Deck 12: Valuation: Cash-Flow-Based Approaches

Question 1

If an analyst wants to value a potential investment in the net operating assets of a division of another firm,the analyst should discount the projected free cash flows at the

A) cost of debt capital
B) cost of equity capital
C) weighted average cost of capital
D) risk free rate

Answer 1

C

Question 2

A disadvantage of the free cash flow valuation method is

A) The terminal value tends to dominate the total value in many cases.
B) The projection of free cash flows depends on earnings estimates.
C) The free cash flow method is not rigorous.
D) The free cash flow method is not used widely in practice.

Answer 2

A

Question 3

Houston,Inc. The following information pertains to Houston,Inc.a manufacturer of belt buckles:
What is Houston's free cash flow for common equity holders for year 2012?

A) $564
B) $399
C) $324
D) $412

Answer 3

D

Question 4

If an analyst wants to value a potential investment in the net operating assets of a division of another firm,the relevant cash flows the analyst should use are

A) free cash flow from operations
B) free cash flows for all debt and equity capital stakeholders
C) free cash flows to common equity shareholders
D) cash flow from operations

Question 5

Starting with cash flow from operations and adjusting for net interest after tax and cash requirements for liquidity equals

A) free cash flows for all debt and equity capital stakeholders
B) free cash flow
C) free cash flows to common equity capital shareholders
D) free cash flow from operations

Question 6

All of the following are logical steps that enable the analyst to determine reliable estimates of value except:

A) understand the economics of the industry
B) assess the particular firm's strategy
C) evaluate the quality of the firm's accounting
D) derive a single point estimate of value for a share's current price

Question 7

Houston,Inc. The following information pertains to Houston,Inc.a manufacturer of belt buckles:
What is Houston's free cash flow for all debt and equity holders for year 2012?

A) $564
B) $399
C) $324
D) $202

Question 8

Nonsystematic risk factors would include all of the following except:

A) the sustainability of the firm's strategy
B) the firm's ability to generate revenue growth
C) the firm's ability to control expenses
D) unemployment levels

Question 9

Operating assets include all of the following except

A) accounts receivable
B) property, plant, and equipment
C) intangible assets
D) property held for sale

Question 10

The conceptual framework for free cash flows separates the balance sheet equation into the following categories:

A) CA + LT A = CL + LT L + SE
B) OA + FA = OL + FL + SE
C) OA + FA = OL + FL + OSE + FSE
D) Non-FA + FA = Non-FL + FL + SE

Question 11

Which of the following is not a problem with using a dividend-based valuation formula

A) dividends are arbitrarily established
B) dividends represent a transfer of wealth to shareholders
C) some firms do not pay a regular periodic dividend
D) it is a challenge to forecast the final liquidating dividend

Question 12

Operating liabilities include all of the following except

A) accounts payable
B) pension obligations
C) accrued taxes
D) long-term debt

Question 13

Continuing free cash flows represent

A) the cash flows remaining after deducting cash flows attributable to debt holders
B) the free cash flows after the point at which the firm has settled into a long-run steady-state growth rate.
C) all sustainable free cash flows
D) all after-tax free cash flows

Question 14

If an analyst wants to value a potential investment in the common stock equity in a firm,the relevant cash flows the analyst should use are

A) free cash flow from operations
B) free cash flows for all debt and equity capital stakeholders
C) free cash flows to common equity shareholders
D) cash flow from operations

Question 15

If a firm's stock returns covary identically with returns to a marketwide portfolio,then its market beta from such a regression is:

A) equal to zero.
B) equal to one.
C) less than one.
D) greater than one.

Question 16

Steady-state growth in free cash flows could be driven by long-run expectations for growth attributable to

A) interest rates
B) national exports
C) general economic productivity
D) balance of payments

Question 17

If an analyst wants to value a potential investment in the common stock equity of a firm,the analyst should discount the projected free cash flows at the

A) required return on equity capital
B) weighted average cost of capital
C) risk free rate
D) market risk premium

Question 18

Free cash flow is calculated as net cash provided by operating activities less

A) dividends.
B) capital expenditures and depreciation.
C) capital expenditures.
D) capital expenditures and dividends.

Question 19

The conceptual framework for free cash flows separates all assets and liabilities into the following categories:

A) Current and non-current
B) Monetary and non-monetary
C) Operating and non-operating
D) Operating and financial

Question 20

When calculating free cash flows to common equity shareholders,financing activities do not include:

A) Debt cash flows
B) Adjustments for capital expenditures
C) Adjustments for Preferred stock cash flows
D) Financial asset cash flows

Question 21

If the objective is to value operating assets net of operating liabilities of a firm then the appropriate free cash flow measure to be used is ______________________________________________________________________.

