FA FA Financial Modeling & Valuation 2 — Questions and Answers
Question 1: Which approach to calculating the Weighted Average Cost of Capital (WACC) reflects the market-value weights of debt and equity?
- Using current market capitalization and market value of debt (Correct answer)
- Using book values from the balance sheet
- Using historical average share prices
- Using par value of bonds and common stock
Correct answer: Using current market capitalization and market value of debt
WACC should use market-value weights because they represent the current opportunity cost investors face, not historical accounting values.
Question 2: In LBO modeling, what is the primary driver of equity returns for a private equity sponsor?
- Financial leverage, operational improvements, and multiple expansion (Correct answer)
- Dividend reinvestment and share buybacks only
- Tax refunds and government subsidies
- Reduction in working capital alone
Correct answer: Financial leverage, operational improvements, and multiple expansion
LBO returns are driven by the combination of leverage (amplifying gains), EBITDA growth, and selling at a higher multiple than the purchase price.
Question 3: What does a 'hockey stick' projection in a financial model typically indicate?
- Unrealistically optimistic growth assumptions skewed heavily toward future periods (Correct answer)
- A steady, conservative linear growth rate
- Declining revenue in early years followed by stability
- A model error in the depreciation schedule
Correct answer: Unrealistically optimistic growth assumptions skewed heavily toward future periods
Hockey stick projections show flat or slow near-term performance followed by a sharp upward inflection, often signaling overly optimistic management assumptions.
Question 4: Which schedule in a financial model tracks the beginning balance, additions, depreciation, and ending balance of fixed assets?
- PP&E (Property, Plant & Equipment) roll-forward schedule (Correct answer)
- Accounts receivable aging schedule
- Working capital bridge
- Debt maturity schedule
Correct answer: PP&E (Property, Plant & Equipment) roll-forward schedule
The PP&E roll-forward schedule links capital expenditures and depreciation to the balance sheet and income statement in a three-statement model.
Question 5: What financial ratio measures how efficiently a company converts sales into profit after all expenses?
- Net profit margin (Correct answer)
- Current ratio
- Debt-to-equity ratio
- Asset turnover ratio
Correct answer: Net profit margin
Net profit margin (net income ÷ revenue) shows the percentage of each dollar of revenue that ultimately becomes profit.
Question 6: When building a merger model (M&A), what does 'accretion' mean in the context of EPS?
- The deal increases the acquirer's earnings per share (Correct answer)
- The deal decreases the acquirer's earnings per share
- The acquirer's book value increases
- The target's revenue grows post-merger
Correct answer: The deal increases the acquirer's earnings per share
An accretive deal raises the combined entity's EPS above the acquirer's standalone EPS, often due to synergies or a lower-cost funding mix.
FA FA Financial Modeling & Valuation 2
Which approach to calculating the Weighted Average Cost of Capital (WACC) reflects the market-value weights of debt and equity?