1.

Question 1

/ 10

Abnormal earnings are net profit adjusted for a capital charge, which is computed as the
discount rate multiplied by the beginning book value of equity.

1. T

True

2. F

False

2. Question 2

/ 10

One common approach to estimating the cost of debt is to use the capital asset pricing model
(CAPM).

1. T

True

2. F

False

3. Question 3

/ 10

Present value of abnormal earnings (growth) or free cash flows occurring beyond the last year
of the forecasting period (labeled terminal year) is called terminal value.

1. T

True

2. F
 False

4. Question 4

/ 10

In order to overcome the issue of finding comparable firms, industry averages may be used
instead.

1. T

True

2. F

False

5. Question 5

/ 10

Valuations based on price multiples are widely used by analysts. The primary reason for the
popularity of this method is its complexity.

1. T

True

2. F

False

6. Question 6

/ 10

Price multiples have traditionally been popular, primarily because they do not require analysts
to make multiyear forecasts of performance.

1. T

True
 2. F

False

7. Question 7

/ 10

Negative book equity and negative earnings make it easier to use the accounting-based
approach to value a firm’s equity.

1. T

True

2. F

False

8. Question 8

/ 10

For shareholders, a firm’s equity value is the present value of future dividends.

1. T

True

2. F

False

9. Question 9

/ 10

The discounted dividend method attempts to forecast dividends directly.

1. T

True
 2. F

False

10. Question 10

/ 10

The cost of debt is the interest rate on the debt.

1. T

True

2. F

False

11. Question 11

/ 10

Step 1 for valuation using price multiples requires the calculation of price multiples for
comparable firms.

1. T

True

2. F

False

12. Question 12

/ 10

Valuation is the process by which forecasts of performance are converted into estimates of
price.

1. T

True
 2. F

False

13. Question 13

/ 10

Strategy analysis provides a critical understanding of a company’s value proposition, and

whether current performance is likely to be sustainable in future.

1. T

True

2. F

False

14. Question 14

/ 10

If all equity effects (other than capital transactions) flow through the income statement, the
expected book value of equity for existing shareholders at the end of year 1 is simply the book
value at the beginning of the year plus expected net profit less expected dividends.

1. T

True

2. F

False

15. Question 15

/ 10

Investment outlays are expenditures for non-current operating and investment assets less asset
sales.

1. T
 True

2. F

False

16. Question 16

/ 10

Firms with large free cash flows also pose a valuation challenge.

1. T

True

2. F

False

17. Question 17

/ 10

The abnormal earnings approach expresses the value of a firm’s equity as book value plus
discounted expectations of future abnormal earnings.

1. T

True

2. F

False

18. Question 18

/ 10

Valuation formula views a firm as having a definite life.

1. T
 True

2. F

False

19. Question 19

/ 10

Finance theory holds that the value of any financial claim is simply the future value of the cash
payoffs that its claimholders receive.

1. T

True

2. F

False

20. Question 20

/ 10

Accounting analysis and ratio analysis provide a deep understanding of a company’s current
performance, and whether the ratios themselves are reliable indicators of performance.

1. T

True

2. F

False

21. Question 21

/ 10

Double-entry bookkeeping is by nature self-correcting.

1. T
 True

2. F

False

22. Question 22

/ 10

A firm’s dividend policy can affect its value if managers do not invest free cash flows optimally

1. T

True

2. F

False

23. Question 23

/ 10

When a company uses ‘‘biased’’ accounting – either conservative or aggressive – the analyst
needs to recognize the bias to ensure that value estimates are not biased.

1. T

True

2. F

False

24. Question 24

/ 10

Rate of return that equity and debt investors demand on their investment and discount rate in
the (business) asset valuation model.

1. T
 True

2. F

False

25. Question 25

/ 10

A potential problem of choosing comparable firms from different countries is that a variety of
factors that influence multiples may differ across countries.

1. T

True

2. F

False

26. Question 26

/ 10

The cash flows that are available to equity holders are the cash flows generated by the firm’s
business assets minus investment outlays, adjusted for cash flows from and to debt holders,
such as interest payments, debt repayments, and debts issues.

1. T

True

2. F

False

27. Question 27

/ 10

The discounted cash flow method represents a firm’s equity value by expected future free cash
flows discounted at the cost of debt.
 1. T

True

2. F

False

28. Question 28

/ 10

Terminal value estimates for the abnormal earnings, abnormal earnings growth, and ROE
methods tend to represent a much smaller fraction of total value than under the discounted cash
flow or dividend methods.

1. T

True

2. F

False

29. Question 29

/ 10

Cost of equity is rate of return that equity investors demand on their investment and discount
rate in the debt valuation model.

1. T

True

2. F

False

30. Question 30

/ 10
 Accounting choices that affect a firm’s current earnings also affect its book value, and therefore
they affect the capital charges used to estimate future abnormal earnings.

1. T

True

2. F

False

31. Question 31

/ 10

It is important to recognize that both the accounting-based valuations and the discounted cash
flow valuation assume a dividend payout that can potentially vary from period to period.

1. T

True

2. F

False

32. Question 32

/ 10

One of the questions that needs to be answered in discounted abnormal earnings method is the
cost of equity to be used.

1. T

True

2. F

False

33. Question 33
 / 10

If interest rates are projected to rise by 3 percent as a result of expected inflation, the cost of
debt for the firm we are analyzing should increase by 6 percent.

1. T

True

2. F

False

34. Question 34

/ 10

A five- to ten-year forecast horizon should be more than sufficient for most firms.

1. T

True

2. F

False

35. Question 35

/ 10

A firm’s accounting choices can influence analysts’ perceptions of the real performance of the
firm and hence the forecasts of future performance.

1. T

True

2. F

False

36. Question 36
 / 10

A key question in the terminal value is whether it is reasonable to assume a continuation of the
terminal year performance or whether some other pattern is expected.

1. T

True

2. F

False

37. Question 37

/ 10

Accounting choices must affect both earnings and book value, and because of the self-correcting
nature of double-entry bookkeeping, estimated values will not be affected by accounting choices,
as long as the analyst recognizes the accounting distortions.

1. T

True

2. F

False

38. Question 38

/ 10

A variety of valuation techniques are employed in practice, and there is no single method that
clearly dominates others.

1. T

True

2. F

False
39. Question 39

/ 10

The weights assigned to debt and equity in the above equations represent their respective
fractions of total capital provided, measured in terms of economic values.

1. T

True

2. F

False

40. Question 40

/ 10

Abnormal ROE represents difference between ROE and the cost of equity.

1. T

True

2. F

False