Deck 18: Business Formation, Growth and Valuation

Question 1

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

Answer 1

True

Question 2

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

Answer 2

False

Question 3

Limited partnerships are no more costly to form than sole proprietorships.

Answer 3

False

Question 4

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

Question 5

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

Question 6

An LLC leads to unlimited liability for the people who make the business decisions in the firm while enabling all investors to retain the tax advantages of a limited partnership.

Question 7

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 8

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

Question 9

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.

Question 10

A business has a better chance to succeed if one doesn't overanalyze opportunities to the point where you are just convincing yourself not to proceed.

Question 11

Limited partnerships are more costly to form than sole proprietorships because the partners must hire an attorney to draw up and maintain the partnership agreement.

Question 12

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 13

An S-corporation can have no more than 50 stockholders.

Question 14

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

Question 15

The cash budget summarizes the cash flows into and out of a firm over a period of time.

Question 16

An S-corporation allows the stockholders to avoid double taxation but places limits on the ownership of the firm's stock.

Question 17

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

Question 18

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

Question 19

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

Question 20

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

Question 21

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

Question 22

The free cash flow from the firm (FCFF) approach uses only the portion of the cash flows that are available for distribution to stockholders.

Question 23

Which one of the following statements is true?

A) Limited partnerships are no more costly to form than sole proprietorships.
B) Like a corporation, an LLC provides limited liability for the people who make the business decisions in the firm while enabling all investors to retain the tax advantages of a limited partnership.
C) The lives of partnerships and LLCs are not flexible.
D) Limited partners and LLCs are more constrained than general partnerships because they can raise money only from limited partners or "members."

Question 24

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 25

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

Question 26

Which one of the following statements is true?

A) An Scorporation can have more than100 stockholders.
B) All profits of an Scorporation pass directly to the stockholders as they would pass to the partners in a partnership.
C) An Scorporation is a variation of the LLC.
D) Only foreign investors can own the shares of an S-corporation.

Question 27

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 28

A limited liability company (LLC) is

A) a hybrid of a limited partnership and a corporation.
B) more costly to form than sole proprietorships
C) less constrained than general partnerships because they can raise money from limited partners.
D) All of the above

Question 29

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

Question 30

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 31

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 32

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 33

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 34

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

A) not jump into a business without careful thought.
B) not overanalyze 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 35

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 firm.

Question 36

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

Question 37

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 firm as long as expected.

Question 38

Cost approaches include replacement cost and multiples analysis.

Question 39

Which one of the following statements is NOT true?

A) An Scorporation can have no more than100 stockholders.
B) All profits of an Scorporation pass directly to the stockholders as they would pass to the partners in a partnership.
C) An Scorporation is a variation of the Ccorporation form that is used by public corporations.
D) Only some Ccorporations can become an Scorporation with approval from the IRS.

Question 40

All of the following are organizational forms EXCEPT

A) sole proprietorships, partnerships, and Z-corporations.
B) sole proprietorships, S-corporations, and limited liability companies.
C) C- Corporations, S-corporations, and LLCs.
D) C- Corporations, S-corporations, and partnerships.

Question 41

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

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

Question 42

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 stockholders.
C) for distribution to stockholders.
D) None of the above.

Question 43

Important issues that one must consider in valuing private firms include

A) whether key people remain in the firm, 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 firm, and whether a controlling ownership interest or a minority interest is being valued.
D) None of the above.

Question 44

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 45

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

A) A detailed description or 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 46

In the free cash flow from the firm (FCFF) approach, the total value of the firm, V_F, is computed as the present value of the FCFF,

A) discounted by the firm's cost of equity
B) discounted by the firm's WACC
C) discounted by the firm's cost of debt
D) None 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 firm 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 investment value.
D) A financial investor, on the other hand, is only interested in the financial performance of the firm and not in acquiring the business.

Question 48

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

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

Question 49

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 firm.
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 50

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 51

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 52

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.

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 firms is not an easy task.
C) of differences in the capital structures of the firms being compared.
D) All of the above.

Question 54

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 summarizes the cash flows into and out of a firm 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 55

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 56

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 maximizing 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 57

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

A) The present value of these cash flows exceeds the total value of the firm, 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 noninterest-bearing current liabilities, which are included in the firm's cost of sales and other operating expenses, are subtracted in the calculation of FCFF.
D) the total value of the firm, V_F, is computed as the present value of the FCFF, discounted by the firm's WACC.

Question 58

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 59

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 60

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 61

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

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

Question 62

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

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

Question 63

Multiples analysis: What is the value of Turnbull Corp's debt? Round to the nearest million dollars.

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

Question 64

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

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

Question 65

Break-even analysis: Jackson Electronics makes circuit boards and markets them to electronic goods manufacturers. The firm has nonsalary 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 66

Income approaches: You are valuing the equity of Cirona Corp. using the FCFE approach and have estimated that the FCFE in the next three years will grow at a 8 percent 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 percent per year for the indefinite future. The cost of equity for the firm is10 percent. What is the value of equity in this company?

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

Question 67

Multiples analysis: What is the enterprise value of Turnbull Corp.? Round to the nearest million dollars.

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

Question 68

Break-even analysis: Sherwin Furniture makes period pieces. The firm 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 firm?

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

Question 69

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 firm expects free cash flows of $262.5 million next year. These cash flows are expected to grow at a 30 percent rate over the following four years, and thereafter its cash flows will grow at a steady rate of 6 percent per annum. The company has nonoperating assets (NOA) of $31 million in the form of cash.. If the appropriate WACC is 9 percent, what is the enterprise value of this business? Round to the nearest million.

A) $26,490 million
B) $22,222 million
C) $19,014 million
D) $22,191 million

Question 70

Adjusted BV: Sterling, Inc., has cash of $10,000, receivables of $31,250, and inventory of $27,445. In addition, the firm has fixed assets of $125,000. Management has also told you that you can reasonably expect to collect 91 percent of the receivables, that the inventory could be sold to realize 85 percent 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 71

Break-even analysis: Triad Electrical Supply Company needs to sell 3,500 circuit breakers to break even. Its unit variable cost is $341.50, and its unit selling price is $713.50. What is the fixed cost of this company?

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

Question 72

Income approaches: Shenandoah Corp. is expected to grow rapidly in the next four years and then have a zero growth rate for the foreseeable future. The firm 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 percent, 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 73

Break-even analysis: Johnstone Corp. 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 74

Income approaches: Rentech, Inc., a biotech firm, is expected to grow rapidly in the next three years and then have a level growth rate for the foreseeable future. The firm 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 percent per annum. The company has no nonoperating assets (NOA). If the appropriate WACC is 11.25 percent, 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 75

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 firm 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 percent 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 76

Adjusted BV: Troy Corp. has cash of $24,250, receivables of $81,700, and inventory of $117,875. In addition, the firm has property, plant, and equipment of $152,000. Management has also told you that you can reasonably expect to collect 85 percent of the receivables, that the inventory could be sold to realize 80 percent 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 77

Break-even analysis: Trident, Inc., makes designer gold bracelets. Their annual costs include shop rent of $12,500, salaries for two jewelers 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 labor, 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 78

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

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

Question 79

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 percent per year for the indefinite future. You estimate that the cost of equity is 12 percent. What is the value of equity in this company?

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

Question 80

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

A) $301 million
B) 354 million
C) $241 million
D) $144 million