CFM Corporate Finance & Valuation Flashcards

The Weighted Average Cost of Capital (WACC) is used as the discount rate when:

Answer: Discounting a firm's expected free cash flows to determine enterprise value

WACC represents the blended cost of all capital sources and is used as the discount rate in discounted cash flow (DCF) analysis to determine enterprise value.

Which capital budgeting method calculates the discount rate at which NPV equals zero?

Answer: Internal Rate of Return (IRR)

IRR is the discount rate that makes the NPV of a project's cash flows equal to zero; if IRR exceeds the cost of capital, the project adds value.

What does the Modigliani-Miller theorem suggest about capital structure in a world without taxes?

Answer: Capital structure is irrelevant and does not affect firm value

M&M Proposition I states that in perfect markets without taxes, firm value is unaffected by capital structure because investors can replicate any leverage ratio themselves.

Enterprise Value (EV) is calculated as:

Answer: Market capitalization + Debt - Cash

EV = Market Cap + Total Debt - Cash and equivalents, representing the total cost to acquire a business including assumption of debt net of available cash.

What is the primary advantage of using the Payback Period method for capital budgeting?

Answer: It is simple, easy to calculate, and emphasizes liquidity and speed of recovery

The payback period is straightforward to calculate and highlights how quickly an investment recovers its cost, making it useful for liquidity-constrained firms.

Which valuation multiple compares enterprise value to a company's operating earnings before non-cash charges?

Answer: EV/EBITDA

EV/EBITDA compares total enterprise value to EBITDA, making it useful for comparing companies with different capital structures and depreciation policies.