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Question 1. What is the primary difference between Free Cash Flow to Firm (FCFF) and Free Cash Flow to Equity (FCFE)? A) FCFF is before debt payments, FCFE is after debt payments B) FCFF excludes capital expenditures, FCFE includes them C) FCFF is only used in private company valuation D) FCFE is calculated using gross profit Answer: A Explanation: FCFF represents cash flows available before debt payments, while FCFE is after all debt obligations have been met. Question 2. Which discount rate should be used when valuing a firm using the FCFF model? A) Cost of Debt B) Cost of Equity C) Weighted Average Cost of Capital (WACC) D) Internal Rate of Return (IRR) Answer: C Explanation: FCFF is discounted at WACC because it represents cash flows available to all providers of capital. Question 3. What is the appropriate discount rate for valuing equity using FCFE? A) WACC B) Cost of Equity C) Cost of Debt D) Risk-Free Rate Answer: B Explanation: FCFE reflects cash flows available to equity holders, so it should be discounted using the cost of equity.
Question 4. When calculating FCFF, which of the following adjustments is necessary? A) Add back interest expense (after-tax) B) Subtract dividends paid C) Add back depreciation and amortization D) Subtract net income Answer: C Explanation: Depreciation and amortization are non-cash charges that must be added back to net income to calculate FCFF. Question 5. Which of the following is NOT subtracted when calculating FCFF from EBIT? A) Taxes B) Depreciation C) Capital Expenditures D) Changes in Net Working Capital Answer: B Explanation: Depreciation is added back, not subtracted, since it is a non-cash charge. Question 6. In applying the Gordon Growth Model for terminal value, which assumption is critical? A) Constant growth in perpetuity B) Variable growth rates indefinitely C) Declining capital expenditures D) Decreasing discount rate Answer: A Explanation: The Gordon Growth Model assumes a constant growth rate in perpetuity.
Explanation: EV/EBITDA compares enterprise value to unlevered cash flow, making EBITDA the relevant metric. Question 10. What is the main benefit of using forward multiples in relative valuation? A) Reflects historical performance B) Incorporates analyst forecasts of future earnings C) Removes the impact of industry cycles D) Ignores future growth Answer: B Explanation: Forward multiples are based on forecasted earnings, providing a forward-looking view. Question 11. When normalizing earnings for valuation, which item should typically be adjusted? A) Depreciation B) Extraordinary gains C) Cost of goods sold D) Interest expense Answer: B Explanation: Extraordinary or non-recurring gains/losses should be adjusted to reflect sustainable earnings. Question 12. Which of the following best describes Present Value of Growth Opportunities (PVGO)? A) Value of assets in place B) Value from future projects not yet taken C) Present value of dividends D) Present value of debt Answer: B
Explanation: PVGO is the present value of opportunities to invest in future projects that will generate returns above the required rate. Question 13. In a three-stage DCF model, what does the second stage typically represent? A) Declining growth phase B) Stable growth phase C) Transition phase D) Initial high growth Answer: C Explanation: The second stage in a three-stage model is the transition phase, where growth slows before reaching stability. Question 14. How is residual income calculated? A) Net Income – Equity Charge B) Revenues – COGS C) EBIT – Taxes D) Net Income + Depreciation Answer: A Explanation: Residual income is net income minus the cost of equity capital (equity charge). Question 15. What is the main advantage of the residual income model over the Dividend Discount Model (DDM)? A) Does not require dividend forecasts B) Ignores book value C) Uses market value of assets D) Relies solely on free cash flow
Answer: B Explanation: The APV model adds the value of financing benefits, such as the tax shield from debt, to the unlevered firm value. Question 19. Which method is commonly used for early-stage company valuation? A) Cost approach B) Venture Capital Method C) Dividend Discount Model D) P/E Multiple Answer: B Explanation: The Venture Capital Method is suited to early-stage companies with uncertain cash flows. Question 20. What is the rationale for applying a control premium in precedent transaction analysis? A) To reflect minority ownership discounts B) To account for synergies and control benefits C) Because target companies are always overvalued D) To adjust for historical inflation Answer: B Explanation: Control premiums reflect the added value buyers expect from gaining control of the target company. Question 21. Which variable is most sensitive in terminal value calculations using the Gordon Growth Model? A) Beta B) Perpetual growth rate (g) C) Tax rate
