Chapter 1 Fundamental Principles of Valuations

True/False
1. True – The value of an object, asset, or investment is subjective and can vary
depending on who is assessing it. This is consistent with the concept that different
investors or market participants may have different perspectives on value.
2. True – Valuation methods can indeed differ between asset classes. For example,
valuing real estate typically involves different approaches (such as the comparable
sales method or income capitalization) compared to valuing a business (which
might use discounted cash flow analysis).
3. True – This reflects a fundamental concept in finance where businesses treat
capital as a limited resource and manage it efficiently, as capital is necessary to
drive growth and operations.
4. True – According to the CFA Institute, valuation involves estimating the value of
an asset based on factors such as future returns, comparisons to similar assets, or
even liquidation value if needed.
5. True – Forecasts and projections are indeed integral to the valuation process, as
they help in estimating future cash flows or asset values.
6. True – Valuation techniques differ based on asset type (stocks, bonds, real
estate, etc.), but they are all grounded in fundamental principles that aim to
determine an asset’s worth based on factors like risk, return, and time value of
money.
7. True – This is correct, as valuation often deals with future projections and
involves making assumptions based on available data, which needs to be rational
and aligned with the valuation’s objective.
8. True – The principle that a company creates value when its return on invested
capital exceeds the cost of capital is foundational in corporate finance. This idea
was popularized by economists like Alfred Marshall.
9. True – This relates to the concept of shareholder value, where the value to
shareholders is the difference between cash inflows (returns from investments) and
the capital costs associated with generating those returns, adjusted for risk and the
time value of money.
10. True – Intrinsic value refers to an asset’s true value based on a full
understanding of its investment characteristics, often estimated through detailed
analysis of future cash flows, growth prospects, and risks.
11. True – The going concern assumption is a fundamental accounting principle that
assumes a company will continue its operations into the foreseeable future. Firm
value based on this assumption is different from a liquidation scenario.
12. True – Liquidation value represents the net amount that could be recovered if a
company were to cease operations and sell off its assets individually, often at a
lower value than the company's ongoing business value.
13. True – Fair market value is defined as the price at which an asset would trade
between willing and knowledgeable parties in an open market, where neither party
is under any obligation to buy or sell. This is a standard definition used in finance
and law.
14. True – Fundamental analysts focus on determining the intrinsic value of a
company based on financial data, such as earnings, revenue, and economic
indicators, rather than market movements.
15. True – Fundamentals of a company include financial health, profitability, and risk
profile, all of which are critical in assessing its value or growth potential. This is the
basis of fundamental analysis.
16. True – Activist investors typically acquire significant equity stakes in companies
to influence management and strategic decisions, often leading to takeovers or
restructuring to align with their vision for improving company performance.
17. True – Chartists or technical analysts use stock price charts, historical data, and
market indicators such as trading volume and short sales to predict future stock
price movements, based on investor behavior and market sentiment.
18. True – Information traders are individuals who trade based on newly revealed
information about companies, reacting quickly to news such as earnings reports or
industry developments to take advantage of market inefficiencies.
19. True – An acquisition involves a buyer and a seller. The buying firm evaluates
the target company’s fair value before making a bid, factoring in the potential
synergies and strategic benefits of the acquisition.
20. True – A merger refers to the combination of two companies to form a new
entity, typically to achieve economies of scale, increase market share, or expand
into new markets.
21. True – Divestiture refers to the sale of a major component or segment of a
business, such as a product line or a subsidiary, to another company. This is often
done to raise capital or focus on core operations.
22. True – A spin-off involves separating a part of a company (e.g., a division or
subsidiary) and creating an independent legal entity. The ownership is transferred to
the original company’s shareholders.
23. True – A leveraged buyout (LBO) is the acquisition of a company using a large
amount of borrowed money, with the acquired company’s assets often used as
collateral for the loans.
24. True – Synergy refers to the benefits that arise from the combination of two
companies, such as cost reductions, increased revenues, or operational efficiencies.
It is one of the key reasons companies pursue mergers and acquisitions.
25. True – Corporate finance involves managing a firm’s capital structure, including
decisions about how to fund operations (equity, debt, etc.) and the strategies
needed to maximize firm value.
26. True – Valuation is important for legal and tax purposes, such as determining
the value of assets in a merger, acquisition, or divestiture, or for calculating taxes
owed on business transactions.
27. True – The top-down forecasting approach begins with macroeconomic factors
(e.g., national or international economic trends) and then narrows down to industry-
specific data to predict future performance.
28. True – The bottom-up forecasting approach starts with detailed data from the
company (such as sales and operations) and builds up to create a forecast for the
entire company.
29. True – Sensitivity analysis is a common method in valuation where analysts test
how changes in input variables (e.g., cost of capital, growth rates) affect the
valuation outcome. It is used to assess how sensitive the valuation is to changes in
key assumptions.
30. True – Uncertainty in valuation models is typically accounted for by adjusting
the discount rate or cost of capital, which reflects the risk and uncertainty
associated with future cash flows.
31. True - In valuation models, uncertainty or risk is reflected in the cost of capital
or discount rate. A higher rate accounts for higher perceived risks, which reduces
the present value of future cash flows. This is standard practice in discounted cash
flow (DCF) models, where riskier investments or companies will have a higher
discount rate.
32. True - Valuation methods like DCF, comparable company analysis, and
liquidation value estimate the worth of an asset or company based on factors like
expected cash flows, market comparisons, or potential sale values. These
approaches are common and well-accepted in finance.
33. True - The concept of value changes based on the context of the valuation. For
instance: - *Intrinsic value*: The perceived inherent value based on fundamental
analysis. - *Going concern value*: The value assuming the business continues
operating. - *Liquidation value*: The estimated proceeds if the company is
dissolved. - *Fair market value*: The price an asset would sell for in an open
market between a willing buyer and seller.
*34. 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*: Valuation is crucial in many areas. For portfolio management, it helps in
assessing the worth of investments. In business transactions, it aids in determining
the fair price for buying or selling a business. In corporate finance, it is used for
capital budgeting and financial planning. For legal and tax purposes, accurate
valuations are necessary for compliance and litigation.

*35. Generally, valuation process involves these five steps: understanding of the
business, forecasting financial performance, selecting the right valuation model,
preparing the valuation model based on forecasts, and applying conclusions and
providing recommendations.*
- *False*: While the steps mentioned are broadly correct, the valuation process
usually involves more detailed steps. The typical steps include understanding the
business, analyzing historical financials, forecasting future performance, selecting
the appropriate valuation methods (which might include multiple models), applying
these models to estimate value, and then reconciling and finalizing the valuation
with recommendations. The process is more iterative and nuanced than the five
steps listed.

*36. Value is defined at a specific point in time.*

- *True*: Value is indeed assessed as of a particular date, since it reflects the
conditions, risks, and opportunities present at that specific moment. This is
important for accurate and relevant valuation.

*37. Value varies based on the ability of the business to generate future cash flows.*
- *True*: The ability of a business to generate future cash flows is a key determinant
of its value. Valuation methods like discounted cash flow (DCF) explicitly rely on
projections of future cash flows.

*38. Market dictates the appropriate rate of return for investors.*

- *True*: Market conditions, including risk factors and investor expectations,
influence the rate of return required. This rate is often determined by comparing
investment opportunities and assessing the risk-adjusted returns.

*39. Value is influenced by the transferability of future cash flows.*

- *True*: The ease with which future cash flows can be transferred or realized can
impact value. For example, an investment with a high degree of liquidity or
transferability might be valued higher than one with restricted transferability.
*40. Value is impacted by liquidity.*
- *True*: Liquidity affects value because assets that can be quickly and easily sold
are generally valued higher than those that are difficult to sell or convert into cash.
Liquidity risk typically leads to a lower value for less liquid assets.

