CPFM Corporate Valuation Methods 2 — Questions and Answers
Question 1: In a discounted cash flow (DCF) analysis, what does the terminal value typically represent?
- The value of cash flows beyond the explicit forecast period (Correct answer)
- The book value of assets at liquidation
- The initial investment outlay
- The sum of all dividends paid to date
Correct answer: The value of cash flows beyond the explicit forecast period
Terminal value captures the present value of all cash flows occurring after the explicit forecast horizon.
Question 2: The Gordon Growth Model calculates terminal value using which formula?
- FCF × (1 + g) / (WACC − g) (Correct answer)
- FCF / WACC
- FCF × WACC
- FCF / (g − WACC)
Correct answer: FCF × (1 + g) / (WACC − g)
The Gordon Growth Model divides the next-period cash flow by the difference between WACC and the perpetual growth rate.
Question 3: Which discount rate is most appropriate for discounting free cash flow to the firm (FCFF)?
- Weighted average cost of capital (WACC) (Correct answer)
- Cost of equity only
- Risk-free rate
- After-tax cost of debt only
Correct answer: Weighted average cost of capital (WACC)
FCFF represents cash available to all capital providers, so it is discounted at the WACC.
Question 4: An analyst increases the perpetual growth rate assumption in a DCF. All else equal, what happens to the enterprise value?
- It increases (Correct answer)
- It decreases
- It stays the same
- It becomes negative
Correct answer: It increases
A higher perpetual growth rate raises terminal value, increasing total enterprise value.
Question 5: What is the primary limitation of using the Gordon Growth Model when g approaches WACC?
- Terminal value approaches infinity, producing unrealistic results (Correct answer)
- The model becomes overly conservative
- It ignores all future cash flows
- It overstates the cost of debt
Correct answer: Terminal value approaches infinity, producing unrealistic results
As the growth rate nears the discount rate, the denominator shrinks toward zero and value explodes unrealistically.
Question 6: When converting enterprise value to equity value, which adjustment is correct?
- Subtract net debt (Correct answer)
- Add net debt
- Subtract total revenue
- Add total equity
Correct answer: Subtract net debt
Equity value equals enterprise value minus net debt (debt less cash).
Question 7: In a two-stage DCF model, what distinguishes the two stages?
- A high-growth explicit period followed by a stable perpetual-growth period (Correct answer)
- A pre-tax stage and a post-tax stage
- An equity stage and a debt stage
- A historical stage and a current stage
Correct answer: A high-growth explicit period followed by a stable perpetual-growth period
Two-stage models forecast a high-growth phase explicitly, then apply stable growth in perpetuity.
CPFM Corporate Valuation Methods 2
In a discounted cash flow (DCF) analysis, what does the terminal value typically represent?