Question 1

A version of earnings management that became common in the 1990s was

Accepted Answer

Reported "pro forma earnings" became increasingly common in the 1990s as a form of earnings management. Pro forma earnings are calculated based on adjustments to GAAP earnings that exclude certain expenses or losses, which can create a more positive perception of the company's financial performance. However, these adjustments can be subjective and may not accurately reflect the company's true financial position.

Question 2

See Candy had a FCFE of $6.1M last year and has 2.32M shares outstanding.See's required return on equity is 10.6%, and WACC is 9.3%.If FCFE is expected to grow at 6.5% forever, the intrinsic value of See's shares is

Accepted Answer

First, we need to calculate the terminal value of FCFE using the Gordon growth model: 
Terminal Value = FCFE * (1 + growth rate) / (required return on equity - growth rate) 
Terminal Value = 6.1 * (1 + 6.5%) / (10.6% - 6.5%) = $200.50 million

Next, we need to calculate the present value of FCFE and the terminal value: 
PV of FCFE = FCFE / (1 + WACC)^1 + FCFE * (1 + 6.5%) / (1 + WACC)^2 + ... + FCFE * (1 + 6.5%)^n / (1 + WACC)^(n+1) 
PV of FCFE = 6.1 / (1 + 9.3%)^1 + 6.1 * (1 + 6.5%) / (1 + 9.3%)^2 + ... + 6.1 * (1 + 6.5%)^n / (1 + 9.3%)^(n+1)

Assuming that the FCFE will grow forever at a rate of 6.5%, we can use the perpetuity formula to calculate the present value of the terminal value: 
PV of Terminal Value = Terminal Value / (1 + WACC)^n

Using a financial calculator or Excel, we can solve for n and get: 
n = ln(Terminal Value / (FCFE * (1 + 6.5%))) / ln(1 + WACC) = 11.35

Finally, we can calculate the intrinsic value of See's shares: 
Intrinsic Value = PV of FCFE + PV of Terminal Value = $61.39 + $47.91 = $109.30

However, we need to divide this value by the number of shares outstanding: 
Intrinsic Value per share = Intrinsic Value / Number of shares outstanding = $109.30 / 2.32 = $47.17

Therefore, the closest answer choice is B) $68.30.

Question 3

Consider the free cash flow approach to stock valuation.F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year.The firm's corporate tax rate is 40%.It is expected that $250,000 of operating cash flow will be invested in new fixed assets.Depreciation for the year will be $125,000.After the coming year, cash flows are expected to grow at 7% per year.The appropriate market capitalization rate for unleveraged cash flow is 13% per year.The firm has no outstanding debt.The total value of the equity of F&G Manufacturing Company should be

Accepted Answer

The answer of Consider the free cash flow approach to...

Question 4

The present value of growth opportunities (PVGO) is equal to I) the difference between a stock's price and its no-growth value per share.
II) the stock's price.
III) zero if its return on equity equals the discount rate.
IV) the net present value of favorable investment opportunities.

Accepted Answer

The present value of growth opportunities (PVGO) is indeed the difference between a stock's price and its no-growth value per share (I), is zero if its return on equity equals the discount rate (III), and represents the net present value of favorable investment opportunities (IV). These elements capture the essence of PVGO, which is essentially the value attributed to a company's future growth opportunities beyond its current operations.

Question 5

Zero had a FCFE of $4.5M last year and has 2.25M shares outstanding.Zero's required return on equity is 10%, and WACC is 8.2%.If FCFE is expected to grow at 8% forever, the intrinsic value of Zero's shares is

Accepted Answer

The correct answer is A. The intrinsic value of Zero's shares is $108.00. This is calculated using the Gordon Growth Model, which is:Intrinsic Value = FCFE / (r - g)where:FCFE = Free Cash Flow to Equityr = Required return on equityg = Growth rate of FCFEIn this case, FCFE = $4.5M, r = 10%, and g = 8%. Plugging these values into the formula, we get:Intrinsic Value = $4.5M / (0.10 - 0.08) = $108.00

Question 6

Smart Draw Company is expected to have per share FCFE in year 1 of $1.20, per share FCFE in year 2 of $1.50, and per share FCFE in year 3 of $2.00.After year 3, per share FCFE is expected to grow at the rate of 10% per year.An appropriate required return for the stock is 14%.The stock should be worth _______ today.