Multiple Choice Theory:

1. *Value* - *Explanation*: "Value" pertains to how much a particular object is
worth to a particular set of eyes, reflecting subjective worth.
2. *Valuation* - *Explanation*: According to the CFA Institute, "Valuation" is the
process of estimating an asset's value based on factors like future investment
returns, comparisons with similar assets, or estimates of liquidation proceeds.
3. *Professional judgment* - *Explanation*: Valuation emphasizes "Professional
judgment" in the exercise, as it requires subjective assessment and expertise.
4. *All of the above* - *Explanation*: The value of a business can be linked to all
three major factors: "Current Operations," "Future Prospects," and "Embedded
Risks." Therefore, "All of the above" is the correct answer.
5. *Current Operations* - *Explanation*: "Current Operations" reflects the
operating performance of the firm in the recent year, showing how well the business
has been performing currently.
6. *Future Prospects* - *Explanation*: "Future Prospects" reflects the long-term
and strategic decisions of the company, focusing on what the business aims to
achieve in the future.
7. *Embedded Risks* - *Explanation*: "Embedded Risks" shows the business
risks involved in running the business, including uncertainties and potential threats.
8. *Intrinsic Value* - *Explanation*: "Intrinsic Value" refers to the value of any
asset based on the assumption of a complete understanding of its investment
characteristics.
9. *Liquidation Value* - *Explanation*: "Liquidation Value" is particularly
relevant for companies experiencing severe financial distress, as it represents the
value of assets if the business were to be sold off in parts.
10. *Going concern value* - *Explanation*: "Going concern value" is determined
under the assumption that the business will continue to operate indefinitely,
reflecting its ongoing viability.
11. *Fair Market Value* - *Explanation*: "Fair Market Value" is the price at which
property would change hands between a hypothetical willing and able buyer and
seller, with both parties acting in their best interests and having reasonable
knowledge of the relevant facts, in an open and unrestricted market.
12. *Portfolio Management* - *Explanation*: The relevance of valuation in
"Portfolio Management" largely depends on the investment objectives of the
investors or financial managers managing the investment portfolio.
13. *Fundamental Analysts* - *Explanation*: "Fundamental Analysts" are
interested in understanding and measuring the intrinsic value of a firm through
financial statements and other qualitative and quantitative factors.
14. *Fundamentals* - *Explanation*: "Fundamentals" refer to the characteristics
of an entity related to its financial strength, profitability, or risk appetite.
15. *Activist Investors* - *Explanation*: "Activist Investors" tend to look for
companies with good growth prospects that may have poor management, with the
aim of influencing or changing management practices to improve value.
16. *Chartists* - *Explanation*: "Chartists" (or technical analysts) believe that
market metrics and price patterns reflect investor psychology and can predict future
movements in stock prices.
17. *Information Traders* - *Explanation*: "Information Traders" are believed to
be more adept at acquiring and interpreting new information about firms and
predicting how the market will react, which correlates with value.
18. *Both can be performed* - *Explanation*: In portfolio management,
valuation techniques can be used for both "Stock Selection" and "Deducing Market
Expectation."
19. *Spin-off* - *Explanation*: A "Spin-off" involves separating a segment or
component business and transforming it into a separate legal entity, with ownership
transferred to shareholders.
20. *Divestiture* - *Explanation*: A "Divestiture" refers to the sale of a major
component or segment of a business to another company.
21. *Mergers* - *Explanation*: The general term for a transaction where two
companies combine to form a wholly new entity is "Mergers."
22. *Acquisitions* - *Explanation*: In "Acquisitions," the buying firm needs to
determine the fair value of the target company before making an offer, while the
selling firm or target company should also understand its own value to assess the
reasonableness of offers.
23. *Leveraged buy-out* - *Explanation*: A "Leveraged buy-out" involves
acquiring another business using significant debt, with the acquired business often
serving as collateral for the loan.
24. *Synergy* - *Explanation*: "Synergy" assumes that the combined value of
two firms will be greater than the sum of their separate values, due to factors like
efficient operations, cost reductions, increased revenues, and combined expertise.
25. *Financial Management* - *Explanation*: "Financial Management" deals
with prioritizing and distributing financial resources to activities that increase firm
value, aiming to maximize firm value while balancing profitability and risk.
26. * All of the Above* - *Explanation*: Each of the listed steps—Understanding
the Business, Forecasting Financial Performance, and Preparing the Valuation Model
Based on Forecasts—are all typically considered in the valuation process. Therefore,
"All of the Above" is the correct answer for what is *not* an exception.
27. *The value of a business is defined only at a specific point in time* -
*Explanation*: This principle acknowledges that business value can fluctuate daily
based on transactions and market conditions, emphasizing that valuation is specific
to a particular point in time.
28. *Uncertainty* - *Explanation*: "Uncertainty" refers to the possible range of
values where the real firm value lies due to the inherent risks and unknowns in
valuation.
29. *Market dictates the appropriate rate of return for investors* -
*Explanation*: This principle states that market forces influence the rate of return
investors should expect, reflecting changing market conditions.
30. *Value varies based on the ability of the business to generate future
cash flows* - *Explanation*: This principle highlights that most valuation
techniques focus on future cash flows to determine value, although in some cases,
liquidation value might be more appropriate.

Chapter 2 Asset Based Valuation

True/False
1. *True* - *Explanation*: An asset is defined as a resource expected to yield future
economic benefits from past transactions.
2. *False* - *Explanation*: "Brownfield investment" refers to investing in existing
businesses or properties, not starting from scratch. The term for starting from
scratch is "Greenfield investment."
3. *False* - *Explanation*: Enterprise-wide Risk Management aims to manage risks
to stabilize or enhance performance, not to increase variability. 4. *True* -
*Explanation*: Risk identification is crucial for investors to understand and assess
the potential impact of risks on their investments.
5. *True* - *Explanation*: Brownfield investments are generally easier to evaluate
because they involve existing operations with historical information available. 6.
*True* - *Explanation*: Book value is derived from amounts reflected in the financial
statements, representing the value of assets and liabilities.

6. *True*
7. *False* - *Explanation*: Borrowings due after 24 months are classified as non-
current liabilities, not current liabilities.
8. *True* - *Explanation*: Equipment is classified as a non-current asset because it
is used over a long period.
9. *False* - *Explanation*: To calculate book value per share, you subtract total
liabilities from total assets to get equity, then divide by the total number of
outstanding shares, not authorized shares.
10. *True* - *Explanation*: The book value method is transparent as it relies on
financial statements, which are publicly available and audited.
11. *True* - *Explanation*: Replacement cost is the cost to acquire similar assets
with the nearest equivalent value as of the valuation date.
12. *False* - *Explanation*: Replacement value is affected by asset age and size,
but not by competitive advantage. Competitive advantage is more relevant to the
overall value or performance of the business rather than the replacement value of
an asset.
13. *True* - *Explanation*: Insurance companies often use replacement value to
determine premiums, reflecting the cost to replace an asset.
14. *False* - *Explanation*: For real properties, both age and size are important
factors in valuation. Age alone is not necessarily more important than size.
15. *False* - *Explanation*: Replacement value is not necessarily superior to book
value; each method serves different purposes. Replacement value reflects the cost
to replace an asset, while book value reflects historical cost less depreciation.
16. *True* - *Explanation*: Replacement value estimates the cost to reproduce,
create, develop, or manufacture a similar asset.
17. *True* - *Explanation*: If comparable assets are not available in the market,
using the reproduction value method, which estimates the cost to recreate an asset,
may be more appropriate.
18. *True* - *Explanation*: Reproduction value is indeed used for business
ventures with highly specialized equipment, as it reflects the cost to reproduce such
unique assets.
19. *False* - *Explanation*: Reproduction value can be challenging to validate,
especially without comparable assets, because it relies on estimating the cost to
recreate highly specialized equipment, which can be complex.
20. *False* - *Explanation*: The book value method reflects historical cost and
depreciation, not the most recent market value. Other methods, such as market
value or replacement value, typically provide a more current approximation of a
company's value.

Multiple Choice Theory:

1. *a. Asset* - *Explanation*: An asset is defined as a resource that yields future
economic benefits as a result of past transactions. It represents value that a
company can use in the future.
2. *b. Brown Field Investments* - *Explanation*: Brown Field Investments refer
to investments in existing businesses or sites with a track record, where there is
historical proof of growth potential. "Green Field Investments" involve starting a new
project from scratch, while "Blue Field" and "Black Field" are not standard
investment terms.
3. *a. Facilitates elimination of all business risks* - *Explanation*:
Enterprise-wide Risk Management (ERM) helps manage risks and improve resilience
but does not eliminate all risks. It focuses on managing performance variability,
enhancing resilience, and improving resource distribution.
4. *d. Enables stakeholders to validate firm value based on the value of
assets it currently owns* - *Explanation*: Asset-based valuation methods allow
stakeholders to assess the value of a company based on its current assets. This
approach does not rely on future revenues or market perceptions but rather on the
present value of existing assets.
5. *Book value* - *Explanation*: Book value refers to the value of an asset or a
company as recorded in the accounting books, based on historical cost and
accounting entries, as reflected in the audited financial statements.
6. *Non-current Assets* - *Explanation*: Receivables that are collectible after 60
days are typically classified as non-current assets because they are not expected to
be collected within the current operating cycle or fiscal year.
7. *Total shareholder's equity* - *Explanation*: The net book value of assets,
when considering liabilities, represents total shareholder’s equity. It’s calculated as
total assets minus total liabilities.
8. *Historical value* - *Explanation*: Book value reflects the historical value of
assets as recorded in the accounting books, not liquidation, intrinsic, or fair market
value.
9. *Validated by a third-party expert with knowledge on how much assets
are sold in the open market* - *Explanation*: Book value is derived from
financial statements and does not typically involve validation by third-party experts
on market sales, which is more relevant for fair market value assessments.
10. *Replacement cost* - *Explanation*: Replacement cost is the cost of
acquiring similar assets with the nearest equivalent value as of the valuation date,
reflecting current prices.
11. *Competitive advantage of the asset* - *Explanation*: Replacement value
is generally affected by factors such as asset size, age, and original acquisition cost,
but not the competitive advantage of the asset.
12. *b. Replacement cost* - *Explanation*: Insurance premiums are often based
on the replacement cost, which is the cost to replace an asset with a similar one at
current prices, ensuring the asset can be replaced if damaged.
13. *c. Appraisers* - *Explanation*: When determining replacement costs,
valuators typically consult with appraisers who specialize in evaluating the current
cost to replace or reproduce an asset.
14. *b. Book value can be computed from the financial statements while
replacement value is gathered by employing services of an appraiser.* -
*Explanation*: Book value is derived from financial statements based on historical
costs and accounting adjustments. Replacement value requires appraisers to
estimate the cost to replace the asset with a similar one at current prices.
15. *c. Reproduction value method* - *Explanation*: The reproduction value
method estimates the cost to reproduce an asset as closely as possible to the
original. This is used when there is no comparable external information available.
16. *c. Companies that are highly reliant on intangible assets* -
*Explanation*: The reproduction value method is typically not suitable for
companies reliant on intangible assets, as it focuses on physical assets and their
replacement or reproduction, rather than intangible elements like patents or
trademarks.
17. *a. Estimate of cost of reproducing, creating, developing or
manufacturing a similar asset internally* - *Explanation*: Reproduction value
refers to the cost of reproducing an asset as closely as possible to the original,
including creating or developing it internally.
18. *c. Difficulty validating reasonableness of calculated value because of
limited comparators* - *Explanation*: A limitation of the reproduction value
method is the challenge in validating the calculated value due to a lack of
comparable assets, making it difficult to confirm the reasonableness of the
estimate.
19. *d. Book value method* - *Explanation*: The book value method reflects
historical costs and does not provide the most recent market value of firm assets.
The replacement value, liquidation value, and reproduction value methods provide
more current valuations.
20. *a. Total liabilities* - *Explanation*: To compute book value, you subtract
total liabilities from total assets. The resulting figure represents the net book value
or equity of the firm.