Question 22

If a firm generates a rate of return on __________________________________________________ equal to the discount rate used by the investor then it does not matter if an analyst uses cash flows to the investor or cash flows to the firm.

Question 23

The analyst can use expectations of the dividends to be paid to the investor or the free cash
flows to be generated by the firm (that will ultimately be paid to the investor)as equivalent
approaches to measure the ____________________ expected payoffs to shareholders.

Question 24

Even in relatively efficient securities markets,____________________ is observable but ____________________ is not; therefore,____________________ must be estimated.

Question 25

What three elements are needed to value a resource when using cash flows?

Question 26

The risk-adjusted discount rate used to compute the present value of all the projected free cash flows for common equity shareholders equals the _______________________________________________________.

Question 27

Free cash flows for common equity shareholders are the cash flows specifically available to the common shareholders after making all capital expenditures,_____________________________________________ and ____________________________________________________________.
debt service payments to lenders,paying dividends to preferred shareholders or
paying dividends to preferred shareholders,debt service payments to lenders

Question 28

If cash flow projections include the effect of inflation then the discount rate used should be a ____________________ rate.

Question 29

Provide the rationale for using expected free cash flow in valuation.

Question 30

Steady-state growth in ___________________________________ could be driven by long-run expectations for growth attributable to economy-wide inflation,general economic productivity,the population,or long-run growth in industry's sales.
ree cash flows

Question 31

One disadvantage of the free cash flow valuation method is that many times the ______________________________ dominates the total value.

Question 32

An equity security with systematic risk equal to the average amount of systematic risk of all equity securities in the market

A) has a market beta equal to one.
B) should expect to earn the same rate of return as the average stock in the market portfolio.
C) gives no insight into the risk premium of stock.
D) Both a and b are correct.

Question 33

For most firms,______________________________ include cash and short-term investment securities,accounts receivable,inventory,property,plant and equipment,intangible assets and investments in affiliated companies.

Question 34

The forecasting and valuation process is particularly difficult for ______________________________ when the near term free cash flows tend to be negative.

Question 35

The cash-flow-based valuation approach measures and values the cash flows that are "free" to be ________________________________________ unencumbered by necessary reinvestments in operating assets or required payments to debt holders.

Question 36

Changes in general price levels cause the ______________________________ of the monetary unit to change over time.

Question 37

____________________ is an estimate of systematic risk based on the degree of covariation between a firm's stock returns and an index of stock returns for all firms in the market.

Question 38

________________________________________ typically include accounts payable,accrued expenses,accrued taxes,deferred taxes,pension obligations and other retirement benefit obligations.

Question 39

Free cash flow from operations equals cash flow from operations adjusted for net interest after tax and adjusted for __________________________________________________.

Question 40

The present value of future free cash flows valuation method focuses on free cash flows,a base that economists argue has more economic meaning than ____________________.

Question 41

When should an analyst use nominal cash flows and when should an analyst use real cash flows?

Question 42

Clarmont Corporation engaged in the following cash transactions during 2012:
Required:
What is Clarmont's free cash flow,assuming that it reported net cash provided by operating activities of $400,000?

Question 43

Shady Sunglasses operates retail sunglass kiosks in shopping malls.Below is information related to the company:
Using a five-year forecast horizon,compute the sum of the present value of free cash flows accruing to common equity holders for years 2012 to 2016.

Question 44

Simpson Department Store
Simpson Department Stores operates retail department store chains throughout the United States.At the end of Year 10,Simpson reports debt of $4,658 million and common shareholders' equity at book value of $4,323 million.The market value of its common stock is $6,905,and its market equity beta is .89.An equity buyout group is considering an LBO of Simpson as of the beginning of Year 11.The group intends to finance the buyout with 20 percent common equity and 80 percent debt carrying an interest rate of 11 percent.
Regarding the equity buyout,compute the unlevered market equity (asset)beta of Simpson before consideration of
the LBO.Assume that the book value of the debt equals its market value.The income
tax rate is 35 percent.

Question 45

Discuss under which scenario it is appropriate to use free cash flows for all debt and equity capital stakeholders.

Question 46

Regarding the equity buyout,compute the weighted average cost of capital of the new capital structure.

Question 47

Starting with free cash flows from operations,discuss how an analyst would measure free cash flows to common equity shareholders.

