Question 1

If cash flow projections include the effect of inflation then the discount rate used should be a ____________________ rate.

Accepted Answer

nominal

Question 2

The quarterly cash flows from operations for two computer companies are as follows:
 $\begin{array}{|l|l|l|l|l|l|}
\hline \text { (in Millions) } & 2012 & 2012 & 0012 & 2012 & 2013 \
\hline & \mathrm{Q} 1 & \mathrm{Q} 2 & \mathrm{Q} 3 & \mathrm{Q} 4& \mathrm{Q} 1 \
\hline \text { Firm A } & \$ 406.1 & \$ 204.2 & \$ 729.1 & \$ 440.2 & \$ 587.8 \
\hline \text { Firm B } & \$ 136.7 & \$ 243.1 & \$ 708.2 & \$ 87.9( & \$ 161.4) \
\hline
\end{array}$
 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

Accepted Answer

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:
 $\begin{array}{c}
\begin{array}{|l|}
 \hline\
\hline\
 \hline \text {Firm A}\
 \hline \text {Firm B (revised}\
 \hline \
 \hline \text {\% change in quarterly cash }\
 \text {flow}\
 \hline \text {Firm A}\
 \hline \text {Firm B}\
 \hline  
\end{array}
\begin{array}{l|}
 \hline  2012\
 \hline  \text {Q1}\
  \hline \$406.1\
 \hline \$336.7\
\hline\
 \hline \
\
 \hline \

\hline \
 \hline 
\end{array}
\begin{array}{l|}
\hline2012\
\hline\text { Q2 } \
\hline\$ 204.2 \
\hline\$ 443.1 \
\hline\
\hline\
\
\hline50 \% \
\hline132 \% \
\hline 
\end{array}
\begin{array}{l|}
\hline2012\
\hline\text { Q3 } \
\hline\$729.1\
\hline\$908.2\
\hline\
\hline\
\
\hline357\%\
\hline20.5\%\
\hline 
\end{array}
\begin{array}{l|}
\hline 2012 \
\hline\text { Q4 }\
\hline \$ 440.2 \
\hline\$ 112.1\
\hline\
\hline\
\
\hline 60 \% \
\hline12 \%\
\hline
\end{array}
\begin{array}{l|}
\hline 2013 \
\hline\text { Q1 }\
\hline \$ 587.8 \
\hline\$ 38.6\
\hline\
\hline\
\
\hline 134 \% \
\hline34 \%\
\hline
\end{array}
\end{array}$
 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.

Question 3

One disadvantage of the free cash flow valuation method is that many times the ______________________________ dominates the total value.

Accepted Answer

terminal value

Question 4

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?

Accepted Answer

The answer of Explain "free" cash flows. Describe which types...

Question 5

If an analyst wants to value a potential investment in the net operating assets of a division of another firm, the relevant cash flows the analyst should use are

Accepted Answer

A)   free cash flow from operations
B)   free cash flows for all debt and equity capital stakeholders
C)   free cash flows to common equity shareholders
D)   cash flow from operations

Question 6

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

Accepted Answer

A)   cost of debt capital
B)   cost of equity capital
C)   weighted average cost of capital
D)   risk free rate

Question 7

The cash-flow-based valuation approach measures and values the cash flows that are "free" to be ________________________________________ unencumbered by necessary reinvestments in operating assets or required payments to debt holders.

Accepted Answer

The answer of The cash-flow-based valuation approach measures and values...

Question 8

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 to all debt and equity capital stakeholders for Garland Products for year 2012 and 2011.

Accepted Answer

The answer of Below is information from the statement of...

Question 9

Suppose a firm faces the following costs of capital:
 $\begin{array}{|l|l|l|l|l|l|l|}
\hline & \text { Pstroportion in Capital Structure} & \text { Pretax Cost } & \begin{array}{l}
\text { Tax } \
\text { Taxfect }
\end{array} & \text { After-tax Cost } & \begin{array}{l}
\text { Weighted Average } \
\text { Cost of Capital }
\end{array} & \
\hline & & & & & \text { Pretax } & \text { After Tax } \
\hline \text { Debt } & 33 & 10 \% & 40 & 6 \% & 33 \% & 2.00 \% \
\hline \text { Equity } & .67 & 18 \% & - & 18 \% & 12.00 \% & 12.00 \% \
\hline1.00&&&&&15.33\%&14.00\%\
\hline
\end{array}$
 Assume that this firm expects to generate $80 million of pretax-free cash flows.
Required:
(1) What would be the after-tax free cash flows one year from today?
(2) Assuming a one-year horizon, what is the appropriate valuation to be used by the analyst?

