1. A major disadvantage of the free cash flow valuation method is? a. The termin
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Question
1. A major disadvantage of the free cash flow valuation method is?
a. The terminal value tends to dominate the total value in many cases.
b. The projection of free cash flows depends on earnings estimates.
c. The free cash flow method is not rigorous.
d. The free cash flow method is not used widely in practice.
2. The results for a discounted residual income valuation application are presented below. Both dollar and relative contributions to the overall equity value are shown.
a. An agricultural equipment manufacturer
b. An early development gene therapy pharmaceutical company
c. A public accounting and consulting firm
d. A software and social media development company
3. Which of the following valuation multiples is consistent with economic theory and provides a basis for analyzing firms that have been classified as growth or value investments?
a. The market to book ratio
b. The trailing price to earnings multiple
c. The ratio of the terminal value perpetuity value to book value of equity
d. The degree of operating leverage ratio
Book Value of Equity Total Present Value of YBY Residual Income Residual Income Perpetuity 196,560 80.5% 19,691 27,849 11.4% 8.1% Market Value of Equity 24,100 100.0%Explanation / Answer
1A) The terminal value tends to dominate the total value in many cases.
2B) An early development gene therapy pharmaceutical company. If you see the residual value is accounting for only 20% of the market value, while book value accounts for 80%. This is true for companies which do not pay dividends, and when there is high level of uncertainty about the terminal value.
3D) The degree of operating leverage ratio. It shows the efficiency of a company. It arises out of the cost structure of a company. It measures the sensitivity of the EBIT to sales of the company. High ratio means that the company needs higher sales volume for profitability.
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