Financial Modelling And Valuation MCQ With Solutions Part 2
Q1- Which of the following is the correct sequence of steps to perform a DCF analysis?
I. Determine Terminal Value
II. Study the Target and Determine Key Performance Drivers
III. Calculate Present Value and Determine Valuation
IV. Project Free Cash Flow
V. Calculate Weighted Average Cost of Capital
A. II, V, IV, III, and I
B. II, IV, V, I, and III
C. III, IV, V, I, and II
Correct Answer is B Explanation: The correct order is: I. Study the Target and Determine Key Performance Drivers II. Project Free Cash Flow III. Calculate Weighted Average Cost of Capital IV. Determine Terminal Value V. Calculate Present Value and Determine Valuation
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Q2-Which of the following is a current asset?
B. Property, plant and equipment
C. Prepaid expenses
Correct Answer is C Explanation: Prepaid expenses are current assets, which are payments made by a company before a product is delivered or a service is performed. Long-term assets or liabilities are the other options.
Q3- Which of the following factors should be considered when generating assumptions for FCF projections in a DCF?
I. Historical interest expense
II. Historical growth rates
III. Classes of debt securities
VI. Historical EBIT margins
A. I and II
B. II and IV
C. I, II, III, and IV
Correct Answer is B Explanation: Historical growth rates, EBIT margins, and other ratios, especially for mature companies in non-cyclical industries, can be a good predictor of future success. When predicting future financial success, the previous three-year period (if available) is usually a good proxy.
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Q4- Which of the following are commonly sensitized key variables in the DCF?
II. Exit multiple
IV. EBIT margins
A. I and III
B. II and III
C. I, II, and IV
Correct Answer is C Explanation: In the DCF, WACC, exit multiples, and EBIT margins are frequently sensitive. Perpetual growth rate and sales growth rates are two other variables that are frequently sensitive.
Q5- A stock with a beta greater than 1.0 are
A. Lower systematic risk than the market
B. Higher systematic risk than the market
C. Lower unsystematic risk than the market
D. Higher unsystematic risk than the market
Correct Answer is B Explanation: A stock with a beta less than 1.0 has less systematic risk than the market, whereas a stock with a beta greater than 1.0 has more systematic risk. This is mathematically captured in the CAPM, with higher beta stocks having a greater cost of equity, and lower beta stocks having a lower cost of equity.
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Q6- A company with no debt in its capital structure would have a WACC equal to its
A. Cost of Equity
B. Cost of Debt
C. Tax-effected cost of equity
Correct Answer is A Explanation: When there is no debt in the capital structure, WACC is equal to the cost of equity.
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Q7- An increase in inventory is
A. A use of cash
B. A source of cash
C. No change in cash
Correct Answer is A Explanation: When a current asset (e.g. accounts receivable, inventory) increases, it is considered a use of cash. When a current asset decreases, it is considered a source of cash.
Q8- What does inventory turns measure?
A. Number of times a company turns over its inventory per month
B. Number of times a company turns over its inventory per quarter
C. Number of times a company turns over its inventory per year
Correct Answer is C Explanation: Inventory turns measures the number of times a company turns over its inventory in a given year.
Q9- What does days payable outstanding measure?
A. Number of days it takes a company to make payment on outstanding purchases of goods and services
B. Number of days it takes a company to collect payment after sale of a product or service
C. Number of days it takes a company to make payment on outstanding fixed expenses
Correct Answer is A Explanation: DPO is a measure that evaluates how long it takes a company to pay for its outstanding purchases of goods and services. The higher a company's DPO, the more time it has to put its cash on hand to good use before paying outstanding bills.
Q10- What method is used to calculate cost of equity?
Correct Answer is B Explanation: Cost of equity is the required annual rate of return that a company equity investors expect to receive (including dividends). To calculate the expected return on a company equity, employ the capital asset pricing model.
Q11- Which of the following sectors should have the lowest beta?
Correct Answer is B Explanation: Companies in the Technology and chemicals sector are more volatile and riskier than companies in the utility sector. Therefore, a utility company should have a lower beta.
Q12- Which methodology is used to capture a company's value beyond its forecast period?
A. Long-term value
B. Terminal value
D. Projected value
Correct Answer is B Explanation: The DCF (Discounted Cash Flow) approach to valuation is based on determining the present value of all future FCF produced by a company. As it is infeasible to project a company's FCF indefinitely, a terminal value is used to determine the value of the company beyond the projection period.
Q13- How does using a mid-year convention affect valuation in a DCF?
A. Higher value than year-end discounting
B. Lower value than year-end discounting
C. Same value as year-end discounting
Correct Answer is A Explanation: The use of a mid-year convention results in a slightly higher valuation than year-end discounting due to the fact that FCF (Free Cash Flow) is received sooner.
Q14- Why might perpetuity growth method be used instead of exit multiple method?
A. Absence of relevant comparable to determine an exit multiple
B. Difficult to determine a long-term growth rate
C. Current economic environment is volatile
Correct Answer is A Explanation: PGM can be used to compute a terminal value if there are no relevant comparable companies to use for determining an exit multiple.
Q15- Which one of the following is considered a weakness of the DCF?
A. Market independent
B. Terminal value represents a large portion of the total value
C. Can handle multiple financial performance scenarios
Correct Answer is B Explanation: The use of a terminal value is considered as a possible weakness. It is quite sensitive to the user's inputs and can account for up to 75% of the DCF valuation.