CBB Business Valuation & Financial Analysis 2 — Questions and Answers
Question 1: Which financial metric represents earnings before interest, taxes, depreciation, and amortization?
- Net Income
- EBITDA (Correct answer)
- Gross Profit
- Operating Cash Flow
Correct answer: EBITDA
EBITDA strips out financing, tax, and non-cash charges to measure core operating profitability.
Question 2: A business broker applying the excess earnings method would first need to identify:
- The company's total debt
- A reasonable owner's compensation (Correct answer)
- The weighted average cost of capital
- The price-to-earnings ratio of comparable public companies
Correct answer: A reasonable owner's compensation
Excess earnings are calculated after deducting a reasonable owner's compensation from adjusted net income.
Question 3: When recasting financial statements, a broker adds back a $24,000 personal auto expense charged to the business. This adjustment is known as:
- Depreciation add-back
- Discretionary expense normalization (Correct answer)
- Capital expenditure adjustment
- Working capital normalization
Correct answer: Discretionary expense normalization
Personal expenses run through the business are discretionary items that must be added back to reflect true earning power.
Question 4: The Gordon Growth Model is primarily used to value a business by:
- Dividing net assets by a cap rate
- Capitalizing a stabilized cash flow stream with a growth assumption (Correct answer)
- Multiplying EBITDA by an industry multiple
- Summing the present value of projected free cash flows
Correct answer: Capitalizing a stabilized cash flow stream with a growth assumption
The Gordon Growth Model divides normalized cash flow by the capitalization rate minus the expected long-term growth rate.
Question 5: A business with $500,000 SDE and a 3.5x multiple has an indicated value of:
- $143,000
- $500,000
- $1,750,000 (Correct answer)
- $3,500,000
Correct answer: $1,750,000
$500,000 × 3.5 = $1,750,000 indicated value under the income approach using an SDE multiple.
Question 6: Which of the following would DECREASE the capitalization rate applied in a business valuation?
- High customer concentration risk
- Long-term contracts with blue-chip clients (Correct answer)
- Declining industry trends
- Dependence on a single key employee
Correct answer: Long-term contracts with blue-chip clients
Long-term contracts with creditworthy clients reduce business risk, which lowers the required cap rate and increases value.
Question 7: A buyer is evaluating a manufacturing company and notices the owner pays himself $250,000 but industry-standard compensation for the same role is $120,000. How should the broker handle this in recasting?
- Use the owner's actual compensation as stated
- Add back $250,000 and note it as SDE
- Add back $130,000 excess compensation to SDE (Correct answer)
- Reduce the purchase price by $130,000
Correct answer: Add back $130,000 excess compensation to SDE
Only the excess above a market-rate compensation ($250K - $120K = $130K) is added back to normalize earnings.
CBB Business Valuation & Financial Analysis 2
Which financial metric represents earnings before interest, taxes, depreciation, and amortization?