Exam 12: Valuation: Cash-Flow-Based Approaches

The quarterly cash flows from operations for two computer companies are as follows: Required: 1)Explain why Firm B has more credit risk than Firm A. 2)Suppose that Firm B's cash flow was $200 million higher each quarter.Explain why Firm B might still be viewed as having higher credit risk than Firm A.

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Question 1

Correct Answer:

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1.The quarterly operating cash flows of both firms exhibit seasonal volatility,meaning that operating cash flow levels change from quarter to quarter.Seasonal patterns in sales and operating cash flow are common in many industries,and the cash flow volatility produced by seasonal sales is itself a contributor to increased credit risk.In addition,Firm B's operating cash flows are lower than those of Firm A and are negative in the two most recent quarters.These two features of Firm B's operating cash flow make it a greater credit risk than Firm A. 2.Here are the revised operating cash flow amounts for each firm:

Firm B now exhibits higher operating cash flows than Firm A in two of the five quarters,but the sharp decline in the two most recent quarters is still a cause for concern.The level of operating cash flows in these two most recent quarters,especially when compared to those of Firm A,make Firm B a greater credit risk.

The present value of future free cash flows valuation method focuses on free cash flows,a base that economists argue has more economic meaning than ____________________.

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Question 2

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earnings

Below is information from the statement of cash flow and income statement for Garland Products,Inc.for 2012 and 2011.Marketable securities represent investments of excess cash that Garland Products does not need for operations.Garland Products' tax rate is 35%. Using the above information calculate the amount of free cash flows for common equity shareholders for Garland Products for year 2012 and 2011.

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Question 3

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The analyst can use expectations of the dividends to be paid to the investor or the free cash flows to be generated by the firm (that will ultimately be paid to the investor)as equivalent approaches to measure the ____________ expected payoffs to shareholders.

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Question 4

Steady-state growth in ___________________________________ could be driven by long-run expectations for growth attributable to economy-wide inflation,general economic productivity,the population,or long-run growth in industry's sales.

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Question 5

If the objective is to value operating assets net of operating liabilities of a firm then the appropriate free cash flow measure to be used is ______________________________________________________________________.

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Question 6

________________ is an estimate of systematic risk based on the degree of covariation between a firm's stock returns and an index of stock returns for all firms in the market.

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Question 7

An equity security with systematic risk equal to the average amount of systematic risk of all equity securities in the market

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Question 8

Simpson Department Store Simpson Department Stores operates retail department store chains throughout the United States. At the end of Year 10, Simpson reports debt of $5,897 million and common shareholders' equity at book value of $4,400 million. The market value of its common stock is $6,895, and its market equity beta is ..79. An equity buyout group is considering an LBO of Simpson as of the beginning of Year 11.The group intends to finance the buyout with 25 percent common equity and 75 percent debt carrying an interest rate of 10.65 percent. -Regarding the equity buyout,compute the cost of equity capital with the new capital structure that results from the LBO.Assume a risk-free rate of 3.75percent and a market risk premium of 5.0 percent.

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Question 9

Amherst,Inc.had the following balance sheet at December 31,2012: During 2013 the following occurred. 1.Amherst liquidated its available for sale investment portfolio at a loss of $5,000. 2.A tract of land was purchased for $38,000. 3.An additional $30,000 in common stock was issued at par. 4.Dividends totaling $10,000 were declared and paid to stockholders. 5.Net income for 2013 was $35,000,including $12,000 in depreciation expense. 6.Land was purchased through the issuance of $30,000 of additional bonds. 7.At December 31,2013,Cash was $70,200,Accounts Receivable was $42,000 and Accounts Payable was $40,000. Required: (a)What were Amherst's cash flows from operating activities for the year ended December 31,2013? (b) Compute Amherst's free cash flow and current cash debt coverage for 2013. (c) How does information in the balance sheet and statement of cash flows help the user or analyst of the financial statements?

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Question 10

Financial liabilities include all of the following except

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Question 11

A disadvantage of the free cash flow valuation method is

(Multiple Choice)

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Question 12

If a firm's stock returns covary identically with returns to a marketwide portfolio,then its market beta from such a regression is:

(Multiple Choice)

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Question 13

Explain "free" cash flows.Describe which types of cash flows are free and which are not.How do free cash flows available for debt and equity stakeholders differ from free cash flows available for common equity shareholders?

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Question 14

The forecasting and valuation process is particularly difficult for ______________________________ when the near term free cash flows tend to be negative.

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Question 15

If a firm generates a rate of return on __________________________________________________ equal to the discount rate used by the investor then it does not matter if an analyst uses cash flows to the investor or cash flows to the firm.

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Question 16

________________________________________ typically include accounts payable,accrued expenses,accrued taxes,deferred taxes,pension obligations and other retirement benefit obligations.

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Question 17

Plough Corporation reports the following information: Plough's free cash flow is

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Question 18

Shady Sunglasses operates retail sunglass kiosks in shopping malls.Below is information related to the company: Using the above information and assuming that steady-state growth in year 2017 and beyond will be 4% calculate Shady Sunglasses' current value per share.

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Question 19

If an analyst wants to value a potential investment in the net operating assets of a division of another firm,the analyst should discount the projected free cash flows at the

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Question 20

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The present value of future free cash flows valuation method focuses on free cash flows,a base that economists argue has more economic meaning than ____________________.

The analyst can use expectations of the dividends to be paid to the investor or the free cash flows to be generated by the firm (that will ultimately be paid to the investor)as equivalent approaches to measure the ____________ expected payoffs to shareholders.

Steady-state growth in ___________________________________ could be driven by long-run expectations for growth attributable to economy-wide inflation,general economic productivity,the population,or long-run growth in industry's sales.

If the objective is to value operating assets net of operating liabilities of a firm then the appropriate free cash flow measure to be used is ______________________________________________________________________.

________________ is an estimate of systematic risk based on the degree of covariation between a firm's stock returns and an index of stock returns for all firms in the market.

An equity security with systematic risk equal to the average amount of systematic risk of all equity securities in the market

Financial liabilities include all of the following except

A disadvantage of the free cash flow valuation method is

If a firm's stock returns covary identically with returns to a marketwide portfolio,then its market beta from such a regression is:

Explain "free" cash flows.Describe which types of cash flows are free and which are not.How do free cash flows available for debt and equity stakeholders differ from free cash flows available for common equity shareholders?

The forecasting and valuation process is particularly difficult for ______________________________ when the near term free cash flows tend to be negative.

If a firm generates a rate of return on __________________________________________________ equal to the discount rate used by the investor then it does not matter if an analyst uses cash flows to the investor or cash flows to the firm.

________________________________________ typically include accounts payable,accrued expenses,accrued taxes,deferred taxes,pension obligations and other retirement benefit obligations.

Plough Corporation reports the following information: Plough's free cash flow is

Shady Sunglasses operates retail sunglass kiosks in shopping malls.Below is information related to the company: Using the above information and assuming that steady-state growth in year 2017 and beyond will be 4% calculate Shady Sunglasses' current value per share.

If an analyst wants to value a potential investment in the net operating assets of a division of another firm,the analyst should discount the projected free cash flows at the

Overview of Financial Reporting, financial Statement Analysis, and Valuation

Asset and Liability Valuation and Income Measurement

Income Flows Versus Cash Flows: Understanding the Statement of Cash Flows

Profitability Analysis

Risk Analysis

Accounting Quality

Financing Activities

Investing Activities

Operating Activities

Forecasting Financial Statements

Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach

Valuation: Earnings-Based Approaches

Valuation: Market-Based Approaches

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