D) Depreciation Answer: B Explanation: Small changes in the perpetual growth rate (g) can have a large impact on terminal value. Question 22. How is Economic Value Added (EVA) related to residual income? A) EVA uses book value while residual income uses market value B) EVA and residual income are conceptually similar C) EVA ignores the cost of capital D) Residual income is always higher than EVA Answer: B Explanation: EVA and residual income both measure value created above the required return on capital. Question 23. What is a key limitation of relative valuation using comparables? A) Ignores market sentiment B) Assumes market prices are always correct C) Requires perfectly comparable firms D) Does not use accounting data Answer: C Explanation: The method assumes that selected comparables are truly similar, which is rarely the case. Question 24. When calculating WACC, why are market-value weights preferred over book-value weights? A) Book values are more volatile B) Market values reflect current investor expectations C) Market values are historical
D) Equity Value – Goodwill Answer: A Explanation: EV includes equity, net debt, preferred stock, and minority interest, net of cash. Question 28. What is the purpose of normalizing earnings in valuation? A) To increase reported profits B) To reflect recurring, sustainable earnings C) To match competitor performance D) To reduce taxes Answer: B Explanation: Normalizing adjusts for non-recurring items, showing sustainable earnings power. Question 29. What is a liquidity discount in private company valuation? A) Premium for marketability B) Reduction in value due to illiquidity C) Increase in value for quick sale D) Discount for control Answer: B Explanation: Private companies are less liquid, so their valuation often includes a discount for lack of marketability. Question 30. Which model directly incorporates the value of real options in project valuation? A) Dividend Discount Model B) Residual Income Model C) Real Options Valuation
D) P/B Multiple Answer: C Explanation: Real Options Valuation models embed the value of managerial flexibility (options) in investment decisions. Question 31. Which factor does NOT typically influence the choice of valuation multiple? A) Industry norms B) Company growth prospects C) Interest rates D) Historical inflation rates Answer: D Explanation: While industry, growth, and interest rates matter, historical inflation is not a primary determinant of multiples. Question 32. What is the main risk of using an exit multiple based on current market data for terminal value? A) Overestimating depreciation B) Ignoring future market shifts C) Using non-recurring earnings D) Double-counting debt Answer: B Explanation: Current multiples may not reflect future industry or economic conditions. Question 33. How is the equity charge calculated in the residual income model? A) Net Income × Cost of Equity B) Book Value of Equity × Cost of Equity
C) For companies with negative earnings D) For banks only Answer: B Explanation: Normalized P/E adjusts for one-off items, providing a more accurate valuation during volatile periods. Question 37. Which of the following is an example of a non-recurring item to be excluded from normalized earnings? A) Salaries B) Interest expense C) Restructuring charges D) Taxes Answer: C Explanation: Restructuring charges are typically non-recurring and should be excluded for normalized earnings. Question 38. What is the theoretical justification for using the cost of equity as the discount rate for FCFE? A) FCFE is available to all capital providers B) FCFE is available only to equity holders C) FCFE is before debt service D) FCFE is equivalent to FCFF Answer: B Explanation: FCFE represents cash flows after debt obligations, available solely to equity holders. Question 39. Which of the following best describes sensitivity analysis in valuation? A) Estimating the required rate of return
B) Testing the impact of varying key assumptions C) Calculating cost of capital D) Projecting historical earnings Answer: B Explanation: Sensitivity analysis measures how changes in inputs affect valuation results. Question 40. What does the Fama-French three-factor model add to CAPM for cost of equity estimation? A) Interest rate risk B) Size and value factors C) Inflation adjustment D) Dividend growth Answer: B Explanation: Fama-French adds size (SMB) and value (HML) premiums, enhancing CAPM’s explanatory power. Question 41. How is unlevered beta calculated? A) Levered beta × (1 + (1 - tax rate) × (debt/equity)) B) Levered beta ÷ (1 + (1 - tax rate) × (debt/equity)) C) Cost of debt × equity D) Asset beta × risk-free rate Answer: B Explanation: Unlevered beta removes the effect of debt using the formula: Levered beta ÷ (1 + (1 - t) × (D/E)). Question 42. What is the primary purpose of relevering beta in valuation?
