Chapter 5 - FUNDAMENTAL PRINCIPLES OF VALUATION

TRUE OR FALSE

1. Market forces are usually constant and do not change, for these forces are the guide of
what the rate of return investors should expect. Answer: FALSE, market forces are
usually in a state of flux or constantly changing.
2. According to the CFA Institute, valuation is the ignorance of an asset's value based on
variables perceived to be related to future investment returns, on comparisons with
similar assets, or when relevant, on estimates of immediate liquidation proceeds.
FALSE; IGNORANCE should be ESTIMATION.
3. Valuation ensures that the financial outcomes and corporate strategy drives
maximization of firm value. False, it should be corporate finance
4. A company with a higher underlying net tangible asset value has lower going concern
value.False, it should be HIGHER going concern value
5. Valuation plays a significant role in the business world with respect to portfolio
management, business transactions or deals, corporate finance, legal and tax purposes.
TRUE
6. Even assets are identical and exchanged in contemporaneous transactions, fluctuations
in the prices agreed between different transactions can often be observed. These
fluctuations can be caused by factors such as differences in the objectives, knowledge or
motivation of the parties.TRUE
7. According to Michael Porter, there are generic corporate strategies to achieve
competitive advantage: Cost leadership. Similarities and Focus - FALSE
(Differentiation)
8. Sensitivity analysis is a common methodology in valuation exercises wherein multiple
other analyses are done to understand how changes in an input or variable will affect the
outcome (i.e. firm value). TRUE
9. Forecasting financial performance can be looked at two lenses: a macro perspective and
micro perspective - TRUE
10. Current operation, future prospects and embedded risk are the three major factors that
are linked in the value of a business. TRUE
MULTIPLE CHOICE

1. Statement 1: In the first principle, the value of a business is defined only at a specific point in
time, thus valuation made a year ago may hold true and reflect the prevailing firm value today.
Statement 2: The second principle of business valuation suggests that historical results (prior to
the valuation date) can be used as a guide to define the business future results under certain
conditions.
A. Statements 1 and 2 are False
B. Statement 1 is True but Statement 2 is False
C. Statement 1 is False but Statement 2 is True
D. Statements 1 and 2 are TruE

2. In what principle of valuation suggests that business owners must consider several factors,
including the type of industry, economic conditions, financing costs, etc..
A. Principle 2
B. Principle 6
C. Principle 1
D. Principle 3

3. __________ , individually or collectively, has value.

A. Liability
B. Income
C. Assets
D. Equity

4.____________ places great emphasis on the professional judgement that is associated with
the exercise.
A. Valuation
B. Capital
C. Value
D. Assets

5.___________ assumes that the combined value of two firms will be greater than the sum of
separate firms.
a. Merger
b. Control
c. Synergy
d. None of the above

6. Business deals include the following corporate events except:

a. Separating a segment or component business and transforming this into a
separate legal entity.
b. Sale of a major component or segment of a business to another company
 c. Acquisition of another business by using significant debt which uses the acquired
business as a collateral.
d. Change in people managing the organization brought about by the
acquisition. Any impact to firm value resulting from the change in
management and restructuring of the target company.

7.Statement 1:In the fifth fundamental principle of business valuation, value is influenced by
transferability of future cash flows.
Statement 2: Value is impacted by liquidity is the last principle of business valuation.
A. Only statement I is true
B. Only statement II is true
C. Both statements are true
D. Both statements are false

8. This principle of business valuation measures of the relationship between the operational
value of a company and its net tangible value.
A. Value is impacted by liquidity
B. Value is influenced by transferability of future cash flows
C. The value of a business is defined only at a specific point in time
D. The value of a business may be impacted by underlying net tangible asset

9. Fundamental analysts lean towards long-term investment strategies which encapsulate the
following principles except
a. Relationship between value and underlying factors can be reliably measured.
b. Any deviations from the above relationship can be corrected within a reasonable
time
c. Basis for assessment of potential lending activities by financial institutions
d. Above relationship is stable over an extended period

10. It relies on the concept that stock prices are significantly influenced by how investors think
and act.
a. Activist Investors
b. Chartists
c. Information Traders
d. Stock Selection

11. Choose what describes valuation uncertainty.

a. When a market is disrupted at the valuation date by current or very recent events such
as sudden economic or political crises.
b. The possibility that the estimated value may differ from the price that could be
obtained in a transfer of the same asset or liability taking place at the same time
under the same terms and within the same market environment.
c. Arises from characteristics of either the valuation model, or method, used. For certain
asset types, more than one method may be customarily used to estimate value
 d. Arises where there are a number of equally reasonable or feasible inputs or assumptions
that can be used from the degree of veracity that can be attached to the data inputs
used in the valuation and their impact on the outcome.

