CPFM Corporate Valuation Methods 2

Question 1

In a discounted cash flow (DCF) analysis, what does the terminal value typically represent?

Accepted Answer

The value of cash flows beyond the explicit forecast period

Answer

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?

Accepted Answer

FCF × (1 + g) / (WACC − g)

Answer

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)?

Accepted Answer

Weighted average cost of capital (WACC)

Answer

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?

Accepted Answer

It increases

Answer

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?

Accepted Answer

Terminal value approaches infinity, producing unrealistic results

Answer

As the growth rate nears the discount rate, the denominator shrinks toward zero and value explodes unrealistically.

CPFM Practice Test