Multiple Choice Problems:

1. D
To calculate the book value per share, follow these steps:
1. *Determine the Total Ordinary Equity*: This is given as Php 120,000.
2. *Find the Number of Ordinary Shares*: This is given as 10,000 shares.
3. *Calculate the Book Value per Share*:
Use the formula: Book Value per Share= Total Ordinary Equity/Number of
Ordinary Shares
Substituting the values: 120K / 10K
So, the correct answer is: *Php 12.00*
2. B
3. B
1.52M – 675K = 845K
845,000/250,000 = 3.38
4. A
5. D
4.45M – 2.6M = 1.85M
6. D
1. Calculate Total Assets: 880000 + 3000000 = 3,880,000
2. Calculate Total Liabilities: 500,000 + 1,500,000 = 2,000,000
3. Calculate Total Equity: 3,880,000 - 2,000,000 = 1,880,000
4. Calculate Book Value per Share: 1,880,000/1,500,000 = 1.25
7. D

8. B

9. A
10.D
11.C
12.B
9. Book Value of Hercules Company as of December 31, 2019

Given:
- Current Assets = Php 750,000
- Non-current Assets = Php 1,400,000
- Current Liabilities = Php 400,000
- Non-current Liabilities = Php 500,000

Step 1: Calculate Total Assets

750,000 + 1,400,000 = 2,150,000
Step 2: Calculate Total Liabilities
400,000 + 500,000 = 900,000
Step 3: Calculate Book Value
2,150,000 - 900,000 = 1,250,000

Thus, the *book value* of Hercules Company as of December 31, 2019, is

*Php 1,250,000*.

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10. Book Value per Share in 2019

Book Value = Php 1,250,000 (from the previous calculation)

Outstanding Ordinary Shares = 1,000,000 shares

{1,250,000 / 1,000,000} = 1.25

Thus, the *book value per share* in 2019 is *Php 1.25*.

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11. Net Working Capital as of December 31, 2020

To calculate *Net Working Capital*, we use the formula:

Net Working Capital = Current Assets- Current Liabilities

First, we need to update the current assets and liabilities for 2020:
- Current Assets in 2020 increased by 25%:
750,000 x 1.25 = 937,500

- Current Liabilities in 2020 increased by 10%:

400,000 x 1.10 = 440,000

#### Step 1: Calculate Net Working Capital in 2020

Net Working Capital = 937,500 - 440,000 = 497,500

Thus, the *net working capital* as of December 31, 2020, is *Php 497,500*.

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12. Book Value per Share as of December 31, 2020
 First, we update the book value for 2020 based on changes in assets,
liabilities, and the new shares issued.

Current Assets: 937,500 (from the previous calculation)

Non-current Assets increased by 20%:
1,400,000 x 1.20 = 1,680,000

Current Liabilities: 440,000 (from the previous calculation)

Non-current Liabilities: Half were paid off, so:
500,000 x 0.50 = 250,000

Step 1: Calculate Total Assets in 2020

Total Assets = 937,500 + 1,680,000 = 2,617,500

Step 2: Calculate Total Liabilities in 2020

Total Liabilities = 440,000 + 250,000 = 690,000
Step 3: Calculate Book Value in 2020
Book Value = 2,617,500 - 690,000 = 1,927,500

Step 4: Calculate Book Value per Share in 2020

In 2020, 250,000 new shares were issued, so the total outstanding shares
are:
1,000,000 + 250,000 = 1,250,000

Now, calculate the book value per share:

Book Value per Share} = 1,927,500 / 1,250,000} = 1.54

Thus, the *book value per share* as of December 31, 2020, is *Php 1.54*.

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*Final Answers*:
- *Book Value as of 2019*: Php 1,250,000
- *Book Value per Share in 2019*: Php 1.25
- *Net Working Capital as of 2020*: Php 497,500
- *Book Value per Share as of 2020*: Php 1.54
13.B
14.D
15.C
16.C

17.A

18.A
 19.C

20.B

Chapter 3 Liquidation Based Valuation

True/False:
1. *True*. Liquidation value refers to the value of a company if it were dissolved
and its assets sold individually. This value represents the amount that can be
gathered if the business is shut down and its assets are sold piecemeal.
2. *True*. Liquidation value represents the net amount that can be gathered if the
business is shut down and its assets are sold piecemeal. This is because it reflects
the amount that would be realized under liquidation conditions.
3. *True*. Liquidation value is often considered the base price or floor price in
valuation exercises. It reflects the minimum value that can be realized if the
company were to be liquidated.
4. *True*. Liquidation value should not be used to value profitable or growing
companies because this approach does not consider the future growth prospects of
the business.
5. *True*. Liquidation value is particularly relevant for dying or failing companies
where liquidation is imminent, to assess whether profits can still be realized from
the sale of the company's assets.
6. *False*. Liquidation value is not unique to firms operating under a proprietorship
or partnership model. It applies to any type of business facing potential liquidation.
7. *True*. Business failure is commonly associated with low or negative returns,
which are early symptoms indicating that a business may close or liquidate.
8. *True*. Insolvency occurs when a company cannot pay its liabilities as they come
due. This is a financial state where short-term obligations exceed available assets.
9. *True*. Bankruptcy is a severe form of business failure where liabilities exceed
the company's assets. It represents a formal legal status where the business cannot
meet its debt obligations.
10. *True*. Divestment can be driven by various internal factors, such as
mismanagement, poor financial decisions, failure to execute strategic plans,
inadequate cash flow planning, or poor management of working capital.
11. *True*. External factors like severe economic downturns, natural calamities,
pandemics, changing consumer preferences, and adverse governmental regulations
can contribute to business failure.
12. *True*. Most corporations and joint ventures have a finite operational lifespan
as stated in their Articles of Incorporation or project agreements, similar to projects
with defined durations or lifespans.
13. *True*. If the business is certain to end, using the going concern value to
compute the terminal value might still be appropriate if the business will continue to
operate until the end of its life.

14. *True*. If a government contract expires or resources are depleted with no new
plans, liquidation may be imminent, making liquidation value relevant for valuation.
15. *False*. Liquidation value is not always the most appropriate method. It’s
suitable when the business is expected to cease operations. If the business is still
operational and expected to continue, going concern or income approach values
might be more appropriate.
16. *False*. If the liquidation value is higher than the going concern value and
liquidation is a consideration, then liquidation value should be used, not ignored.
17. *True*. For businesses with a limited operational life, like quarries, terminal
value should reflect liquidation value, including all associated costs to close
operations.
18. *True*. Non-operating assets are best valued using liquidation methods because
they are not part of the ongoing business operations. If this liquidation value
exceeds the value from operating cash flows, it should be used.
19. *True*. If business continuity relies on current management who will leave,
liquidation value may be more relevant, as the business may not continue as a
going concern.
20. *True*. Analysts can use liquidation value as a benchmark for investment
decisions to assess the potential value if the business were to be liquidated.

