CPA Financial Modeling & Forecasting 3 — Questions and Answers
Question 1: What is the purpose of a 'sensitivity table' (also called a data table) in Excel-based financial models?
- To summarize historical financial data in tabular form
- To show how the output metric changes across a range of two input assumptions simultaneously (Correct answer)
- To calculate the weighted average cost of capital
- To reconcile the balance sheet across multiple forecast periods
Correct answer: To show how the output metric changes across a range of two input assumptions simultaneously
A two-variable sensitivity table displays how an output (e.g., enterprise value or IRR) changes as two key inputs (e.g., revenue growth and EBITDA margin) vary.
Question 2: In a DCF model, 'terminal value' typically represents what portion of total enterprise value for a mature company?
- 10–20% of total enterprise value
- 30–50% of total enterprise value
- 60–80% of total enterprise value (Correct answer)
- More than 90% of total enterprise value
Correct answer: 60–80% of total enterprise value
For most mature companies, terminal value accounts for 60–80% of total DCF enterprise value, reflecting the long-term going-concern cash generation beyond the explicit forecast period.
Question 3: Which depreciation method results in higher depreciation expense in the early years of an asset's life, reducing taxable income more quickly?
- Straight-line depreciation
- Units-of-production depreciation
- Double-declining balance depreciation (Correct answer)
- Sum-of-the-years'-digits depreciation applied linearly
Correct answer: Double-declining balance depreciation
Double-declining balance is an accelerated method that applies twice the straight-line rate to the remaining book value, front-loading depreciation expense.
Question 4: What does 'normalization' of financial statements mean in the context of building a financial model?
- Converting all figures to a common currency
- Adjusting historical results to remove non-recurring or unusual items to reflect ongoing business performance (Correct answer)
- Standardizing the number of forecast periods to 5 years
- Applying GAAP rules uniformly across all line items
Correct answer: Adjusting historical results to remove non-recurring or unusual items to reflect ongoing business performance
Normalization removes one-time items (restructuring charges, litigation settlements, asset write-downs) so the model's baseline reflects true recurring operations.
Question 5: In a merger model, 'accretion' to EPS occurs when:
- The acquirer's post-merger EPS is lower than its pre-merger EPS
- The acquirer's post-merger EPS is higher than its pre-merger EPS (Correct answer)
- The target's P/E multiple exceeds the acquirer's P/E multiple
- Goodwill created in the transaction exceeds the purchase price premium
Correct answer: The acquirer's post-merger EPS is higher than its pre-merger EPS
An accretive deal increases the acquirer's earnings per share, often when the target is purchased at a lower P/E than the acquirer's own P/E multiple.
Question 6: When a financial model uses a 'plug' to balance the balance sheet, what is the most common plug used?
- Goodwill on the asset side
- Retained earnings on the equity side
- Revolving credit facility (revolver) on the liabilities side or excess cash on the assets side (Correct answer)
- Deferred tax liabilities on the liabilities side
Correct answer: Revolving credit facility (revolver) on the liabilities side or excess cash on the assets side
The revolver (if the company needs cash) or excess cash (if the company generates surplus) is used as the balancing plug to ensure Assets = Liabilities + Equity.
Question 7: Which forecasting method extrapolates a future value by applying an assumed constant percentage growth rate to the most recent historical period?
- Moving average method
- Regression analysis
- Compound annual growth rate (CAGR) extension (Correct answer)
- Exponential smoothing
Correct answer: Compound annual growth rate (CAGR) extension
CAGR extension applies a single assumed growth rate compounded forward from the last known data point to project future values.
CPA Financial Modeling & Forecasting 3
What is the purpose of a 'sensitivity table' (also called a data table) in Excel-based financial models?