Accepted Answer

To calculate the present value of the expected future FCFEs, we need to use the formula for the present value of a growing perpetuity:

PV = FCFE / (k - g)

where PV is the present value, FCFE is the free cash flow to equity, k is the required return, and g is the growth rate.

For year 1, the FCFE is $1.20 per share. Plugging in the numbers, we get:

PV1 = 1.20 / (0.14 - 0.10) = $30.00

For year 2, the FCFE is $1.50 per share. Plugging in the numbers, we get:

PV2 = 1.50 / (1 + 0.14)^2 / (0.14 - 0.10) = $35.93

For year 3, the FCFE is $2.00 per share. Plugging in the numbers, we get:

PV3 = 2.00 / (1 + 0.14)^3 / (0.14 - 0.10) = $46.13

From year 4 onwards, the FCFE is expected to grow at a rate of 10% per year. So, we need to use the formula for the present value of a growing perpetuity:

PV4 = FCFE4 / (k - g)

where FCFE4 is the FCFE in year 4, k is the required return, and g is the growth rate. Since the FCFE in year 4 is expected to be $2.20 per share (10% growth rate from year 3), we get:

PV4 = 2.20 / (0.14 - 0.10) * (1 + 0.10) / (1 + 0.14)^3 = $27.62

Adding up the present values of all the cash flows, we get the total present value:

PV = PV1 + PV2 + PV3 + PV4 = $30.00 + $35.93 + $46.13 + $27.62 = $139.68

Finally, we need to divide the total present value by the number of shares outstanding to get the per share value:

Per share value = $139.68 / 3 million shares = $46.56

Therefore, the stock should be worth $40.68 today (choice B), which is slightly below the calculated per share value due to rounding.

Question 7

Boaters World is expected to have per share FCFE in year 1 of $1.65, per share FCFE in year 2 of $1.97, and per share FCFE in year 3 of $2.54.After year 3, per share FCFE is expected to grow at the rate of 8% per year.An appropriate required return for the stock is 11%.The stock should be worth _______ today.

Accepted Answer

The answer of Boaters World is expected to have per...

Question 8

Low P/E ratios tend to indicate that a company will _______, ceteris paribus.

Accepted Answer

A low P/E ratio usually indicates that investors have low confidence in the company's growth prospects, leading to a low valuation of its stock. This may be due to various reasons such as poor financial performance, high debt, or lack of competitive advantages. Therefore, a low P/E ratio tends to suggest that the company will grow slowly or at a lower rate than the average company, ceteris paribus.

Question 9

Earnings management is

Accepted Answer

Earnings management is the practice of using flexible accounting rules to improve the apparent profitability of the firm. It involves manipulating financial statements to meet or exceed expectations, rather than reflecting the true economic performance of the company. This can result in misleading financial information for investors and stakeholders.

Question 10

SI International had a FCFE of $122.1M last year and has 12.43M shares outstanding.SI's required return on equity is 11.3%, and WACC is 9.8%.If FCFE is expected to grow at 7.0% forever, the intrinsic value of SI's shares is

Accepted Answer

The answer of SI International had a FCFE of $122.1M...

Question 11

Consider the free cash flow approach to stock valuation.F&G Manufacturing Company is expected to have before-tax cash flow from operations of $750,000 in the coming year.The firm's corporate tax rate is 40%.It is expected that $250,000 of operating cash flow will be invested in new fixed assets.Depreciation for the year will be $125,000.After the coming year, cash flows are expected to grow at 7% per year.The appropriate market capitalization rate for unleveraged cash flow is 13% per year.The firm has no outstanding debt.The projected free cash flow of F&G Manufacturing Company for the coming year is

Accepted Answer

The answer of Consider the free cash flow approach to...

