CFM Corporate Finance & Valuation 1 — Questions and Answers
Question 1: What is the weighted average cost of capital (WACC)?
- The after-tax cost of debt only
- A blended cost of all capital sources weighted by their proportion in the capital structure (Correct answer)
- The return required by common equity shareholders
- The prime lending rate plus a spread
Correct answer: A blended cost of all capital sources weighted by their proportion in the capital structure
WACC blends the cost of equity and after-tax cost of debt weighted by their respective proportions, representing the minimum return a company must earn on its assets.
Question 2: Which valuation method discounts projected future cash flows back to present value?
- Comparable company analysis
- Discounted cash flow (DCF) analysis (Correct answer)
- Asset-based valuation
- Price/earnings multiples approach
Correct answer: Discounted cash flow (DCF) analysis
DCF analysis estimates a company's intrinsic value by discounting its projected free cash flows back to the present using an appropriate discount rate.
Question 3: What does the terminal value in a DCF model represent?
- The salvage value of physical assets at the end of the forecast period
- The present value of all cash flows beyond the explicit forecast period (Correct answer)
- The final year's net income multiplied by a P/E ratio
- The cost to wind down the business
Correct answer: The present value of all cash flows beyond the explicit forecast period
Terminal value captures the present value of all cash flows expected after the discrete forecast period, typically using a perpetuity growth model or exit multiple.
Question 4: In the capital asset pricing model (CAPM), beta measures:
- A company's total risk relative to the market
- A stock's systematic (market) risk relative to the overall market (Correct answer)
- The risk-free rate of return
- The equity risk premium
Correct answer: A stock's systematic (market) risk relative to the overall market
Beta measures a stock's sensitivity to market movements; a beta of 1.2 means the stock tends to move 20% more than the market in either direction.
Question 5: What is the enterprise value (EV) of a company?
- Total equity market capitalization
- Market cap plus total debt minus cash and equivalents (Correct answer)
- Total assets minus total liabilities
- Net income multiplied by the P/E ratio
Correct answer: Market cap plus total debt minus cash and equivalents
Enterprise value represents the total value of the firm available to all capital providers: equity market cap plus debt minus cash.
Question 6: What does the EV/EBITDA multiple measure in relative valuation?
- How much equity investors pay per dollar of earnings
- How much total enterprise value investors pay per dollar of operating earnings before non-cash charges (Correct answer)
- The ratio of debt to operating income
- The dividend yield relative to enterprise value
Correct answer: How much total enterprise value investors pay per dollar of operating earnings before non-cash charges
EV/EBITDA compares enterprise value to earnings before interest, taxes, depreciation, and amortization, allowing comparisons across capital structures and tax regimes.
CFM Corporate Finance & Valuation 1
What is the weighted average cost of capital (WACC)?