Question 45. Which of the following best describes the capitalized earnings method? A) Dividing normalized earnings by a capitalization rate B) Multiplying book value by WACC C) Discounting future cash flows D) Adjusting for inflation Answer: A Explanation: The method capitalizes normalized earnings at a rate reflecting required returns for risk. Question 46. What is the main challenge of using the DDM for bank valuation? A) Banks do not pay dividends B) Dividend payments are unpredictable C) Bank dividends are highly regulated and linked to earnings D) DDM ignores book value Answer: C Explanation: Bank dividends are closely tied to regulatory and economic conditions, complicating DDM use. Question 47. In a real options analysis, what does the “option to abandon” represent? A) The ability to sell the project if it becomes unprofitable B) The right to expand production C) The right to issue new equity D) The ability to increase prices Answer: A Explanation: The option to abandon allows management to exit a losing investment, reducing downside risk.
Question 48. What is Expanded Net Present Value (ENPV)? A) NPV plus the value of embedded real options B) NPV minus market risk premium C) NPV discounted by WACC D) NPV of book value only Answer: A Explanation: ENPV is the traditional NPV plus the value of managerial options/flexibility. Question 49. Which type of synergy is most commonly assessed in M&A valuation? A) Marketing synergy B) Financial synergy C) Cost synergy D) Human resource synergy Answer: C Explanation: Cost synergies, such as operating expense reductions, are most frequently quantified in M&A. Question 50. What is the main difference between enterprise value and equity value? A) Enterprise value includes both debt and equity; equity value only includes equity B) Equity value includes debt C) Enterprise value excludes cash D) Equity value is always higher than enterprise value Answer: A Explanation: Enterprise value captures the value of the entire capital structure, while equity value is for shareholders only.
Question 54. What is a key consideration in selecting comparable companies for multiples analysis? A) Dividend yield B) Similar business model, size, and growth prospects C) Historical stock price D) Age of the firm Answer: B Explanation: True comparability requires similar business models, size, and growth. Question 55. What does the cost of debt represent in WACC? A) The coupon rate on all outstanding debt B) The yield to maturity on existing or new debt, net of tax C) The bank prime rate D) The rate of inflation Answer: B Explanation: The cost of debt is the after-tax yield expected by debt holders. Question 56. Which is NOT a standard adjustment when normalizing financial statements? A) Removing non-recurring items B) Adjusting for accounting policy differences C) Adding cash balances D) Removing extraordinary gains/losses Answer: C Explanation: Normalizations typically exclude items like cash balances.
Question 57. What does the Modigliani-Miller (M&M) Proposition I state about firm value in the absence of taxes and bankruptcy costs? A) Value increases with leverage B) Value is independent of capital structure C) Value decreases with leverage D) Value is maximized with equity only Answer: B Explanation: In a perfect market, M&M I says capital structure does not affect firm value. Question 58. What is the main benefit of using the Adjusted Present Value (APV) model? A) It separates operating and financing decisions B) It always produces higher valuations C) It does not require discounting cash flows D) It ignores tax effects Answer: A Explanation: APV allows separate assessment of unlevered operations and financing effects. Question 59. In the context of DCF, what is the stable growth rate? A) The rate of inflation B) The long-term growth rate of cash flows in perpetuity C) The company’s historical average growth D) The GDP growth rate Answer: B Explanation: The stable growth rate is assumed for cash flows beyond the explicit forecast period.