12. Statement I. Porter’s Five forces is the most common tool used to encapsulate industry
structure.
Statement II. The Porter’s Five forces are Industry rivalry, New Entrants, Substitutes, Suppliers
power and Buyer Power.
A. Only statement I is correct
B. Only statement II is correct
C. Both statement are correct
D. Both statement are incorrect

13. It is an analysis that pertains to the detailed review of all financial statements and
accompanying notes to assess sustainability of company performance and validate accuracy of
financial information versus economic reality.
A. Balance sheet items
B. Operating cash flows
C. Buyer Power
D. Quality earning

14. Statement 1: Core operation refers to additional value considered in a stack investment if
acquiring it will give controlling power to the investor.
Statement 2: Lack of marketability discount means that the stock cannot be easily sold as there
is no ready market for it (e.g., non-publicly traded discount). Lack of marketability discount
drives down snare value.
a. Only statement 1 is true
b. Only statement 2 is true
c. Both statements are true
d. Both statements are false

15. The appropriate valuation model will depend on the context of the valuation and the inherent
characteristics of the company being valued. Details of these valuation models and the
circumstances when they should be used will be discussed in succeeding lectures.
a. Applying valuation conclusions and providing recommendation
b. Preparing valuation model based on forecasts
c. Selecting the right valuation model
d. None of the above.

16. Statement 1: Top down forecast approach starts from international or national
macroeconomic projections with utmost consideration to industry specific forecasts.
Statement 2: A micro perspective viewing the economic environment and industry where the
firm operates in.
a. Only statement 1 is true
b. Only statement 2 is true
c. Both statement are true
d. Both statement are false

17. Which of the following approaches starts from the lower levels of the firm and builds the
forecast as it captures what will happen to the company?
a. Macro perspective
b. Micro perspective
c. top-down forecasting approach
d. bottom-up forecasting approach

18. Refers to the estimated worth of an asset based on a hypothetically complete

understanding of its investment characteristics.
a. Going concern value
b. Liquidation value
c. Intrinsic value
d. Fair market value

19. A company creates value if and only if the return on capital invested exceed the cost of
acquiring capital.
a. Karl marx
b. Adams smith
c. Alfred marshall
d. Milton friedman

20. Fundamental Analysts tend to look for companies with good growth prospects that have
poor management.
a. TRUE
b. FALSE
 Chapter 6 - ASSET-BASED VALUATION
True or False
1. When the historical growth pattern is undetermined, some analysts only consider the
cost of capital or their required return to determine the terminal value of the company.
True
2. The advantage of EBITDA is that it enables the investor to focus on companies baseline
of profitability without capital expenses factored into the assessment. True
3. A high dividend yield ratio yield may be due to recent increase in the market price of
stock of the company. False
4. Going concern business opportunities are those businesses that have a short term to
definite operational period. False- long term to infinite operational period
5. EBITDA multiple is determined by dividing the common share to EBITDA per share -
False- Market value per share / EBITDA per share

6. Statement 1: The elements that must be considered in using Economic Value Added are
Reasonableness of earnings or returns and Appropriate cost of debt
Statement 2: The other factors to be considered in Valuation are the earning accretion or
dilution, equity control premium and precedent transactions.
A. Statement 1 is correct
B. Statement 2 is correct
C. Both statements are correct
D. Both statements are incorrect

7. Statement 1: Valuation should be kept confidential to allow the company to negotiate a

better position for them to acquire an opportunity.
Statement 2: It is more challenging to determine the value of a green field investment
since all shall be based on purely estimate than brown field.
A. Statement 1 is correct
B. Statement 2 is correct
C. Statement 1 and 2 is correct
D. Statement 1 and 2 is incorrect

8. Statement 1: The market price per share represents the value at which the stock is
trading in the market, it is a significant metric that is useful in computing the market
capitalization and the value of a firm.
Statement 2: The market price is used to determine various ratios such as the P/E ratio,
market-to-book ratio, etc.
a. Statement 1 is correct.
b. Statement 2 is correct.
c. Statement 1 & 2 is correct.
d. Statement 1 & 2 is incorrect.
 9. Statement 1: Comparable analysis is a technique that uses relevant drivers for growth
and performance.
Statement 2: Total and absolute values should be compared is one of the factors must
be considered in determining the value using comparable analysis
a. Statement 1 is correct.
b. Statement 2 is correct
c. Both statements are correct
d. Both statements are incorrect

10. Statement 1: The principle of Bird in the Theory is popularized by Thyron Gordon and
John Lintner.
Statement 2: The theory assumes that the value of the firm is affected by the dividends
that the company pays.
a. Statement 1 is correct
b. Statement 2 is correct
c. Both statement are correct
d. Both statement are incorrect

Multiple Choice

1. Archer Inc. has 500,000 shares of Php10 par value common stock outstanding. For the
current year, Archer paid a cash dividend of Php4.00 per share and had earnings per share of
Php3.20. The market price of Archer's stock is Php36 per share. The average price/earnings
ratio for Archer's industry is 14.00. When compared to the industry average, Archer's stock
appears to be?

a. Overvalued by approximately 10%

b. Overvalued by approximately 25%
c. Undervalued by approximately 25%
d. Undervalued by approximately 10%