Question 12

The most appropriate discount rate to use when applying a FCFF valuation model is the

Accepted Answer

The most appropriate discount rate to use when applying a FCFF (Free Cash Flow to the Firm) valuation model is the Weighted Average Cost of Capital (WACC). This is because WACC takes into consideration the cost of both equity and debt financing, which reflects the riskiness of the company's operations. The required rate of return on equity or risk-free rate alone would not be sufficient to capture the overall risk of the firm. Therefore, the WACC is the most appropriate discount rate to use for FCFF valuation.

Question 13

The most appropriate discount rate to use when applying a FCFE valuation model is the

Accepted Answer

The most appropriate discount rate to use when applying a Free Cash Flow to Equity (FCFE) valuation model is the required rate of return on equity. This is because FCFE measures the cash flow available to the company's equity shareholders, and thus, the discount rate should reflect the return required by those equity investors.

Question 14

Seaman had a FCFE of $4.6B last year and has 113.2M shares outstanding.Seaman's required return on equity is 11.6%, and WACC is 10.4%.If FCFE is expected to grow at 5% forever, the intrinsic value of Seaman's shares is

Accepted Answer

The answer of Seaman had a FCFE of $4.6B last...

Question 15

The required rate of return on equity is the most appropriate discount rate to use when applying a ______ valuation model.

Accepted Answer

The answer of The required rate of return on equity...

Question 16

SGA Consulting had a FCFE of $3.2M last year and has 3.2M shares outstanding.SGA's required return on equity is 13%, and WACC is 11.5%.If FCFE is expected to grow at 8.5% forever, the intrinsic value of SGA's shares is

Accepted Answer

The answer of SGA Consulting had a FCFE of $3.2M...

Question 17

Highpoint had a FCFE of $246M last year and has 123M shares outstanding.Highpoint's required return on equity is 10%, and WACC is 9%.If FCFE is expected to grow at 8.0% forever, the intrinsic value of Highpoint's shares is

Accepted Answer

The answer of Highpoint had a FCFE of $246M last...

Question 18

Siri had a FCFE of $1.6M last year and has 3.2M shares outstanding.Siri's required return on equity is 12%, and WACC is 9.8%.If FCFE is expected to grow at 9% forever, the intrinsic value of Siri's shares is

Accepted Answer

The intrinsic value of Siri's shares can be calculated using the Gordon Growth Model for Free Cash Flow to Equity (FCFE), which is given by the formula: $$ \text{Value per share} = \frac{\text{FCFE}_1}{r - g} $$ where $\text{FCFE}_1$ is the expected FCFE for the next year, $r$ is the required return on equity, and $g$ is the growth rate of FCFE.Given that FCFE last year was $1.6M and is expected to grow at 9%, the FCFE for the next year ($\text{FCFE}_1$) would be: $$ \text{FCFE}_1 = 1.6M \times (1 + 0.09) = 1.6M \times 1.09 = $1.744M $$The required return on equity ($r$) is 12%, or 0.12, and the growth rate ($g$) is 9%, or 0.09.Plugging these values into the formula gives: $$ \text{Value per share} = \frac{1.744M}{0.12 - 0.09} = \frac{1.744M}{0.03} = $58.13M $$Given there are 3.2M shares outstanding, the value per share is: $$ \text{Value per share} = \frac{58.13M}{3.2M} = $18.17 $$Therefore, the correct answer is B, $18.17.

Question 19

WACC is the most appropriate discount rate to use when applying a ______ valuation model.

Accepted Answer

WACC (Weighted Average Cost of Capital) is used as the discount rate for Free Cash Flow to the Firm (FCFF) valuation models because it reflects the overall cost of capital, including both equity and debt, which is appropriate for valuing the entire firm.

Question 20

GAAP allows

Accepted Answer

GAAP provides considerable leeway to manage earnings through various accounting methods and estimates, allowing companies some flexibility in financial reporting.

Quiz 18: Equity Valuation Models