Accepted Answer

The answer of Suppose a firm faces the following costs...

Question 10

Operating assets include all of the following except

Accepted Answer

A)   accounts receivable
B)   property, plant, and equipment
C)   intangible assets
D)   property held for sale

Question 11

When should an analyst use nominal cash flows and when should an analyst use real cash flows?

Accepted Answer

The answer of When should an analyst use nominal cash...

Question 12

Currently financial reporting does not take into account changes in prices, either at the general level or at the specific level. Many analysts believe that not taking price changes into account distorts the meaningfulness of financial reports. How do changing prices affect financial reports?

Accepted Answer

The answer of Currently financial reporting does not take into...

Question 13

Free cash flow is calculated as net cash provided by operating activities less

Accepted Answer

A)   dividends.
B)   capital expenditures and depreciation.
C)   capital expenditures.
D)   capital expenditures and dividends.

Question 14

Houston, Inc. 
The following information pertains to Houston, Inc. a manufacturer of belt buckles:
$\begin{array}{c}
\begin{array}{l}
 \text { (dollar aniounts in thousands)}\
 \text { Net Cash Flow from Operations}\
 \text { Interest Expense after tax}\
 \text { Decrease (Increase) in Cash Required for Operations}\
 \text { Net Cash Flow from Investing}\
 \text { Net Cashifrom Debt Financing}\
\
\text { Present Value Factores for  85 \%}

\end{array}
\begin{array}{l}
\underline{2012}\
564 \
122 \
-75 \
-287 \
210\
\
0.922 
\end{array}
\begin{array}{l}
\underline{2013} \
628 \
134 \
-54 \
-300 \
204\
\
0.849 
\end{array}
\begin{array}{l}
\underline{2114}\
854 \
148 \
-48 \
-310 \
140\
\
0.783 
\end{array}
\begin{array}{l}
\underline{2015}\
1059 \
145 \
-32 \
-285 \
85 \
\
0722
\end{array}
\begin{array}{l}
\underline{2016}\
1345 \
155 \
-61 \
-294 \
-40\
\
0.665
\end{array}
\begin{array}{l}
\underline{2017}\
165 \
148 \
-48 \
-277 \
-46\
\
\ 
\end{array}
\end{array}$

-
 What is Houston's free cash flow for common equity holders for year 2012?

Accepted Answer

A)   $564
B)   $399
C)   $324
D)   $412

Question 15

Free cash flow from operations equals cash flow from operations adjusted for net interest after tax and adjusted for __________________________________________________.

Accepted Answer

The answer of Free cash flow from operations equals cash...

Question 16

The risk-adjusted discount rate used to compute the present value of all the projected free cash flows for common equity shareholders equals the _______________________________________________________.

Accepted Answer

The answer of The risk-adjusted discount rate used to compute...

Question 17

Sun Corporation reports the following information: Net cash provided by operating activities $255,000
Average current liabilities 150,000
Average long-term liabilities 100,000
Dividends paid 60,000
Capital expenditures 110,000
Payments of debt 35,000

Sun's free cash flow is

Accepted Answer

A)   $195,000
B)   $145,000
C)   $50,000
D)   $85,000

Question 18

If an analyst wants to value a potential investment in the common stock equity of a firm, the analyst should discount the projected free cash flows at the

Accepted Answer

A)   required return on equity capital
B)   weighted average cost of capital
C)   risk free rate
D)   market risk premium

Question 19

Provide the rationale for using expected free cash flow in valuation.

Accepted Answer

The answer of Provide the rationale for using expected free...

Question 20

Nonsystematic risk factors would include all of the following except:

Accepted Answer

A)   the sustainability of the firm's strategy
B)   the firm's ability to generate revenue growth
C)   the firm's ability to control expenses
D)   unemployment levels

Exam 12: Valuation: Cash-Flow-Based Approaches