21. *True*. When a company is profitable and has a positive industry outlook, the
market price of its shares typically reflects growth potential and is usually higher
than the liquidation value.
22. *True*. Share prices often incorporate future growth prospects, which are not
considered in the liquidation value. Liquidation value only reflects the current
realizable value of assets after deducting liabilities.
23. *True*. For firms in decline or industries that are shrinking, share prices might
be lower than the liquidation value because the market is pessimistic about future
earnings, while liquidation value reflects the immediate realizable value of assets.
24. *False*. The idea that investors can buy shares at the prevailing market price
and sell the company at a higher liquidation value is typically not feasible in
practice due to the complexities and costs involved in liquidation, as well as market
efficiency preventing such arbitrage opportunities.
25. *True*. Liquidation value takes into account the net proceeds from selling
assets, after deducting closure costs, debt repayment, and settlement of liabilities,
including taxes and transaction costs.
26. *True*. To compute the liquidation value per share, divide the total liquidation
value by the number of outstanding ordinary shares.
27. *True*. Liquidation value per share should be considered along with other
metrics, such as current share price and going concern value, to make well-informed
business decisions.
28. *False*. Selling assets strategically over time to maximize value is called
"orderly liquidation." Forced liquidation refers to selling assets quickly, often at
lower prices, due to urgent financial distress.
29. *False*. Orderly liquidation involves selling assets over time in a planned
manner to maximize value, not as quickly as possible. The process described is
more aligned with forced liquidation.
30. *True*. Liquidation value is calculated based on the expected sales price of
assets in a forced or orderly liquidation rather than their book value. Book value,
which is based on historical costs, may not accurately reflect the current realizable
value of the assets in a liquidation scenario.
31. *True*. Liquidation value should be based on the potential sales price of assets
rather than their recorded costs. This approach reflects the actual value that can be
realized from selling the assets.
32. *False*. Liquidation value is not based on the potential earning capacity of
assets when sold. Instead, it reflects the immediate realizable value, which may be
less than the original capital invested or lower than the value generated by assets
in ongoing business operations.
33. *True*. In determining the liquidation value of a business, the liabilities are
subtracted from the liquidation value of the assets. This typically results in a lower
value compared to the going-concern value, which assumes the business will
continue operating and generating profits.
34. *True*. When computing the present value of a business or property on a
liquidation basis, the estimated net proceeds should be discounted to reflect the
risk and timing of the liquidation process, compared to the date of valuation.
35. *False*. Estimating liquidation values can be more complex when assets are
not easily separated or identified. In such cases, individual asset valuation might be
challenging or impractical.

Multiple Choice Theory:

1. b. Liquidation Value* *Explanation:* Liquidation value reflects the net

amount that can be obtained from selling a business's assets individually if the
business is shut down. ###
2. d. If liquidation value becomes higher compared against going concern
value, this may signal that a significant business event transpired which
makes the liquidation value more appropriate in valuation exercise.*
*Explanation:* This statement is incorrect because if liquidation value is higher
than the going concern value, it usually suggests that liquidation might be a more
financially beneficial option, not necessarily that a significant business event has
occurred. It indicates that the business may be better off liquidating rather than
continuing operations.
3. b. Divestment* *Explanation:* Liquidation value is used in cases of business
failure, corporate end of life, or depletion of resources. Divestment, which involves
selling parts of the business while it continues to operate, typically does not use
liquidation value.
4. a. If the liquidation value is below income approach valuation (based on
going-concern principle) and liquidation comes into consideration,
liquidation value should be used.* *Explanation:* This statement is incorrect
because if the liquidation value is lower than the income approach valuation (which
assumes the business will continue), the income approach should generally be
preferred unless liquidation is imminent or inevitable. Liquidation value is
considered only when the business is expected to cease operations, not when it is
lower than the going concern value.
5. Which statement is not correct about liquidation value? - *d. If liquidation
value becomes higher compared against going concern value, this may
signal that a significant business event transpired which makes the
liquidation value more appropriate in valuation exercise.* *Explanation:*
This statement is incorrect because if liquidation value is higher than the going
concern value, it usually suggests that liquidation might be a more financially
beneficial option, not necessarily that a significant business event has occurred. It
indicates that the business may be better off liquidating rather than continuing
operations.
6. These are situations that most likely consider liquidation value, except: - *b.
Divestment* *Explanation:* Liquidation value is used in cases of business failure,
corporate end of life, or depletion of resources. Divestment, which involves selling
parts of the business while it continues to operate, typically does not use liquidation
value.
7. Which of the following is not correct related to liquidation value? - *a. If the
liquidation value is below income approach valuation (based on going-
concern principle) and liquidation comes into consideration, liquidation
value should be used.* *Explanation:* This statement is incorrect because if the
liquidation value is lower than the income approach valuation (which assumes the
business will continue), the income approach should generally be preferred unless
liquidation is imminent or inevitable. Liquidation value is considered only when the
business is expected to cease operations, not when it is lower than the going
concern value.
8. This liquidation process will expose assets for sale on the open market, with a
reasonable time allowed to find a purchaser, both buyer and seller having
knowledge of the uses and purposes to which the asset is adapted and for which it
is capable of being used, the seller being compelled to sell and the buyer being
willing, but not compelled, to buy. - *a. Orderly Liquidation* *Explanation:*
Orderly liquidation involves selling assets with sufficient time to find buyers who are
informed about the asset’s value and uses, unlike forced liquidation where assets
are sold quickly under distressed conditions.
9. Liquidation is done immediately especially if creditors have sued or a bankruptcy
is filed. Assets are sold in the market at the soonest time possible which result in
lower prices because of the rush sale. This ultimately drives down liquidation value.
- *b. Forced Liquidation* *Explanation:* Forced liquidation occurs when assets
are sold quickly, often due to financial distress or bankruptcy, leading to lower
prices and a decreased liquidation value.
10. Which of the following statements is incorrect? - *c. Liquidation value can be
obtained based on the costs recorded in the books.* *Explanation:*
Liquidation value should not be based solely on book costs. It is based on the
realizable value of assets in a liquidation scenario, which may differ from their
recorded costs.
11. This is the situation where liquidation value is considered when insolvency
happens which means when a company cannot pay liabilities as they come due. -
*a. Business Failures* *Explanation:* Liquidation value is relevant in situations
of business failure or insolvency, where the company cannot meet its liabilities and
may need to sell off assets to pay creditors.
12. This is the situation where liquidation value is considered when the number of
years the company can operate is not extended particularly when the primary
objective is reached like in cases of Partnership and Joint Ventures. - *c. Corporate
End of Life* *Explanation:* Liquidation value is relevant when a company’s
operations are ending due to reaching its primary objective or due to the end of its
useful life, such as in partnerships or joint ventures that have a defined end.
13. This is the situation where liquidation value is considered for industries which
purpose are related to highly regulated by the government which are normally
limited like mining and oil. - *d. Depletion of scarce resources* *Explanation:*
In industries like mining or oil, where resources are depleting and the business is
highly regulated, liquidation value becomes important as the resources are finite
and the industry’s operational life is limited.
14. If the nature of the business implies limited lifetime (e.g., a quarry, gravel, fixed-
term company, etc.), the terminal value must be based on liquidation. All costs
necessary to close the operations (e.g., plant closure costs, disposal costs,
rehabilitation costs) should also be factored in and deducted to arrive at the
liquidation value. - *a. Statement is True* *Explanation:* For businesses with a
limited operational life, such as a quarry or fixed-term company, the terminal value
should be based on liquidation value, including all closure and disposal costs.
15. Statement A. In computing for the present value of a business or property on a
liquidation basis, the estimated net proceeds should be discounted at a rate that
reflects the risk involved back to the date of the original valuation. Statement B.
This is important to ensure that all assumptions are aligned. Liquidation value can
be used as basis for terminal cash flow (instead of going concern terminal cash flow)
in a DCF calculation in order to compute firm value in case there are years that the
firm will still be operational prior to liquidation. - *A. Both statements are
correct* *Explanation:* Statement A is correct as the estimated net proceeds
should be discounted to reflect risk. Statement B is also correct as liquidation value
can be used as a terminal value in DCF calculations if the business is expected to be
liquidated after some operational years.