SOLUTION:
Archer’s stock is undervalued approximately 25% as calculated below:
Estimated market value = 14.00 x Php3.50
= Php 44.80
Archer market value difference = Php 44.80- Php 36.00
= Php 8.80
Percentage Difference = Php 8.80/ Php 36.00
= 24.4%
2. For net cash flow and valuation purposes, the following current assets and liabilities are
excluded in the computation except:

a. Accounts receivable
b. Short-term notes payable
c. Marketable securities
d. Current portion of long-term debt

3. The ratio is important for those investors who purchase shares to earn

a. Money
b. Profit
c. Cash
d. Dividend income

4. Suppose a company declares dividend at 1.70 per share. The par value of a share of the
company is 15 and the market price per share is 20. The dividend yield ratio would be

a. 0.050
b. 0.90
c. 0.085
d. 0.080

SOLUTION:
= 1.70/20
= 0.085 or 8.5%

5. Magsaysay Company reported the following revenues in the last 5 years:

Year 1 - 2,000,000; Year 2 - 2,500,000; Year 3 - 2,320,000; Year 4 - 2,700,000; Year 5 -
3,100,000
What is the compounded annual growth rate of the revenues reported by Magsaysay
Company?
a. 55.0%
b. 14.8%
c. 11.6%
d. 9.2%
SOLUTION: (rounded off to one decimal place)

6. Which two of the following are likely to result in an increase in a company’s price/earnings
(P/E) ratio?

a. An announcement of increased earnings and A take-over bid made for the

company
b. A company announcing the loss of a major contract
c. A sudden downturn in share prices
d. A stockbroker recommending that clients sell the company’s shares

7. This refers to the total amount used to service loans or debt financing. This is the total
amount of loan repayment and the interest expenses, net of income tax benefit.
a. Proceeds from preferred shares
b. Debt service
c. Proceeds from borrowing
d. Net cash flow to equity

8. All of the following are benefits of having Enterprise-wide Risk Management except:
a. facilitate the management and identification of the risk factors that affect the business
b. identify or create cost-efficient opportunities
c. decrease the opportunities
d. make the business more resilient to abrupt changes.

9. In practice, observe valuation as a _________ and ___________________activity in their

portfolio management.
a. sensitive and confidential
b. sensitivity and proximity
c. sensitive and top secret
d. lucky charm and confidence
10. This represents for the net amount of revenue after deducting operating expenses and
before deducting financial fixed costs, taxes and non cash expenses.
a. EBITDA
b. Dividend yield ratio
c. Book to Market ratio
d. EBITDA multiple

11. This is the ratio of the business value to the net amount of revenue after deducting operating
expenses and before deducting financial fixed costs, taxes and non cash expenses.
a. Dividend yield ratio
b. EBITDA multiple
c. Book to market ratio
d. EBITDA

12. The degree of uncertainty as to the realization of expected returns.

a. Investment value
b. Financial risk
c. Equity risk premium
d. Investment risk

13. This is the amount that is added to the value of the firm in order to gain control of it.
A. Precedent transactions
B. Earning accretion
C. Equity Control premium
D. Investment

14. _______ is a form of income approach in determining the value of the company by
determining any excess of the average earnings after deducting the cost of capital.
A. Economic Value Added
B. Comparison approach
C. Cost approach
D. Income approach

15. Which one of the following accurately defines a perpetuity?

A. a limited number of equal payments paid in even time increments
B. payments of equal amounts that are paid irregularly but indefinitely
C. varying amounts that are paid at even intervals forever
D. unending equal payments paid at equal time intervals
E. unending equal payments paid at either equal or unequal time interval

16. Which one of these statements related to growing annuities and perpetuities is correct?
A. The cash flow used in the growing annuity formula is the initial cash flow at time zero.
B. Growth rates cannot be applied to perpetuities if you wish to compute the present value.
 C. The future value of an annuity will decrease if the growth rate is increased.
D. An increase in the rate of growth will decrease the present value of an annuity.
E. The present value of a growing perpetuity will decrease if the discount rate is
increased.

17. In determining the value using comparable company analysis, the following factors must be
considered except:
a. Comparators must be at least with similar operations or within the different
industry
b. Total and absolute values should not be compared
c. Variables used in determining the ratios must be the same
d. Period of observation must be comparable
e. Non-quantitative factors must also be considered

18. Comparable company analysis is a technique that uses relevant drivers for growth and
______________that can be used as a proxy to set a reasonable estimate for the value of an
asset or investment prospective.
a. Performance
b. Estimate
c. Probability
d. Strategy

19. It describes the relationship between the appreciation of the market on dividends received
per share and the price of the company.
a. Price Earnings Ratio
b. Comparable Company Analysis
c. Book to Market Ratio
d. Dividend Yield Ratio

20. Which of the following is not a financial ratio?

a. Price Earning Ratio
b. Dividend Yield Ratio
c. Market to Book Ratio
d. EBITDA Multiple