invic

Which of the following definitions of value refers to the value that should be the value in the market if the asset is correctly priced?

A) Intrinsic value.

B) Market value.

C) Investment value.

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Intrinsic value is derived from investment analysis and is the value that should be the market value once other investors arrive at this “true” value. Intrinsic value is independent of short-term mispricing that may occur. Market value is used in real estate and other real asset appraisals. Investment value is the value to a particular buyer.

invic

Which of the following definitions of value is the value to a particular buyer?

A) Investment value.

B) Market value.

C) Fair market value.

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Investment value is the value to a particular buyer and may be different for each investor due to different estimates of future cash flows, perceived firm risk, discount rates, financing costs, and synergies with existing assets the buyer holds.

invic

An analyst uses investment analysis in an attempt to determine the “true” value of a security, independent of any short-term mispricing. This estimate of asset value is best defined as:

A) Investment value

B) Intrinsic value

C) Fair market value

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Intrinsic value is the “true” value derived from investment analysis. Fair market value is used for tax purposes in the United States and based on an arm’s length transaction. Investment value, in contrast to the previous definitions that were market based, is the value to a particular buyer. (Study Session 12, LOS 43.c)

invic

Which of the following approaches to private company valuation uses discounted cash flow analysis?

A) The market approach.

B) The asset-based approach.

C) The income approach.

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The income approach values a firm as the present value of its future income. The asset-based approach values a firm as its assets minus liabilities. The market approach values a firm using the price-multiples from the sales of comparable assets.

invic

An analyst is valuing a firm’s equity using the price-to-book-value ratio of similar firms. Which of the following is the most likely valuation approach the analyst will use?

A) The income approach.

B) The market approach.

C) The asset-based approach.

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The market approach values a firm using the price-multiples such as the price-to-book-value ratio and price-earnings ratio of comparable assets. The income approach values a firm as the present value of its future income. The asset-based approach values a firm as its assets minus liabilities

invic

An analyst is valuing a small private firm that is still developing and has yet to generate any earnings. Which of the following best describes the approach that should be used?

A) A market approach based on public comparables would be utilized.

B) Nonoperating assets are not crucial to the firm and should be excluded in any valuation.

C) An asset-based approach would be used.

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The valuation approach used will depend on the firm’s operations and its lifecycle stage. Early in its life, a firm’s future cash flows may be so uncertain that an asset-based approach would be selected. The price multiples from large public firms should not be used for a small private firm when using the market approach. Although a firm’s nonoperating assets are not crucial to the firm, they should be included in any valuation.

invic

An analyst values a private company using a price multiple based on recent sales of comparable assets. This approach to private company valuation is best described as the:

A) income approach

B) asset-based approach

C) market approach

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Under the market approach, a firm is valued using price multiples based on recent sales of comparable assets. Under the income approach, a firm is valued according to the present value of its expected future income. Under the asset-based approach, the value of a firm is calculated as the firm’s assets minus its liabilities. (Study Session 12, LOS 43.d)

invic

Given the following figures, calculate the normalized EBITDA for a financial and strategic buyer.

Reported EBITDA	$4,500,000
Current Executive Compensation	$700,000
Market-Based Executive Compensation	$620,000
Current SG&A expenses	$6,300,000
SG&A expenses after synergistic savings	$5,600,000
Current Lease Rate	$300,000
Market-Based Lease Rate	$390,000

The normalized EBITDA for each type of buyer is:

Financial Buyer

Strategic Buyer

A) $4,190,000 $4,890,000

B) $4,670,000 $5,370,000

C) $4,490,000 $5,190,000

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Both strategic and financial buyers will attempt to reduce executive compensation to market levels by $80,000 ($700,000 − $620,000). They will also have to pay a higher lease rate of $90,000 ($390,000 − $300,000). So the adjustment for both buyers to generate normalized EBITDA is $4,500,000 + $80,000 − $90,000 = $4,490,000.
However, only a strategic buyer will be able to realize synergistic savings of $700,000 ($6,300,000 − $5,600,000). So normalized EBITDA for a strategic buyer is $5,190,000 and for a financial buyer it is $4,490,000.

invic

Given the following figures, calculate the FCFF. Assume the earnings and expenses are normalized and that capital expenditures will cover depreciation plus 3 percent of the firm’s incremental revenues.

Current Revenues	$30,000,000
Revenue growth	6%
Gross profit margin	20%
Depreciation expense as a percent of sales	1%
Working capital as a percent of sales	15%
SG&A expenses	$3,800,000
Tax rate	30%

A) $927,400.

B) $1,785,400.

C) $1,245,400.

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Pro forma Income Statement
Revenues	$31,800,000
Cost of Goods Sold	$25,440,000
Gross Profit	$6,360,000
SG&A Expenses	$3,800,000
Pro forma EBITDA	$2,560,000
Depreciation and amortization	$318,000
Pro forma EBIT	$2,242,000
Pro forma taxes on EBIT	$672,600
Operating income after tax	$1,569,400
Adjustments to obtain FCFF
Plus: Depreciation and amortization	$318,000
Minus: Capital expenditures	$372,000
Minus: Increase in working capital	$270,000
FCFF	$1,245,400

Pro forma Income Statement	Explanation
Revenues	Current revenues times the growth rate: $30,000,000 × (1.06)
Cost of Goods Sold	Revenues times one minus the gross profit margin: $31,800,000 × (1 − 0.20)
Gross Profit	Revenues times the gross profit margin: $31,800,000 × 0.20
SG&A Expenses	Given in the question
Pro forma EBITDA	Gross Profit minus SG&A expenses: $6,360,000 − $3,800,000
Depreciation and amortization	Revenues times the given depreciation expense: $31,800,000 × 0.01
Pro forma EBIT	EBITDA minus depreciation and amortization: $2,560,000 − $318,000
Pro forma taxes on EBIT	EBIT times tax rate: $2,242,000 × 0.30
Operating income after tax	EBIT minus taxes: $2,242,000 − $672,600
Adjustments to obtain FCFF
Plus: Depreciation and amort.	Add back noncash charges from above
Minus: Capital expenditures	Expenditures cover depreciation and increase with revenues: $318,000 + (0.03 × $31,800,000 − $30,000,000)
Minus: Increase in working capital	The working capital will increase as revenues increase: (0.15 × $31,800,000 − $30,000,000)
FCFF	Operating income net of the adjustments above

invic

Which of the following best describes the use of FCFF and FCFE when used in private firm valuation?

A) FCFE is usually favored if the firm is going to change its capital structure because the equityholders are usually the investors requesting the valuation.

B) FCFF is usually favored if the firm is going to change its capital structure because the WACC is less sensitive to leverage changes than the cost of equity.

C) FCFE is usually favored if the firm is going to change its capital structure because the cost of equity is less sensitive to leverage changes than the WACC.

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Free cash flow to the firm (FCFF) can be used to value the firm as a whole and free cash flow to equity (FCFE) can be used for equity. FCFF is usually favored if the firm is going to significantly change its capital structure. The reason is that the discount rate used for FCFF valuation, the weighted average cost of capital (WACC), is less sensitive to leverage changes than the discount rate used for FCFE valuation, the cost of equity. Thus, the FCFF valuation will not vary as much as the FCFE valuation.