FA Financial Modeling and Valuation 2 — Questions and Answers
Question 1: Which approach is used to value a company by adding up the values of its individual business segments?
- Comparable Company Analysis
- Sum-of-the-Parts (SOTP) Valuation (Correct answer)
- Precedent Transaction Analysis
- Liquidation Value Analysis
Correct answer: Sum-of-the-Parts (SOTP) Valuation
Sum-of-the-parts valuation independently values each business unit or segment using appropriate multiples or DCF, then adds them together to derive total enterprise value.
Question 2: In a merger model, accretion occurs when:
- The combined company's EPS is lower than the acquirer's standalone EPS
- The combined company's EPS is higher than the acquirer's standalone EPS (Correct answer)
- Total revenues of the combined company decline
- Goodwill exceeds the purchase price premium
Correct answer: The combined company's EPS is higher than the acquirer's standalone EPS
An accretive acquisition increases the acquirer's earnings per share (EPS), meaning the transaction is financially beneficial to the acquirer's shareholders.
Question 3: What does a football field chart display in investment banking and valuation?
- A company's revenue growth trajectory over time
- A range of values from multiple valuation methodologies side by side (Correct answer)
- The organizational hierarchy of a finance team
- Historical stock price performance vs. peers
Correct answer: A range of values from multiple valuation methodologies side by side
A football field chart presents the value ranges from each valuation method (DCF, comps, precedents) in horizontal bars, showing the implied valuation range and overlap.
Question 4: When building a DCF model, which rate is typically used as the discount rate for an unlevered free cash flow projection?
- Cost of Equity (using CAPM)
- Weighted Average Cost of Capital (WACC) (Correct answer)
- Risk-Free Rate only
- Prime Lending Rate
Correct answer: Weighted Average Cost of Capital (WACC)
Unlevered (firm-level) free cash flows are discounted at WACC, which blends the cost of equity and after-tax cost of debt reflecting all providers of capital.
Question 5: What is the purpose of normalizing earnings in a valuation?
- To maximize reported income for investor relations
- To remove one-time, non-recurring items so recurring earnings power is reflected (Correct answer)
- To convert GAAP earnings to cash earnings only
- To comply with SEC disclosure requirements
Correct answer: To remove one-time, non-recurring items so recurring earnings power is reflected
Normalizing earnings strips out extraordinary or non-recurring items (restructuring charges, one-time gains) to present a clearer picture of sustainable earning power.
Question 6: In LBO modeling, which metric is commonly used to evaluate the return to private equity investors?
- Net Present Value (NPV)
- Internal Rate of Return (IRR) and Multiple on Invested Capital (MOIC) (Correct answer)
- Earnings Per Share (EPS)
- Return on Assets (ROA)
Correct answer: Internal Rate of Return (IRR) and Multiple on Invested Capital (MOIC)
LBO returns are measured by IRR (annualized return) and MOIC (total cash returned vs. invested), as PE investors focus on the total and time-adjusted return on equity invested.
FA Financial Modeling and Valuation 2
Which approach is used to value a company by adding up the values of its individual business segments?