C4 A1 Q1-5 1.Identifying the right comparable firms is a critical step in figuri

Question

C4 A1 Q1-5

1.Identifying the right comparable firms is a critical step in figuring out the value of a new idea or even an existing firm?

a)It depends on the purpose of the valuation

b)True

c) False

2.The cost of capital to be used in valuing a company in most cases is affected by the capital structures of the comparable firms.

a) Partly true, partly false

b) True

c) False

3. Once you have identified an appropriate set of comparables, you only need to estimate the average cost of equity of the comparables to figure out the value of the firm you are analyzing.

a) False

b) True

4. Given that the interest payments on debt are tax deductible, firms have an incentive to borrow.

a) True

b) False

5. Taking on a lot of debt will increase the cost of debt because the debt will face higher chances of default. In leveraged buyouts (where debt can be close to 90% of the value of the firm) private equity firms (who have equity investments in such deals) insist on a quick payoff of debt because the return on equity is lower than the cost of debt.

a) False

b) Partly true, partly false

c) True

Explanation / Answer

1)
b)True is the correct option because valuations work best when there is a comparable firm to use multiples for valuation.

2)
b) True
Cost of capital is dependent on a large extent to the capital structure. Higher debt levels may result in more stressed equity raising the cost of equity over and above the benefits achieved from tax shield.

3)
a) False
It is so because you need the cost of equity as well as cost of debt and different valuation multiples. Equity beta depends to a large extent to the percentage of debt present in capital structure. Hence cost of equity may need to be calculated as unlevered equity and then adjusted for percentage of debt in the capital structure.

4)
a) True
It is so because interest payment provide tax shield to the extent of [Interest payment *(1-tax rate)]

5)
c) True
It is so because due to stressed firm LBO's will want to recoup their investments as early as possible.

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