Multiple Choice Problems:

1. D.

2. A
PV of Cashflows =
 (1.15 >> divide sign sa calcu two times then till 5) >> GT >> -1 >> multiply
2M
PV of cash flow – 6M = Value of the Asset
Value of Asset + 6.5M(assets remaining) - 9M(liabs) = 1,795,690
3. B

4. D
(1M x 80% ) – 270 = 530
530/20 = 26.5
5. C
1M shares x 10% = 100K x 10/share = 1M(this is the 10% which Kristine
owns)
1M / .10 = 100M (cathy owns)
6. D
Deduct ra tanan
7. B
50 + 600 – 500 = 150K
8. A
Ngani jud basta orderly liquidation value, gross of liabs pa
9. C
Gross of liab pa sad ni but ang 4M na kanang willing to pay now
10.C (1M-350K = 650K) >> 650K/10 = 65

Chapter 4 Income Based Valuation

True/False;
1. *True* Many investors and analysts estimate the value of a company or asset by
calculating the value of the returns it will yield (income) or generate, such as cash
flow or profits over time.
2. *True* Income is typically based on the amount of money that a company or
asset generates over a specified period of time, such as revenues or cash flows.
3. *True* In income-based valuation, investors often consider two theories: the
dividend irrelevance theory and the bird-in-hand theory, which provide different
perspectives on the relevance of dividends to stock prices.
4. *False* The dividend irrelevance theory was introduced by *Modigliani and
Miller*, not Myron Gordon. It suggests that dividend policy does not affect stock
prices, as stock price is more dependent on the firm’s earning power and risk.
5. *True* The bird-in-hand theory argues that dividends (or immediate returns)
impact the stock price because investors prefer the certainty of dividends over
uncertain capital gains.
6. *False* The bird-in-hand theory (or dividend relevance theory) was developed by
*Myron Gordon* and *John Lintner*, not Miller.
7. *True* Earnings accretion refers to the additional value in a valuation from
factors like potential growth, operating efficiencies, or increased pricing power that
improves the firm's profitability.
8. *False* Earnings dilution typically reduces value, not increases it, as it refers to a
reduction in earnings per share due to circumstances such as issuing more shares.
9. *True* An equity control premium is the amount added to the value of a firm to
reflect the value of gaining control over it, usually higher than just the market value
of shares.
10. *True* Precedent transactions refer to past deals that are comparable to the
current investment or acquisition being evaluated, helping assess value.
11. *True* In income-based approaches (like discounted cash flow), a key driver is
the cost of capital or the required return, which dictates how future income is
discounted back to present value.
12. *True* The cost of capital can be computed using the Weighted Average Cost of
Capital (WACC) or the Capital Asset Pricing Model (CAPM).
13. *True* The WACC formula is often used to determine the minimum required
return a company needs to generate to satisfy investors. 14. *True* WACC can
include various sources of financing, such as preferred stock and retained earnings,
which are factored into the overall cost of capital.
15. *True.* The cost of equity can be derived using the Capital Asset Pricing Model
(CAPM), which estimates the return required by equity investors based on the risk-
free rate, the equity beta, and the market risk premium.
16. *True.* The cost of capital is a major driver in determining equity value using
income-based approaches, such as discounted cash flow (DCF) analysis, where it
serves as the discount rate.
17. *False.* The most conventional way to determine the value of an asset is
typically through methods such as discounted cash flow (DCF) or market
comparables, not necessarily through economic value added (EVA). EVA is used to
assess performance rather than direct valuation.
18. *True.* Economic Value Added (EVA) is a metric used to evaluate investment
performance by measuring the ability of a firm to generate returns above its cost of
capital. It helps assess whether the firm is creating value.
19. *True.* EVA represents the excess of a company’s earnings over the cost of
capital. It indicates the value generated beyond the required return. 20. *True.* The
general concept of EVA is that higher excess earnings (i.e., positive EVA) indicate
better performance and value creation for the firm.
21. *False.* The cost of debt is not tax-exempt; rather, it is tax-deductible. This
means that the interest expense on debt provides a tax benefit by reducing taxable
income.
22. *False.* Cost of equity is generally considered riskier than the cost of debt
because equity investors require a higher return due to the higher risk they bear.
Cost of debt, while having interest rates that can vary, is generally less risky
because it is secured and has a lower return requirement.
23. *True.* One of the elements to consider when using EVA is the reasonableness
of the earnings or returns, as unrealistic earnings projections can lead to misleading
EVA results.
24. *True.* The value of a company can be associated with anticipated returns or
earnings, based on historical performance and future projections. This is often used
in valuation methods such as discounted cash flow analysis.
25. *True.* In the capitalization of earnings method, earnings are typically
interpreted as resulting cash flows from operations. If cash flow information is
unavailable, net income may be used as an alternative.
26. *True.* In the capitalization of earnings method, the value of the asset or
investment is determined by dividing the anticipated earnings by the capitalization
rate (i.e., cost of capital).
27. *True.* The capitalization of earnings method involves estimating the earnings
of the company, applying the expected yield or required rate of return, and
determining the estimated equity value based on these inputs.
28. *True.* If future earnings are fixed, the capitalization rate is applied directly to
these projected fixed earnings to determine value in the capitalization of earnings
method.
29. True When future earnings vary, the recommended approach is to calculate the
average of all anticipated cash flows and use this average in the capitalization of
earnings method.
30. *False* Capitalized earnings only represent the assets that generate income or
earnings. Idle assets that do not contribute to generating income are generally not
included in the capitalized earnings method.
31. *True* One limitation of the capitalization of earnings method is that it may not
fully capture future earnings or cash flows, which can lead to over- or
undervaluation.
32. *True* When using EVA, it's important to use an appropriate cost of capital, as it
directly affects whether the firm's earnings exceed this threshold and create value.
33. *True* The capitalization of earnings method often does not account for
contingencies like changes in market conditions, which can affect future earnings.
34. *True* A limitation of the capitalization of earnings method is that assumptions
about future cash flows may be incorrect, especially since projections are typically
based on a limited time horizon.
35. *True* Discounted Cash Flow (DCF) is one of the most popular methods for
valuing companies, as it is detailed and considers future cash flows, making it
widely used by investors, analysts, and valuators.
36. *True* DCF is often considered more verifiable than simpler methods because it
uses detailed assumptions about future cash flows, discount rates, and time
periods, leading to a more nuanced valuation.
37. *True* The DCF model calculates equity value by determining the present value
of the firm’s projected future net cash flows, discounted at an appropriate rate to
reflect the cost of capital.
38. *True* There is no single perfect method for determining a company's value, as
each has its own assumptions and limitations. This is why assessing future earnings
can have drawbacks.
39. *False* The *income-based approach* focuses on projected cash flows or
earnings, while the statement refers to characteristics more aligned with the
*market approach*, which uses real-world transactions and comparable market
data to derive value.
40. *True* The mechanics of the income-based approach often involve using a price
multiple (such as the price-to-earnings ratio, EV/EBITDA, or price-to-book value),
which is then multiplied by a relevant financial metric to estimate value.

Multiple Choice Theory:

1. *a. Income Based Valuation Approach* The income-based valuation approach
focuses on a company's ability to generate future revenue, profit, and wealth,
making it the most fitting answer.
2. *b. Economic Value Added, Capitalization of earnings method, and
discounted cashflow method* These are income-based valuation techniques, as
they focus on future earnings and returns, which are core to the income approach.
3. *b. Discounted Cashflows Method Approach* The discounted cash flow
(DCF) approach calculates the equity value by determining the present value of
expected future net cash flows or profits, discounting them to account for risk.
4. *b. Discounted Cashflows Analysis* DCF uses earnings forecasts and terminal
value estimates, discounting these future values to the present, making it the
correct method for estimating a firm’s worth based on future earnings.
5. *d. Going Concern Model* The going concern model refers to a company's
ability to continue operating, not a method to estimate terminal value. Common
methods for terminal value estimation include the liquidation value model, multiples
approach, and stable growth approach.
6. *d. both b and c* In income-based valuation, investors consider the *bird-in-
hand theory* and the *dividend irrelevance theory* as opposing perspectives
on the relevance of dividends to stock prices.
7. *c. dividend irrelevance theory* Modigliani and Miller introduced the
*dividend irrelevance theory*, which argues that stock prices are not affected by
dividends but by the company’s ability to sustain its earnings and growth.
8. *d. both a and b* Both the *dividend relevance theory* and the *bird-in-
hand theory* believe that dividends or capital gains impact the stock price.
9. *a. earnings approach* The *earnings approach* is another term for the
income-based valuation approach, as it focuses on a company's ability to generate
earnings
10. *a. earning accretion* *Earning accretion* refers to the additional value
added in a calculation to account for factors such as potential growth, price
increases, and operating efficiencies that enhance the firm's value.
11. *b. earning dilution*
*Earning dilution* refers to a reduction in earnings or value, often due to factors
like issuing additional shares or other negative circumstances that may reduce the
firm’s value.
12. *c. equity control premium*
The *equity control premium* is the amount added to the value of the firm to
reflect the value of gaining control over it.
13. *b. equity accretion or dilution*
While earning accretion, equity control premiums, and precedent transactions are
relevant to valuation, *equity accretion or dilution* is not typically a direct factor in
income-based valuation approaches.
14. *d. precedent transaction*
*Precedent transactions* refer to previous deals or transactions that are
comparable to the investment being evaluated, used to assess the value of a firm.
15. *a. earning accretion or dilution*
*Earning accretion or dilution* represents risks that may affect the firm's future
ability to realize projected earnings, either increasing (accretion) or reducing
(dilution) value.
16. *d. cost of capital*
The *cost of capital* is used to discount future net cash flows, reflecting the
required return on the investment and accounting for risk.
17. *c. cost of capital; weighted average cost of capital; capital asset
pricing model* The *cost of capital* is calculated using the *weighted average
cost of capital (WACC)*, which takes into account the weighted cost of different
sources of funds (debt and equity). The *capital asset pricing model (CAPM)* is
typically used to calculate the cost of equity.
18. *a. weighted average cost of capital; capital; cost of capital* *Weighted
average cost of capital (WACC)* calculates a firm's *cost of capital*, where
each category of *capital* (debt and equity) is proportionately weighted based on
its contribution to the firm's capital structure.
19. *a. used to represent volatility/risk of the market* The *beta* in the
Capital Asset Pricing Model (CAPM) measures the *volatility or systematic risk*
of a stock in comparison to the market as a whole.
20. *c. EVA is the excess of the company's equity after deducting the cost
of capital* This statement is incorrect. EVA represents the excess *earnings* of a
company after deducting the cost of capital, not the excess of equity. EVA focuses
on whether the firm generates value over its cost of capital
21. *c. Volatility of the market* *Volatility of the market* is not a direct
consideration when calculating Economic Value Added (EVA). EVA primarily focuses
on the firm's *earnings* and the *appropriate cost of capital* to determine
whether the firm is generating value above its cost of capital.
22. *b. Capitalization of Earnings Method* The *Capitalization of Earnings
Method* determines the value of an asset or investment by dividing the
anticipated earnings of the company by the cost of capital or capitalization rate.
23. *c. The formula used in Capitalization of Earnings is actually grossing
up the future earnings using capitalization rate to come up with the
estimated asset value.* This statement is incorrect. The capitalization of earnings
method uses *current or past earnings* rather than grossing up future earnings.
It divides earnings by the capitalization rate to estimate the asset’s value, but
doesn't focus on grossing up future earnings.
24. *b. Idle Assets* *Idle assets*, which do not contribute to generating income,
are not included in the computation under the capitalization of earnings method and
thus need to be added separately to the capitalized earnings.
25. *d. It is simple and convenient* This is not a *limitation* of the
capitalization of earnings method but rather a benefit. The method’s simplicity is
one of its strengths, though it has other limitations, like not fully accounting for
future cash flows or contingencies.
Multiple Choice Problems:
1. A
400K/4M = 10%
500-100 = 400K/10% = 4M
2. B
 40Kx4 = 160K
160k/4M = .04
600K – 500K = 100k / .04 = 2.5M
3. C
6M-1M = 5M base value
1M-600k = 400k
400k/5M = 8%
4. A
750 x 12 = 9k annual income
9k – 5k = 4k annual roi
4k/.10 = 40k
5. A
Get the average then divide by 10%
6. B Get the average then divide by 8%
7. A
Debt to Equity
3:1
Debt: 75%
Equity: 25%
WACC = (75% x 5%) + (25% x 10%) = 6.25%
Cost of capital = 1B x 6.25% = 62.5M
100M – 62.5M = 37.5M
8. C
Debt to ratio: 75:1
1.75 units
Debt: (75/1.75 = .4286)
Equity: (1/1.75 = .5714)
.43 x .04 ) + (.57 x .05) = 4.5%
9. B
10. A
11. B
Get CAPM first: 9.5% (cost of equity)
Cost of Debt: risk free rate + credit spread = 8%
Get the WACC:
(.30 x 9.5%) + (.08 x (1-.30) x 70%) = 6.775
12. A
Cost of debt: 7% (3+4)
After tax sa cost of debt: 4.9%

13. C
14. A
15. B
16. A
17. B
18. B
19. B
20. D
Chapter 5 Discounted Cash Flows Method
Discussion

*EBITDA* stands for *Earnings Before Interest, Taxes, Depreciation, and

Amortization*.
It measures a company's operating performance by focusing on profitability from
core operations, excluding effects of financial structure (interest and taxes) and
non-cash accounting entries (depreciation and amortization).
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
EBITDA MARGIN = EBITDA / Revenue
Or alternatively, if you start with *Operating Income* or *Operating Profit* (also
known as EBIT): EBITDA} = Operating Income + Depreciation + Amortization
Key Components:
1. *Net Income*: The company's profit after all expenses (including interest and
taxes).
2. *Interest*: The cost a company pays on its debt (financial expense, not directly
related to operations).
3. *Taxes*: Government taxes (income tax, etc.), which are not related to core
operations.
4. *Depreciation*: The reduction in value of tangible fixed assets (buildings,
machinery, etc.).
5. *Amortization*: The reduction in value of intangible assets (patents,
trademarks, goodwill, etc.).
Step-by-Step Calculation:
1. *Start with Net Income*: Begin with the company’s net income (found on the
income statement).
2. *Add Back Interest Expense*: Interest is excluded in EBITDA because it relates
to how the business is financed, not to operational performance.
3. *Add Back Taxes*: Taxes are excluded because they vary based on jurisdiction
and tax rates, and aren't related to core operations.
4. *Add Back Depreciation and Amortization*: These are non-cash expenses, so
they're added back to reflect operating cash flow more clearly.
Example Calculation: Assume a company reports the following:
Net Income: Php 15,000
Interest Expense: Php 1,000
Taxes: Php 2,000
Depreciation: Php 500
Amortization: Php 250
To calculate EBITDA: 1. Start with Net Income: Php 15,000 2. Add back Interest: Php
1,000 3. Add back Taxes: Php 2,000 4. Add back Depreciation: Php 500 5. Add back
Amortization: Php 250 \[ \text{EBITDA} = 15,000 + 1,000 + 2,000 + 500 + 250 =
Php 18,750
Why EBITDA Matters:
*Measures core profitability*: It strips away financing, accounting, and tax
decisions to focus purely on operational performance.
*Cash-flow proxy*: As it excludes non-cash expenses like depreciation, it provides
a clearer view of cash flow from operations.
*Comparable across industries*: Because it excludes interest and taxes, it's
useful to compare companies with different capital structures.
Common Adjustments: *Non-recurring expenses*: Sometimes companies adjust
EBITDA for non-operational, one-off costs (like restructuring expenses or legal
settlements).

EBIT (Operating Income) = Revenue – Operating Expenses (including

Depreciation and Amortization)
= Revenue – Operating exp – Depreciation and Amortization
Vs
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
EBIT (Earnings Before Interest and Taxes): • Depreciation is deducted
when calculating EBIT because EBIT measures a company’s profitability
after accounting for operating expenses, which include non-cash expenses
like depreciation and amortization. • EBIT is essentially operating income.
It shows how much profit the company is making from its operations
before paying interest and taxes, but after deducting all operating
expenses, including depreciation.
True/False:
1.
2.

Multiple Choice Theory:

1. *These are business opportunities that have a long-term to infinite
operational period:* - *b. Perpetual Business Opportunities* - *Why*:
"Perpetual" refers to something that continues indefinitely or for an infinite period.
In business, perpetual business opportunities imply opportunities that are expected
to remain viable and operational over a very long term, potentially indefinitely.
2. *This refers to the amount of cash available for distribution to both debt
and equity claimants from the business or asset:* - *d. Net Cash Flows* -
*Why*: Net Cash Flows encompass all the cash generated by the business after
accounting for operating, investing, and financing activities. It represents the cash
available to both debt and equity holders after all necessary cash outflows have
been met.
3. *In determining the value of equity using discounted cash flows, _______
are comprised by activities based on operating and investing activities,
then adjusted by the financing activities to determine the _____, which is
the basis for equity value:* - *a. Net Cash Flows to the Firm; and Net Cash
Flows to Equity* - *Why*: - "Net Cash Flows to the Firm" refers to the cash flows
available to all providers of capital (both debt and equity), which includes cash flows
from operating and investing activities. - "Net Cash Flows to Equity" are derived
from the Net Cash Flows to the Firm after adjusting for financing activities, such as
interest payments and debt repayments. This represents the cash available to
equity shareholders and is used to determine the equity value of the firm.
4. *This represents the cash flows made available to both debt and equity
claims against the company:* - *a. Net Cash Flows to the Firm* - *Why*: Net
Cash Flows to the Firm include cash flows that are available to all capital providers—
both debt and equity holders. It represents the total cash flow generated by the
firm's operations and investments, before financing costs are considered.
5. *This represents the amount of cash flows made available to the equity
stockholders after deducting the net debt or the outstanding liabilities to
the creditors less available cash balance of the company:* - *c. Net Cash
Flows to Equity* - *Why*: Net Cash Flows to Equity is the cash flow available to
equity shareholders after accounting for all financing activities, including interest
payments, debt repayments, and other obligations. It is essentially the cash left for
shareholders after meeting all creditor claims and adjusting for net debt and
available cash balances.
6. *This represents the value of the company in perpetuity or in a going
concern environment:* - *a. Terminal Value* - *Why*: Terminal Value
represents the value of a company at the end of a forecast period extending
indefinitely into the future. It is used in discounted cash flow (DCF) analysis to
estimate the value of a company assuming it continues to operate indefinitely.
7. *DCF Analysis is most applicable to use when the following are
available, except:* - *c. Cash flow pricing multiples* - *Why*: Discounted
Cash Flow (DCF) Analysis focuses on estimating the value of a company based on
its projected cash flows and discount rate. Cash flow pricing multiples, which are
used in valuation based on comparative metrics, are not directly used in DCF
analysis.
8. *The following statements are fallacy on financial modelling concept
except:* - *d. Operations Managers are good candidates for this role given
their ability to understand operational models and design long-term
financial strategies.* - *Why*: Financial modeling is a complex and confidential
activity, and while financial modelers typically have strong financial skills,
operations managers with a deep understanding of operations and strategic
planning can indeed be valuable in financial modeling. The other statements
contain inaccuracies about financial modeling being non-confidential, modelers
lacking financial acumen, and the role of financial modelers.
9. *The following are truths about gathering information except for:* - *d.
Statement of Income are used to determine the historical financial
performance.* - *Why*: While the Statement of Income (or Income Statement) is
used to assess historical financial performance, it is not the only document used.
The statement of income alone doesn’t provide a complete picture; comprehensive
historical analysis typically requires additional information such as the balance
sheet and cash flow statements.
10. *These are the most ideal reference for the historical performance of
the company:* - *a. Audited Financial Statements* - *Why*: Audited Financial
Statements are considered the most reliable reference for assessing a company’s
historical performance because they are verified by external auditors for accuracy
and compliance with accounting standards.

