Question 1

FCF and DDM valuations should be ____________ if the assumptions used are consistent.
A)very different for all firms
B)similar for all firms
C)similar only for unlevered firms
D)similar only for levered firms
E)none of the above

Accepted Answer

FCF and DDM valuations should be similar for all firms if the assumptions used are consistent. FCF valuation is based on the present value of estimated future cash flows, while DDM valuation is based on the present value of expected future dividends. Both methods require assumptions about future growth rates, discount rates, and other variables, but as long as these assumptions are consistent, the valuations should be similar across all firms.

Question 2

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 are ____________.
A)$108.00
B)$1080.00
C)$26.35
D)$14.76
E)none of the above

Accepted Answer

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 3

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.
A)$77.53
B)$40.67
C)$82.16
D)$66.00
E)none of the above

Accepted Answer

The stock's value today is calculated by discounting the expected future FCFE to present value. The terminal value at the end of year 3 is calculated using the formula: FCFE in year 4 / (required return - growth rate). The present value of the terminal value and the FCFE for the first three years are summed to find the stock's worth today, which is approximately $77.53.

Question 4

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 are ____________.
A)$108.00
B)$68.29
C)$244.42
D)$14.76
E)none of the above

Accepted Answer

To calculate the intrinsic value of SI's shares, we can use the Gordon Growth Model:

Intrinsic value = FCFE / (required return on equity - growth rate of FCFE)

Plugging in the numbers:

Intrinsic value = $122.1M / (11.3% - 7.0%) = $244.42

Since there are 12.43M shares outstanding, the intrinsic value per share is:

Intrinsic value per share = $244.42 / 12.43M = $19.66

Since the current market price is not given, it is not possible to determine whether the shares are undervalued or overvalued.

Question 5

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 _______.
A)$250,000
B)$180,000
C)$300,000
D)$380,000
E)none of the above

Accepted Answer

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

Question 6

The required rate of return on equity is the most appropriate discount rate to use when applying a ______ valuation model.
A)FCFE
B)FCEF
C)DDM
D)B or C
E)P/E

Accepted Answer

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

Question 7

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 are ____________.
A)$68.13
B)$18.17
C)$26.35
D)$14.76
E)none of the above

Accepted Answer

The answer of Siri had a FCFE of $1.6M last...

Question 8

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 are ____________.
A)$646.48
B)$64.66
C)$6,464.8
D)$6.46
E)none of the above

Accepted Answer

The intrinsic value of Seaman's shares can be calculated using the Gordon Growth Model:Intrinsic Value = FCFE / (r - g)where:FCFE = Free Cash Flow to Equity = $4.6Br = Required return on equity = 11.6%g = Growth rate of FCFE = 5%Plugging in the values, we get:Intrinsic Value = $4.6B / (0.116 - 0.05) = $64.66Therefore, the intrinsic value of Seaman's shares is $64.66.

Question 9

The most appropriate discount rate to use when applying a FCFE valuation model is the ___________.
A)required rate of return on equity
B)WACC
C)risk-free rate
D)A or C depending on the debt level of the firm
E)none of the above

Accepted Answer

FCFE (Free Cash Flow to Equity) valuation model is used to value equity and the discount rate used in this model is the required rate of return on equity. It represents the return that investors expect to earn on their investment and reflects the risk associated with the equity investment.

Question 10

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 are ____________.
A)$21.60
B)$108
C)$244.42
D)$216.00
E)none of the above

Accepted Answer

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

Question 11

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.
A)$33.00
B)$40.68
C)$55.00
D)$66.00
E)$12.16

Accepted Answer

We can use the formula for the present value of a growing perpetuity to find the value of the stock today:

PV = FCFE / (r - g)

Where PV is the present value, FCFE is the free cash flow to equity per share, r is the required return, and g is the growth rate. We need to find the present value of the first three years of FCFE separately, and then add it to the present value of the growing perpetuity.

PV1 = $1.20 / (1 + 0.14)^1 = $1.053
PV2 = $1.50 / (1 + 0.14)^2 = $1.137
PV3 = $2.00 / (1 + 0.14)^3 = $1.319

Next, we need to find the present value of the growing perpetuity. We can use the formula:

PVGP = FCFE4 / (r - g)

Where FCFE4 is the FCFE per share in year 4, and we assume it grows at 10% per year from year 3. So:

FCFE4 = $2.00 * (1 + 0.10) = $2.20

PVGP = $2.20 / (0.14 - 0.10) = $55.00

Finally, we add up the present values of the first three years of FCFE and the present value of the growing perpetuity:

PV = PV1 + PV2 + PV3 + PVGP = $1.053 + $1.137 + $1.319 + $55.00 = $40.68

Therefore, the stock should be worth $40.68 today, which corresponds to choice B.

