Asset Valuation Flashcards

The free cash flow to equity (FCFE) can be derived from FCFF by:

Answer: Adding net borrowing and subtracting after-tax interest expense

FCFE = FCFF − interest(1−t) + net borrowing, reflecting cash available only to equity holders after debt service.

When using a price-to-sales (P/S) multiple, the primary advantage over P/E is that:

Answer: Sales is always positive, even when earnings are negative

Revenue is rarely negative, making P/S applicable to early-stage or unprofitable companies where P/E is meaningless.

Which of the following describes the 'hockey stick' problem in DCF valuation?

Answer: Projecting unrealistically high growth rates in early years that never materialize

The hockey stick refers to projecting modest near-term growth followed by an implausibly sharp acceleration, biasing value upward.

In venture capital valuation, the post-money valuation is calculated as:

Answer: Pre-money valuation plus the new investment amount

Post-money valuation = pre-money valuation + amount of new investment injected in the round.

A convertible bond's value is best approximated as:

Answer: The value of a straight bond plus the value of an embedded call option on the stock

A convertible bond combines a straight (option-free) bond floor with a call option on the issuer's equity.

Which discount rate is most appropriate when valuing a private company's equity cash flows using the FCFE approach?

Answer: The cost of equity estimated using CAPM or a build-up method

FCFE belongs only to equity holders, so the cost of equity (not WACC) is the correct discount rate.

Under the CFA Institute Standards, when an analyst uses a model to value a security, they must disclose:

Answer: The key assumptions and limitations of the model used

Standard V(B) requires analysts to communicate significant assumptions, risk factors, and limitations underlying their valuation.