11. *This component of Audited Financial Statement is used to determine

the historical financial performance:* - *b. Statement of Income* - *Why*:
The Statement of Income (or Income Statement) shows the company's revenues,
expenses, and profits over a specific period, providing a clear view of its historical
financial performance.
12. *This component of Audited Financial Statement is used to determine
the book value of the assets and the disclosed stakes of debt and equity
financiers:* - *c. Statement of Financial Position* - *Why*: The Statement of
Financial Position (or Balance Sheet) provides details on the company's assets,
liabilities, and equity, which helps determine the book value of assets and the
financial structure of debt and equity.
13. *This component of Audited Financial Statement is used to illustrate
how the company historically financed its operations and investments:* -
*d. Statement of Cash Flows* - *Why*: The Statement of Cash Flows details the
cash inflows and outflows from operating, investing, and financing activities,
showing how the company has financed its operations and investments.
14. *This is one of the most important components of the financial
statements which provides the summary of important disclosures that
should be considered in the valuation:* - *d. Notes to Financial
Statements* - *Why*: The Notes to Financial Statements provide detailed
explanations and additional context about the numbers in the financial statements,
including significant accounting policies, risks, and other important disclosures
relevant for valuation.
15. *Collectively, the financial model must be able to filter the information
that would be necessary for the valuation. What are the two
characteristics of information that are considered very important in
financial modelling?* - *b. Reliability and Relevance* - *Why*: Reliable
information ensures accuracy and consistency, while relevant information directly
impacts decision-making and valuation. Both characteristics are crucial for creating
a credible and useful financial model.
16. *Drivers for growth used in financial modelling are suggested to be
those validated and represented by authorities like government or
experts. The following government agencies provide this information
except:* - *c. Research Centers funded by Local Government Units* -
*Why*: While government agencies like the Philippine Statistics Authority and the
Bangko Sentral ng Pilipinas provide validated economic and financial data, research
centers funded by local government units might not always be considered
authoritative or comprehensive sources for growth drivers in financial modeling.

17. *The usual growth indicators used in financial modelling are as follows,
except:* - *a. Gross National Product* - *Why*: Gross National Product (GNP) is
an indicator of economic performance at a broader level and is less commonly used
as a direct growth indicator in financial modeling compared to indicators like
inflation, population, and the consumer price index.
18. *_____ growth rate is factored in to serve as a growth driver for the
demand of the product, particularly for the merchandising or
manufacturing business:* - *c. Population* - *Why*: Population growth rate is
often used as a growth driver in financial modeling, especially for businesses related
to consumer goods and services, as it directly impacts market demand and
potential sales volume.
19. *The ____ can be used to determine the appropriate cost of capital by
weighing the portion of the asset that was funded through equity and
debt:* - *a. Weighted Average Cost of Capital* - *Why*: The Weighted Average
Cost of Capital (WACC) calculates the average cost of capital by weighting the cost
of equity and the cost of debt according to their proportions in the company's
capital structure. It is used to determine the overall cost of capital for a company.
20. *This will serve as the dashboard to enable the modelers to analyze the
results and to facilitate the readers' appreciation of the results of the
project:* - *a. Data Key Results* - *Why*: Data Key Results typically summarize
and present the most important outcomes and findings of the financial model in an
accessible format, acting as a dashboard for analysis and review.
21. *This refers to the theoretical value of the core activities of a business
entity as reflected in its net cash flows:* - *a. Enterprise Value* - *Why*:
Enterprise Value represents the total value of a business based on its core
operations and net cash flows, including both equity and debt. It provides a
comprehensive valuation of the company's core activities.
22. *Which of the following is not a type of non-cash charge that is
included in the computation of net income?* - *d. After-tax interest
expense* - *Why*: After-tax interest expense is a cash flow item, not a non-cash
charge. Non-cash charges include depreciation, amortization, and impairment of
pension assets, which affect net income but do not involve cash transactions.
23. *This item represents the net investment in current assets like
receivables and inventory reduced by current liabilities:* - *b. Investment
in operating capital* - *Why*: Investment in operating capital (also known as net
working capital) is calculated as current assets (such as receivables and inventory)
minus current liabilities. It reflects the net amount of capital invested in the day-to-
day operations of the business.
24. *When computing net cash flows from EBITDA, which of the following
items should be added back to EBITDA?* - *c. After-tax non-cash charges* -
*Why*: EBITDA is calculated before interest, taxes, depreciation, and amortization.
To find net cash flows, you need to add back non-cash charges such as depreciation
and amortization that were initially deducted to arrive at EBITDA.
25. *This signifies the level of available cash that a business can freely
declare as dividends to its common shareholders:* - *a. Net Cash Flow to
Equity* - *Why*: Net Cash Flow to Equity represents the cash available to equity
shareholders after accounting for all operating expenses, taxes, interest, and other
obligations. This is the cash available for distribution as dividends.

Multiple Choice Problems:

