Conceptuals BFI exam 3 - desai 5/6 and exam review

Considering each action independently and holding all other factors constant, which of the following actions would increase a firm's need for additional capital?

An increase in the cost of goods sold.

3 multiple choice options

t/f: Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm

false

elect the statement that is most correct.

Additional funds needed are typically raised from some combination of notes payable, long-term bonds, and common stock. These accounts are nonspontaneous in that they require an explicit financing decision to increase them.

3 multiple choice options

t/f: The sensitivity of an NPV profile, at least in part, is a function of the timing of the cash flows

true

Select the statement that is most correct

The ability to abandon a project if cash flows are lower than expected can have value irrespective of whether the project is of higher or lower than average risk

3 multiple choice options

Assume that a project has a cash outflow at Year 0 and a single cash inflow at Year 5 (no intervening cash flows during Years 1-4). Which of the following statements is most correct?

The project's MIRR will always be equal to the project's IRR, regardless of the value of the cost of capital

3 multiple choice options

t/f: In a world with no taxes, MM show that the capital structure of a firm does not affect the value of the firm. However, when taxes are considered, MM show a positive relationship between debt and value

true

Assume that the equity beta for an all equity (unlevered) firm is 1.0. Assume now that the firm changes its capital structure to 50% debt and 50% equity, using 8% debt financing, and a tax rate of 40%. You may also assume that the beta for debt is zero. Given these conditions, which of the following statements is most correct?

The beta of the firm's equity will increase.

3 multiple choice options

Select the statement that is most correct

In a profitable firm with a degree of operating leverage greater than one, increasing sales will lead to a more than proportional increase in net income.

3 multiple choice options

You work for an industrial conglomerate interested in the acquisition of a steel com pany. Having run your valuation model through several scenarios, you come up with three outcomes. First, the worst- case scenario has a probability of 25 percent, and the com pany is worth $50 billion. The base- case scenario has a 50 percent chance of happening, and the company is worth $100 billion. Finally, the best- case scenario has a 25 percent chance of happening, and the company is worth $200 billion. What is the highest amount you would bid for the company?

$112.5 billion

3 multiple choice options

You work for a paper mill wanting to acquire a lumber company to reduce costs. You estimate that the present value of the lumber mill as it currently operates is $500 million, based on the DCF analysis. By purchasing the lumber company, you believe you could create synergies with a present value of $50 million, in the form of reduced costs and vertical integration. The lumber mill is publicly traded, so you're able to see that the market is valuing the com pany at $400 million (considering the stock price, the number of shares, and accounting for debt and cash). If you want to retain all the synergy value creation for the paper mill, what is your highest bid for the company

$500 million

3 multiple choice options

The company you work for just acquired one of your competitors. Immediately after the announcement, your company's stock dropped by 10 percent, resulting in the loss of $50 million in market capitalization. The target company’s stock jumped by 15 percent, resulting in a gain of $25 million in market capitalization. Which of the following has occurred as part of the acquisition?

Value destruction, transfer of wealth from acquirer to target

3 multiple choice options

Which of the following is not an example of a valuation multiple?

Current assets to current liabilities

3 multiple choice options

On December 31, 2016, Goodyear Tire and Rubber Company had a multiple of enterprise value to free cash of 16.1. Which of the following implied assumptions were likely to be true?

A discount rate of 9 percent and 3 percent growth.

In an attempt to figure out how much you should pay for an educational program, you perform a valuation. You estimate that the program will increase your annual earnings by $1,000 each year, which will grow along with your salary at 3 percent each year. Considering other similarly risky investments, you calculate a discount rate of 13 percent. For the sake of convenience, assume you will live forever (there’s typically not much difference between this and twenty to thirty years of cash flows). What is the maximum you are willing to pay for this educational program?

$10,000.

You are considering two projects and can choose only one: the rest has an IRR of 15 percent, and the other, an IRR of 25 percent. The WACC is 12 percent. Which project should you choose?

The project with an IRR of 25 percent is probably preferable, but you should conduct a DCF analysis.

You are on the acquisition team valuing a candy factory, to find opportunities better than the 2-4% growth rate in the economy. Your assistant prepared the preliminary valuation review. You see he assumed a 6% growth rate for the first two years, based on the average growth rate of the industry, and used that 6% growth rate as part of the growing perpetuity in the terminal value, whose present value, you notice, makes up 80% of the total valuation of the business. Based on these numbers, he estimated the enterprise value of the company to be $100mil. Furthermore, he estimated that the present value of synergies is $20mil. The company currently has $50mil in debt and $10mil in cash on hand. Your assistant recommends paying $120mil for the equity of the company, which he explains is the sum of the company’s valuation plus its synergies. Which of the following is a mistake your assistant may have made? (can be multiple)

all the above

3 multiple choice options

Which of the following projects will surely create value for your business?

A project with an NPV of $100 million.

3 multiple choice options

On February 14, 2017, Humana, Inc., announced a $2 billion share- repurchase program, with $1.5 billion accelerated to the rst quarter of 2017. Immediately, the stock price increased from $205 per share to $207 per share. Which of the following is a reason stock prices go up after the announcement of a stock buyback?

Signaling

3 multiple choice options

In September 2016, Bayer announced the acquisition of Monsanto for $66 billion. Which of the following is a concern for Bayer after completing the acquisi tion of Monsanto? (Choose all that apply.)

B and C

3 multiple choice options

Your company has $1 million in free cash flows and is trying to determine how to allocate that capital among organic growth, dividends, and share buy backs. The com pany has the opportunity to engage in organic growth, which requires an investment of $1 million and has an NPV of $2.3 million. Alternatively, it can offer a $1 dividend to each of its one million shareholders. Or it could buy back 100,000 shares at $10 each. What should your company do?

Use the $1 million for the organic growth project.

3 multiple choice options

From a finance perspective, what concern might be raised about conglomerates?

Shareholders can diversify on their own and do not need the company to do it for them.

3 multiple choice options

In October 2016, Microsoft announced a $40 billion share buyback program. Which of the following is a reason shareholders might prefer share buybacks to dividends? (Choose all that apply.)

A and B

3 multiple choice options

Which of the following valuation techniques reduces the risk of overpaying for an acquisition?

Scenario analysis.

3 multiple choice options

In 2016, Canadian companies issued more equity than ever before. Why does issuing equity often cause a company's stock price to decrease?

Signaling

3 multiple choice options

Why might an unscrupulous CEO perform a share buyback? (Choose all that apply.)

A and B

3 multiple choice options

Which of the following creates the most value?

Positive NPV projects

3 multiple choice options

Which of the following is a reason for an acquisition to fail? (Choose all that apply.)

all of the above

3 multiple choice options