CFC Financial Analysis and Valuation 1 — Questions and Answers
Question 1: Which financial ratio measures a company's ability to meet short-term obligations using only its most liquid assets?
- Current ratio
- Quick (acid-test) ratio (Correct answer)
- Debt-to-equity ratio
- Interest coverage ratio
Correct answer: Quick (acid-test) ratio
The quick ratio excludes inventory and prepaid expenses from current assets, testing whether the most liquid assets cover current liabilities.
Question 2: Free cash flow to equity (FCFE) represents:
- Operating cash flow before interest and taxes
- Cash available to equity shareholders after capital expenditures and debt repayments (Correct answer)
- Net income plus depreciation
- Total revenue minus operating expenses
Correct answer: Cash available to equity shareholders after capital expenditures and debt repayments
FCFE is calculated as net income plus non-cash charges minus capital expenditures minus changes in working capital plus net borrowing.
Question 3: When a CFC uses discounted cash flow (DCF) analysis, the terminal value accounts for:
- The first five years of projected cash flows
- All cash flows beyond the explicit forecast period in perpetuity (Correct answer)
- The company's liquidation value
- Current balance sheet assets only
Correct answer: All cash flows beyond the explicit forecast period in perpetuity
Terminal value captures the present value of all cash flows beyond the explicit projection period, often representing the majority of a DCF valuation.
Question 4: The debt-to-equity ratio of 2.5 indicates that for every dollar of equity, the company carries:
- $0.40 of debt
- $2.50 of debt (Correct answer)
- $1.25 of debt
- $25.00 of debt
Correct answer: $2.50 of debt
A debt-to-equity ratio of 2.5 means the company has $2.50 in debt for every $1.00 of equity, indicating significant financial leverage.
Question 5: EBITDA is commonly used as a proxy for operating cash flow. What does it add back to net income?
- Taxes and dividends only
- Interest, taxes, depreciation, and amortization (Correct answer)
- Capital expenditures and working capital changes
- Revenue less cost of goods sold
Correct answer: Interest, taxes, depreciation, and amortization
EBITDA starts with net income and adds back interest expense, income taxes, depreciation, and amortization to estimate core operating cash generation.
Question 6: In a comparable company analysis, an analyst selects peer companies and calculates valuation multiples primarily to:
- Estimate the company's liquidation value
- Derive a market-implied value based on how similar businesses are priced (Correct answer)
- Calculate the exact intrinsic value using future cash flows
- Determine the company's book value per share
Correct answer: Derive a market-implied value based on how similar businesses are priced
Comparable company analysis uses trading multiples (like EV/EBITDA or P/E) from similar public companies to establish a market-based value range for the subject company.
CFC Financial Analysis and Valuation 1
Which financial ratio measures a company's ability to meet short-term obligations using only its most liquid assets?