACC is 10 per cent, what is the enterprise value of this business? Round to the nearest million.

A) $628 million
B) $864 million
C) $841 million
D) $818 million

Question 67

Income approaches: Quicksilver Software Co. is expected to grow rapidly in the next three years and then have no growth for the foreseeable future. The company expects free cash flows of $9.1 million, $11.4 million, and $17.7 million over the next three years, and thereafter its cash flows will stay constant. The company has no nonoperating assets. If the appropriate WACC is 12 per cent and debt of 44.5 million, what is the equity value of this business? Round to the nearest million.

A) $135 million
B) $105 million
C) $45 million
D) $90 million

Question 68

Valuing private company: Keshav Sinha is interested in investing in a private company. Based on earnings multiples of similar publicly traded companies, he estimates the value of the private company's shares to be $21.27 per share. He plans to acquire a majority of the shares in the company. The expected control premium is 10 per cent. Keshav estimates the marketability discount for such a company to be 12 per cent. The discount for the key person, one of the founders who may leave the company upon Keshav's control of the company, is 20 per cent. What price should he be willing to pay for these shares?

A) $16.47
B) $31.45
C) $15.72
D) $32.94

Question 69

Valuing private company: Shane Bauer wants to invest in Trajectory Tech, a private company. Based on earnings of multiples of similar publicly traded companies, Shane estimates the value of the private company's shares to be $18.97 per share. He plans to acquire a majority of the shares in the company. The expected control premium is 12 per cent. He estimates the marketability discount for such a company to be 15 per cent. The discount for the key person, one of the founders who may leave the company upon Shane's control of the company, is 15 per cent. What price should he be willing to pay for these shares?

A) $15.35
B) $28.10
C) $14.05
D) $30.70

Question 70

Income approaches: You are valuing the equity of a company using the FCFE approach and have estimated that the FCFE in the next three years will be $6.25, $7.70, and $8.36 million, respectively. Beginning in year 4, you expect the cash flows to increase at a rate of 4 per cent per year for the indefinite future. You estimate that the cost of equity is 12 per cent. What is the value of equity in this company?

A) $77 million
B) $95 million
C) $109 million
D) $60 million

Question 71

In contrast to the FCFE approach, the dividend discount model (DDM) approach values

A) cash flows that are available for distribution to shareholders.
B) the stream of cash flows that shareholders expect to receive through dividend payments.
C) cash flows that remain after payments to all lenders.
D) None of the above.

Question 72

Adjusted BV: Sterling Ltd has cash of $10,000, receivables of $31,250, and inventory of $27,445. In addition, the company has fixed assets of $125,000. Management has also told you that you can reasonably expect to collect 91 per cent of the receivables, that the inventory could be sold to realise 85 per cent of its book value, and that the sale of the property, plant, and equipment would yield $96,100. What is the liquidation value of this company? Round to the nearest dollar.

A) $157,866
B) $193,695
C) $147,866
D) $183,695

Question 73

Important issues that one must consider in valuing private companies include

A) whether key people remain in the company, the amount of dividends that one may receive in the coming years, and whether a controlling ownership interest or a minority interest is being valued.
B) the difficulty in valuing young, rapidly growing companies in contrast to mature, stable companies, the amount of dividends that one may receive in the coming years, and whether a controlling ownership interest or a minority interest is being valued.
C) the difficulty in valuing young, rapidly growing companies in contrast to mature, stable companies, whether key people remain in the company, and whether a controlling ownership interest or a minority interest is being valued.
D) None of the above.

Question 74

Turnbull company had an EBIT of $247 million in the last financial year. Its depreciation and amortisation expenses amounted to $84 million. The company has 135 million shares outstanding and a share price of $12.80. A competing company that is very similar to Turnbull has an enterprise value/EBITDA multiple of 5.40. Multiples analysis: What is the value of Turnbull company's debt? Round to the nearest million dollars.

A) $121 million
B) $165 million
C) $97million
D) $59 million

Question 75

Multiples analysis: Turner company has debt of $230 million and generated a profit of $121 million in the last financial year. In attempting to determine the total value of the company, an investor identified a similar company in Jacobs, Ltd., an all-equity company. This company had 150 million shares outstanding, a share price of $14.25, and profit of $182 million. What is the total value of Turner company? Round to the nearest million dollars.

A) $1,421 million
B) $1,651 million
C) $1,191million
D) $1,715 million

Question 76

Income approaches: Rentech Ltd company a biotech company, is expected to grow rapidly in the next three years and then have a level growth rate for the foreseeable future. The company expects free cash flows of $342.5 million, $512.3 million, and $750 million over the next three years, and thereafter its cash flows will grow at a steady rate of 8 per cent per annum. The company has no non-operating assets (NOA). If the appropriate WACC is 11.25 per cent, what is the enterprise value of this business? Round to the nearest million.

A) $19,367 million
B) $18,101 million
C) $26,190 million
D) $24,923 million

Question 77

Identify and evaluate three difficulties associated with valuing real assets compared to financial asset.

Question 78

Turnbull company had an EBIT of $247 million in the last financial year. Its depreciation and amortisation expenses amounted to $84 million. The company has 135 million shares outstanding and a share price of $12.80. A competing company that is very similar to Turnbull has an enterprise value/EBITDA multiple of 5.40. Multiples analysis: What is the enterprise value of Turnbull company? Round to the nearest million dollars.

A) $1,334 million
B) $453.6 million
C) $1,787million
D) $1,315 million

Question 79

Income approaches: Maryland Electronics, an electronics manufacturer, is expected to grow rapidly in the next five years and then have a stable growth rate for the foreseeable future. The company expects free cash flows of $262.5 million next year. These cash flows are expected to grow at a 30 per cent rate over the following four years, and thereafter its cash flows will grow at a steady rate of 6 per cent per annum. The company has nonoperating assets (NOA) of $31 million in the form of cash. If the appropriate WACC is 9 per cent, what is the enterprise value of this business? Round to the nearest million.

A) $26,490 million
B) $22,222 million
C) $22, 253 million
D) $22,191 million

Question 80

The three specific cash flows associated with lenders that are included in the free cash flow to equity (FCFE) approach are

A) the interest expense on existing debt, the repayment of debt principal, and the proceeds from new debt issues.
B) the interest expense on existing term debt, the repayment of debt principal, and the proceeds from new equity issues.
C) the interest expense on existing debt, the repayment of debt principal, and the payment of dividends.
D) None of the above.