1. A
Only deduct the depreciation expense from the operating expense.
Deduct the computed operating expense from revenue.s
2. C
EBITDA Margin = EBITDA / Revenue
3.
Net Cash Flow = EBITDA – Taxes – Capital Expenditure
4. C
Get first the Net Income: Rev - OpEx – Dep – Interest – Tax
Then add back the Depreciation (or Amort) then deduct any cash
disbursement
5. C
Katong usual, eadd ra tanan after gi discount each
6. 1
7. 1
8. 1
9. 1
10.1
11.1
12.1
13.1
14.1
15.1
16.1
17.1
18.1
19.1
20.1
CHAPTER 6 Market Approach Valuation
DISCUSSION
This method is commonly used in finance to evaluate a company's valuation by
comparing it to similar firms in the same industry or sector. Here's a general
overview of how it's performed:
Steps in Comparable Company Analysis:
1. *Identify Comparable Companies*: - Choose companies operating in the same
industry, with similar revenue sizes, market shares, growth rates, and business
models.
2. *Determine Valuation Metrics*: - Common metrics used include: -
*EV/EBITDA* (Enterprise Value to Earnings Before Interest, Taxes, Depreciation,
and Amortization) - *P/E Ratio* (Price to Earnings) - *EV/Sales* (Enterprise Value
to Sales) - *Price to Book Ratio*
3. *Collect Data*: - Find the necessary financial data for both the target company
and its comparables. This includes revenue, earnings, stock price, and market
capitalization. Sources like financial statements, Bloomberg, and stock market
databases are helpful.
Formulas:
P/E ratio
The *P/E ratio* (Price-to-Earnings ratio) is a financial metric used to evaluate the
valuation of a company. It is one of the most widely used ratios in stock market
analysis and investing. Here's what it measures:
Definition: - *P/E Ratio* = *Price per Share* / *Earnings per Share (EPS)* It compares
the market price of a company's stock to its earnings per share (EPS), giving
investors an idea of how much they are paying for each dollar of the company's
earnings.
Interpretation:
1. *High P/E Ratio*: - Indicates that the market has high expectations for future
growth in the company's earnings. Investors are willing to pay a premium for the
stock. - It can also mean the stock is overvalued compared to its current earnings.
2. *Low P/E Ratio*: - Suggests the stock is undervalued or that the company is
facing challenges that might lower future earnings. - Sometimes, it can indicate that
the stock is a good value or that investors are pessimistic about its future prospects.
Example: - Suppose a company's stock is trading at $100 per share, and its
earnings per share (EPS) is $5.
The P/E ratio would be: - *P/E Ratio* = $100 (Price per Share) ÷ $5 (EPS) = 20 This
means investors are willing to pay $20 for every $1 of earnings the company
generates. Types of P/E Ratios: 1. *Trailing P/E*: - Based on the company's earnings
over the past 12 months (actual performance). 2. *Forward P/E*: - Based on
projected or forecasted earnings over the next 12 months, reflecting investor
expectations.
Limitations:
*P/E Ratio varies by industry*: Some industries, like tech, have naturally higher P/E
ratios due to growth potential, while others, like utilities, tend to have lower P/E
ratios.
*Doesn't reflect growth rate*: A high P/E ratio may be justified if the company has a
high growth rate, while a low P/E ratio may not indicate good value if the company's
growth prospects are poor.
In summary, the P/E ratio is a quick way for investors to assess whether a stock is
valued, overvalued, or undervalued compared to its earnings, though it should be
used alongside other metrics for a comprehensive analysis.
Book to Market
The *Book-to-Market Ratio (B/M Ratio)* is a financial metric used to compare a
company's book value to its market value. It provides insight into whether a stock
may be undervalued or overvalued by the market.
Definition:
*Book-to-Market Ratio (B/M)* = *Book Value per Share* / *Market Value per
Share* Where: - *Book Value per Share* is the value of the company's net assets
(total assets minus total liabilities) divided by the number of shares outstanding. –
*Market Value per Share* is the current stock price in the market.
Interpretation:
1. *High Book-to-Market Ratio (B/M > 1)*: - A ratio above 1 suggests that the
company's book value exceeds its market value. This could indicate that the stock is
undervalued by the market, potentially signaling a buying opportunity. - However, it
might also suggest that investors have a negative outlook on the company, possibly
due to poor future growth prospects or financial struggles.
2. *Low Book-to-Market Ratio (B/M < 1)*: - A ratio below 1 implies that the
market values the company more than its book value. This is common in growth
companies where investors expect future earnings to be strong. - While it indicates
investor confidence, it could also mean the stock is overvalued if the company fails
to meet growth expectations.
Example: If a company has a book value of $500 million and its market value (total
market capitalization) is $1 billion, the book-to-market ratio would be: - *B/M
Ratio* = $500 million ÷ $1 billion = 0.5 In this case, the company's market value is
twice its book value, which may indicate that investors expect strong future growth.
### Why it Matters: - *Value Stocks*: Stocks with a high book-to-market ratio
(often called "value stocks") may be seen as undervalued and are typically favored
by value investors. These investors seek stocks that trade below their intrinsic
value. - *Growth Stocks*: Stocks with a low book-to-market ratio (often called
"growth stocks") are typically more expensive in terms of book value but are
expected to deliver higher future growth, making them attractive to growth
investors. ### Limitations: - *Doesn’t capture intangible assets*: Book value
doesn't account for intangible assets like brand value, intellectual property, or
goodwill. As a result, companies with significant intangible assets may have a low
B/M ratio even if they are not overvalued. - *Industry differences*: Companies in
different industries may naturally have higher or lower book-to-market ratios,
making cross-industry comparisons difficult. For example, tech companies often
have low B/M ratios because much of their value comes from intangible assets and
future growth potential. ### Comparison with P/E Ratio: - While the *P/E ratio*
focuses on a company’s earnings relative to its market price, the *Book-to-Market
ratio* compares the company’s asset value to its market price, providing a different
angle on valuation. Both metrics are used together by investors to gauge a stock’s
valuation, and the B/M ratio is particularly useful for value-oriented investors
looking for potentially underpriced stocks.
DIVIDEND YIELD ratio
The *Dividend Yield Ratio* is a financial metric that measures the income generated
by a stock in the form of dividends, relative to its current stock price. It’s commonly
used by income-focused investors to assess how much cash flow they can expect
from holding a particular stock, particularly in dividend-paying companies.
Formula: - *Dividend Yield* = *Annual Dividends per Share* / *Price per Share*
Interpretation:
1. *High Dividend Yield*: - A higher dividend yield indicates that a stock is providing
a larger dividend income relative to its price. This can be attractive to investors
seeking income, such as retirees. - However, a very high dividend yield may be a
warning sign that the company’s stock price has fallen sharply due to financial
troubles, or the dividend may not be sustainable.
2. *Low Dividend Yield*: - A lower dividend yield means the company is paying out a
smaller percentage of its share price as dividends. This is common for growth
companies that prefer to reinvest earnings into the business rather than pay out
large dividends. - It could also mean the stock price has risen significantly, which
can reduce the yield even if the dividend amount remains unchanged.
Importance: - *Income Generation*: Dividend yield is crucial for income investors
who rely on dividends as a source of regular income. They prefer stocks with higher
yields, but also look for companies that consistently pay and grow their dividends. -
*Risk Indicator*: Sometimes, a very high dividend yield could indicate potential risk.
For example, if the stock price has dropped significantly, the yield will rise, but this
could signal problems with the company’s financial health. - *Investment Strategy*:
- *Value Investors* may look for high-yield stocks that are undervalued. - *Growth
Investors* may prioritize stocks with lower yields but stronger capital appreciation
prospects. ### Types of Dividend Yield: 1. *Forward Dividend Yield*: - Uses
projected dividends over the next 12 months. It reflects future expectations of
dividend payouts. 2. *Trailing Dividend Yield*: - Uses dividends paid over the past 12
months. It reflects the actual yield based on historical payouts. ### Comparison to
Other Metrics: - *Payout Ratio*: While the dividend yield shows the ratio of
dividends to the stock price, the *payout ratio* shows the percentage of earnings
paid out as dividends. It helps investors assess whether the dividend is sustainable.

EBITDA Multiple
The *EBITDA Multiple* (often referred to as the *EV/EBITDA* ratio) is a financial
metric used to assess the value of a company by comparing its *Enterprise Value
(EV)* to its *EBITDA* (Earnings Before Interest, Taxes, Depreciation, and
Amortization). This multiple is frequently used in valuation to compare companies
within the same industry or sector. ### Formula: - *EBITDA Multiple (EV/EBITDA)* =
*Enterprise Value (EV)* / *EBITDA* Where: - *Enterprise Value (EV)* is the total value
of the company, including its equity value (market capitalization), debt, and minus
cash. It represents the theoretical takeover price if the company were to be
acquired. - *EBITDA* is a measure of a company’s operating performance, providing
an approximation of cash flow generated from operations, before the effects of
financing and accounting decisions like taxes, interest, and depreciation.
Interpretation: 1. *High EBITDA Multiple*: - A higher multiple suggests that the
market values the company at a premium relative to its earnings. This could
indicate expectations for strong growth, superior profitability, or a competitive
position in the market. - However, a high multiple might also mean the stock is
overvalued.
2. *Low EBITDA Multiple*: - A lower multiple suggests the company is valued at a
discount relative to its earnings. This could signal an undervalued stock or one with
lower growth prospects. - It could also indicate that the company is experiencing
financial or operational difficulties.
Example: Suppose a company has an enterprise value of $2 billion and generates
an EBITDA of $200 million. The EV/EBITDA multiple would be: - *EV/EBITDA* = $2
billion ÷ $200 million = 10 This means the company is valued at 10 times its
EBITDA. ### Why It’s Important: 1. *Comparable Company Analysis*: - The EBITDA
multiple is widely used to compare companies within the same industry, as it
neutralizes the impact of different capital structures (debt vs. equity) and
accounting policies (e.g., depreciation methods). 2. *Valuation Tool*: - The
EV/EBITDA ratio is a popular tool in mergers and acquisitions (M&A) to estimate a
company's value. It's often preferred over the P/E ratio because EBITDA gives a
better picture of operational performance by excluding non-operating expenses. 3.
*Capital-Intensive Companies*: - Companies with significant capital expenditures
(e.g., in industries like manufacturing or telecom) often use the EV/EBITDA multiple
for valuation, as it excludes depreciation, which can distort earnings in these
capital-heavy industries. ### Advantages: - *Ignores Non-Operating Costs*: Since it
excludes interest, taxes, depreciation, and amortization, EBITDA gives a clearer
picture of operational performance, making it easier to compare companies with
different capital structures. - *Good for Cash Flow Approximation*: EBITDA can be
seen as a proxy for cash flow from operations, making the multiple useful for
companies with high depreciation or interest expenses. ### Disadvantages: -
*Ignores Debt and CapEx*: EBITDA does not account for capital expenditures,
changes in working capital, or debt repayments, all of which are crucial to
understanding a company's true cash flow. - *Can Be Misleading*: EBITDA can
overstate profitability, especially for companies with large debt loads or high capital
expenditures, since it doesn’t account for necessary costs like interest or asset
depreciation. ### Typical Range of EBITDA Multiples: - *Industry-specific*: EBITDA
multiples vary widely by industry. For example: - High-growth tech companies may
trade at higher multiples (e.g., 15x–30x or more). - Stable, low-growth industries
(e.g., utilities) may trade at lower multiples (e.g., 5x–10x). In summary, the *EBITDA
multiple* is a valuable tool for comparing and valuing companies, particularly in
capital-intensive industries, as it focuses on core operational performance while
ignoring non-operating factors.

True/False:
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Multiple Choice Theory:
1.
2.

Multiple Choice Problem:

1.