Fin 3321 (Moore-1)
Fourth Examination
Summer 2014
Exam 4 (Final Examination Period)
Finance 3321 (Moore) – Spring 2014
Exam Number: ________
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Possible
Earned
Multiple Choice:
21
______
Short Problem 1:
9
______
Short Problem 2:
10
______
Discounted Dividends Valuation: 20
______
Free Cash Flow Valuation:
20
______
Residual Income Valuation:
20
______
Total Exam Points Earned
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Fin 3321 (Moore-1)
Fourth Examination
Summer 2014
Multiple Choice Questions: (3.0 Points Each) Total for Section = 21 Points
Clearly Circle the BEST response for each of the following questions:
1. Residual Income valuation models require which of the following discount factors?
a. WACC and the free cash flow growth rate
b. Cost of Debt and Cost of Equity
c. Cost of Debt and the dividend growth rate
d. Cost of Equity and negative terminal value growth rates
e. Cost of Equity and positive terminal value growth rates
2. Assume a firm will pay its first dividend in 2 years. This initial period’s dividend is forecast
to be $3.00 per share and is expected to grow at 6% per year in perpetuity. Assume
WACC = 12%; the cost of equity is 14%; the cost of debt is 8% and the risk-free rate is
5%. The best estimate the today’s share value using the discounted dividends method is:
a. $18.80
b. $21.42
c. $28.86
d. $32.89
e. $37.50
3. The main benefit of the residual income valuation model (as compared to free cash flows
and discounted dividends) is that:
a. Dividend payments are too variable compared with price variability
b. The implied investment horizon to recover value is unrealistically short.
c. The price variability explained by residual income variability is relatively small.
d. The valuation is not as sensitive to terminal value growth rates as compared to free
cash flow and dividend valuation models.
e. Residual income is easier to predict than the other measures.
4. Assume a firm’s revenues and net income are projected to grow by 10% per year into
the foreseeable future. What terminal value growth rate is most appropriate for the free
cash flow valuation model when WACC is 11%?
a. -40%
b. -10%
c. 0%
d. 5%
e. 15%
5. Assume a firm’s revenues and net income are projected to grow by 10% per year into the
foreseeable future. What terminal value growth rate is most appropriate for the Residual
Income valuation model?
a. -30%
b. 0%
c. 5%
d. 15%
e. 40%
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Fin 3321 (Moore-1)
Fourth Examination
Summer 2014
6. Consider the Residual Income Valuation model and the sensitivity analysis you performed
on your projects by varying the cost of equity and the terminal value perpetuity growth rates.
Suppose you were looking at the valuations of XYZ company in a sensitivity analysis table
and find the price at the 15% Ke line to be $23.50 per share when a -10% terminal value
growth rate is use but $29.00 per share when you move to a -40% terminal value growth
rate for the same cost of equity. Which one of the following must be true?
a. The terminal value perpetuity begins as a negative value
b. The terminal value perpetuity begins as a positive value
c. The terminal value perpetuity begins at zero
d. Year by Year residual income is increasing
e. Year by Year residual income is decreasing
7. Why must terminal value perpetuities for the residual income models have negative
growth rates?
a. You must have positive residual income.
b. You must always outperform your cost of capital in the perpetuity
c. You must always underperform your cost of capital in the perpetuity
d. Negative growth rates ensure you return to the equilibrium cost of capital, eventually.
e. Positive growth rates always cause Residual Income or AEG to become more positive.
Question 1: (9 Points)
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Fin 3321 (Moore-1)
Fourth Examination
Summer 2014
Rank-order the intrinsic valuation models we have covered in class (and briefly
explain) in terms of:
1)
2)
3)
4)
Reliability (or confidence) of forecast inputs
The statistical explanatory power of each model in terms of its ability
to explain variability of observed stock prices.
The sensitivity of each model to errors in growth rates or cost of
capital estimates
The inherent compatibility of each model in helping to explain or
understand the strategy and structure of the firm being valued.
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Fin 3321 (Moore-1)
Fourth Examination
Summer 2014
Question 2: (10 Points)
Moore’s Consulting and Crawfish Shack has a before tax WACC of 14% and an
After-tax WACC of 10%. A professional business valuation firm valued this
business at $2,800,000. The cash flows to the firm’s assets were assumed to be a
constant perpetuity on a going-forward basis and tax laws were assumed not to
change.
Compute the annual before-tax and after-tax cash flows that were used in this
valuation.
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