FA Financial Modeling and Valuation 1 — Questions and Answers
Question 1: What is a three-statement financial model?
- A model containing only income statement projections
- An integrated model linking the income statement, balance sheet, and cash flow statement (Correct answer)
- A model used only for merger and acquisition analysis
- A model that includes three years of historical data only
Correct answer: An integrated model linking the income statement, balance sheet, and cash flow statement
A three-statement model integrates all three core financial statements so that changes in one automatically flow through and affect the others, providing a complete financial picture.
Question 2: In financial modeling, what is a 'plug' or 'balancing item'?
- An error in the model that must be fixed
- A line item used to make the balance sheet balance after projections are built (Correct answer)
- A hard-coded number that should never change
- A macro that automates model updates
Correct answer: A line item used to make the balance sheet balance after projections are built
A plug is typically the revolver or cash balance used to ensure the balance sheet balances, adjusting automatically as other projections change.
Question 3: Which valuation multiple is most commonly used for capital-intensive industries where depreciation varies significantly?
- P/E (Price-to-Earnings)
- EV/EBITDA (Correct answer)
- P/B (Price-to-Book)
- P/S (Price-to-Sales)
Correct answer: EV/EBITDA
EV/EBITDA is preferred in capital-intensive industries because it excludes depreciation and amortization, making comparisons across companies with different asset structures more meaningful.
Question 4: In a DCF model, what happens to the present value of cash flows when the discount rate increases?
- Present values increase
- Present values decrease (Correct answer)
- Present values remain unchanged
- Present values become negative
Correct answer: Present values decrease
A higher discount rate reduces the present value of future cash flows because future dollars are penalized more heavily for the time value of money and risk.
Question 5: What is enterprise value (EV)?
- The market capitalization of a company's equity
- The total value of a company including both equity and debt, minus cash (Correct answer)
- The book value of total assets on the balance sheet
- The net present value of all future dividends
Correct answer: The total value of a company including both equity and debt, minus cash
Enterprise value represents the total value of a business (equity + net debt) and is considered a more complete measure of company value than market cap alone.
Question 6: What is the primary use of a sensitivity table (data table) in financial modeling?
- To display historical financial data from accounting systems
- To show how outputs change across a range of two key input assumptions simultaneously (Correct answer)
- To calculate monthly depreciation schedules
- To reconcile the balance sheet to audited financial statements
Correct answer: To show how outputs change across a range of two key input assumptions simultaneously
A two-variable data table shows how a key output (like NPV or EPS) changes across a matrix of two different assumptions, helping analysts understand value drivers.
FA Financial Modeling and Valuation 1
What is a three-statement financial model?