Question 48

Below is information from the statement of cash flow and income statement for Garland Products,Inc.for 2012 and 2011.Marketable securities represent investments of excess cash that Garland Products does not need for operations.Garland Products' tax rate is 35%.
Using the above information calculate the amount of free cash flows to all debt and equity capital stakeholders for Garland Products for year 2012 and 2011.

Question 49

Amherst,Inc.had the following balance sheet at December 31,2012:
During 2013 the following occurred.
1.Amherst liquidated its available for sale investment portfolio at a loss of $5,000.
2.A tract of land was purchased for $38,000.
3.An additional $30,000 in common stock was issued at par.
4.Dividends totaling $10,000 were declared and paid to stockholders.
5.Net income for 2013 was $35,000,including $12,000 in depreciation expense.
6.Land was purchased through the issuance of $30,000 of additional bonds.
7.At December 31,2013,Cash was $70,200,Accounts Receivable was $42,000 and Accounts Payable was $40,000.
Required:
(a)What were Amherst's cash flows from operating activities for the year ended December 31,2013?
(b)Compute Amherst's free cash flow and current cash debt coverage for 2013.
(c)How does information in the balance sheet and statement of cash flows help the user or analyst of the financial statements?

Question 50

Net income for the year for Tanglewood Inc.was $750,000,but the statement of cash flows reports that cash provided by operating activities was $860,000.Tanglewood also reported capital expenditures of $75,000 and paid dividends in the amount of $30,000.Compute Tanglewood's free cash flow.

Question 51

Morgan Company reported the following items in 2012:
Required:
Calculate the following:
(1)net cash provided by operating activities,
(2)the net change in cash during 2012,and
(3)free cash flow.

Question 52

A comparative balance sheet for Otto Inc.is presented below:
Additional information:
1.Net income for 2012 was $105,000.
2.Cash dividends of $40,000 were declared and paid.
3.Bonds payable amounting to $50,000 were retired through issuance of common stock.
Required:
(a)Prepare a statement of cash flows for 2012 for Otto,Inc.
(b)Compute Otto's current cash debt coverage ratio and cash debt coverage ratio.
(c)Determine Otto Inc.'s free cash flow and comment on its liquidity and financial flexibility.

Question 53

Shady Sunglasses operates retail sunglass kiosks in shopping malls.Below is information related to the company:
Using the above information and assuming that steady-state growth in year 2017 and beyond will be 4% calculate Shady Sunglasses' current value per share.

Question 54

Explain "free" cash flows.Describe which types of cash flows are free and which are not.How do free cash flows available for debt and equity stakeholders differ from free cash flows available for common equity shareholders?

Question 55

Currently financial reporting does not take into account changes in prices,either at the general level or at the specific level.Many analysts believe that not taking price changes into account distorts the meaningfulness of financial reports.How do changing prices affect financial reports?

Question 56

Below is a condensed version of the comparative balance sheets for Stiller Corporation for 2011 and 2012:
Additional information:
Investments were sold at a loss (not extraordinary)of $7,000; no equipment was sold; cash dividends paid were $50,000; and net income was $160,000.
Required:
(a)Prepare a statement of cash flows for 2012 for Stiller Corporation.
(b)Calculate the company's free cash flow.

Question 57

Below is information from the statement of cash flow and income statement for Garland Products,Inc.for 2012 and 2011.Marketable securities represent investments of excess cash that Garland Products does not need for operations.Garland Products' tax rate is 35%.
Using the above information calculate the amount of free cash flows for common equity shareholders for Garland Products for year 2012 and 2011.

Question 58

What is the purpose of a free cash flow analysis?

Question 59

Regarding the equity buyout,compute the cost of equity capital with the new capital structure that results from the LBO.Assume a risk-free rate of 4.6 percent and a market risk premium of 6.0 percent.

Question 60

Shady Sunglasses operates retail sunglass kiosks in shopping malls.Below is information related to the company:
Using a five-year forecast horizon compute the sum of the present value of free cash flows accruing to all debt and common equity holders for years 2012 to 2016.

Question 61

Financial statements for Hawk Company are presented below:
Hawk Company
Balance Sheet
December 31,2012

Question 62

Suppose a firm faces the following costs of capital:
Assume that this firm expects to generate $80 million of pretax-free cash flows.
Required:
(1)What would be the after-tax free cash flows one year from today?
(2)Assuming a one-year horizon,what is the appropriate valuation to be used by the analyst?