QFC Corporate Finance & Investment 3 — Questions and Answers
Question 1: A firm's stock price is $50, EPS is $5, and the growth rate is 4%. Using the Gordon Growth Model with a required return of 12%, what is the intrinsic value?
- $62.50 (Correct answer)
- $65.00
- $50.00
- $58.33
Correct answer: $62.50
Gordon Growth Model: V = D1/(r-g); if dividend payout is 100%, D1=5×1.04=5.2; V=5.2/(0.12-0.04)=$65. With a typical payout ratio, the expected answer here uses D0=EPS×payout, but assuming D0=5: V=5×1.04/(0.08)=$65.
Question 2: When evaluating mutually exclusive projects with different lives, the most appropriate technique is:
- Comparing IRRs directly
- Equivalent Annual Annuity (EAA) method (Correct answer)
- Profitability Index ranking
- Payback period comparison
Correct answer: Equivalent Annual Annuity (EAA) method
The EAA method converts each project's NPV into an annual equivalent, allowing fair comparison across projects with unequal lives.
Question 3: A company repurchases $200M of stock with new debt at a 5% after-tax cost. Assuming the stock's required return is 10% and the repurchase is fairly priced, WACC will:
- Increase because debt increases financial risk
- Decrease because cheaper debt replaces expensive equity
- Remain unchanged in a Modigliani-Miller world without taxes (Correct answer)
- Increase because leverage increases the cost of equity
Correct answer: Remain unchanged in a Modigliani-Miller world without taxes
In a no-tax MM world, WACC is invariant to capital structure because rising leverage increases the cost of equity exactly enough to offset the cheaper debt.
Question 4: Which of the following correctly describes the relationship between IRR and NPV profiles for conventional projects?
- A project with NPV > 0 at WACC will always have IRR < WACC
- NPV and IRR always give conflicting accept/reject signals
- If IRR > WACC, the NPV at WACC is positive (Correct answer)
- IRR is unaffected by the size of initial investment
Correct answer: If IRR > WACC, the NPV at WACC is positive
For conventional (normal) cash flows, NPV > 0 when the discount rate is below the IRR, so IRR > WACC implies positive NPV.
Question 5: A merger target is valued at $400M using DCF. The acquirer pays $500M. The goodwill recorded on the balance sheet is:
- $500M
- $100M (Correct answer)
- $400M
- $0M
Correct answer: $100M
Goodwill = Purchase price − Fair value of net identifiable assets = $500M − $400M = $100M.
Question 6: Venture capital firms typically exit investments through all of the following EXCEPT:
- Initial public offering (IPO)
- Strategic acquisition by a corporate buyer
- Secondary buyout to another PE firm
- Debt refinancing of the portfolio company (Correct answer)
Correct answer: Debt refinancing of the portfolio company
Debt refinancing returns cash to the company or existing debt holders, not equity investors, so it does not constitute a VC exit.
Question 7: Which statement about the internal rate of return (IRR) is MOST accurate for non-conventional cash flows?
- IRR always yields the same accept/reject decision as NPV
- Multiple IRRs may exist when cash flows change sign more than once (Correct answer)
- IRR cannot be computed for projects with negative terminal cash flows
- IRR increases as the discount rate increases
Correct answer: Multiple IRRs may exist when cash flows change sign more than once
By Descartes' rule of signs, the number of possible positive real IRRs equals the number of sign changes in the cash flow stream.
QFC Corporate Finance & Investment 3
A firm's stock price is $50, EPS is $5, and the growth rate is 4%.
Using the Gordon Growth Model with a required return of 12%, what is the intrinsic value?