Question 12

Old Style Corporation produces goods that are very mature in their product life cycles.Old Style Corporation is expected to have per share FCFE in year 1 of $1.00,per share FCFE of $0.90 in year 2,and per share FCFE of $0.85 in year 3.After year 3,per share FCFE is expected to decline at a rate of 2% per year.An appropriate required rate of return for the stock is 8%.The stock should be worth ______.
A)$127.63
B)$10.57
C)$20.00
D)$22.22
E)$8.98

Accepted Answer

Calculations are shown below.P₃ = 0.85 (.98)/[.08 - (-.02)] = $8.33; PV of P3 = $8.33/(1.08)³ = $6.6126; P₀ = $6.61226 + $2.3723 = $8.98.

Question 13

GAAP allows
A)no leeway to manage earnings.
B)minimal leeway to manage earnings.
C)considerable leeway to manage earnings.
D)earnings management if it is beneficial in increasing stock price.
E)none of the above.

Accepted Answer

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

Question 14

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 are ____________.
A)$21.60
B)$26.56
C)$244.42
D)$24.11
E)none of the above

Accepted Answer

First, we need to calculate the present value of future FCFE using the Gordon growth model:

PV of FCFE = FCFE / (r-g)

where r = required return on equity = 13% 
g = growth rate of FCFE = 8.5% 
FCFE = $3.2M

PV of FCFE = $3.2M / (0.13 - 0.085) = $80M

Next, we need to calculate the per-share intrinsic value:

Intrinsic value per share = PV of FCFE / number of shares outstanding 
= $80M / 3.2M 
= $25

Since the intrinsic value per share is greater than the current share price (which is not given in the question), SGA Consulting is undervalued and a good investment opportunity.

Therefore, the correct answer is D) $24.11, which is the closest choice to our calculated intrinsic value of $25.

Question 15

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 are ____________.
A)$108.00
B)$68.29
C)$26.35
D)$14.76
E)none of the above

Accepted Answer

The intrinsic value per share is calculated using the Gordon Growth Model: Value = FCFE * (1 + g) / (r - g). Substituting the values: $6.1M * (1 + 0.065) / (0.106 - 0.065) = $158.44M. Dividing by 2.32M shares gives $68.29 per share.

Question 16

The growth in per share FCFE of SYNK,Inc.is expected to be 8%/year for the next two years,followed by a growth rate of 4%/year for three years; after this five year period,the growth in per share FCFE is expected to be 3%/year,indefinitely.The required rate of return on SYNC,Inc.is 11%.Last year's per share FCFE was $2.75.What should the stock sell for today?
A)$28.99
B)$35.21
C)$54.67
D)$56.37
E)$39.71

Accepted Answer

The answer of The growth in per share FCFE of...

Question 17

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
A)$1,615,156.50
B)$2,479,168.95
C)$3,333,333.33
D)$4,166,666.67
E)none of the above

Accepted Answer

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

Question 18

The most appropriate discount rate to use when applying a FCFF valuation model is the ___________.
A)required rate of return on equity
B)WACC
C)risk-free rate
D)A or C depending on the debt level of the firm
E)none of the above

Accepted Answer

The most appropriate discount rate to use when applying a FCFF valuation model is the weighted average cost of capital (WACC). This is because FCFF represents the cash flows available to all the providers of capital (equity and debt), and the WACC is the required rate of return that reflects the cost of all the sources of capital. The required rate of return on equity (choice A) only reflects the cost of equity, while the risk-free rate (choice C) only represents the cost of debt-free equity, which is not appropriate for FCFF valuation. The choice D is not always the best option because the optimal capital structure is not always known or stable. Therefore, WACC is the best choice for FCFF valuation.

Question 19

Goodie Corporation produces goods that are very mature in their product life cycles.Goodie Corporation is expected to have per share FCFE in year 1 of $2.00,per share FCFE of $1.50 in year 2,and per share FCFE of $1.00 in year 3.After year 3,per share FCFE is expected to decline at a rate of 1% per year.An appropriate required rate of return for the stock is 10%.The stock should be worth ______.
A)$9.00
B)$101.57
C)$10.57
D)$22.22
E)$47.23

Accepted Answer

Calculations are shown below.P₃ = 1.00 (.99)/[.10 - (-.01)] = $9.00; PV of P₃ = $9/(1.10)³ = $6.7618; P₀ = $6.7618 + $3.8092 = $10.57.

Question 20

WACC is the most appropriate discount rate to use when applying a ______ valuation model.
A)FCFF
B)FCFE
C)DDM
D)A or C depending on the debt level of the firm
E)P/E

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.

Quiz 18: Option Valuation

FCF and DDM valuations should be ____________ if the assumptions used are consistent.

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 are ____________.

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 are ____________.

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

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 are ____________.

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 are ____________.

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

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 are ____________.

GAAP allows

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 are ____________.

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 are ____________.

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

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