Financial Statement Analysis
Test Preparation
Course Introduction
Financial Statement Analysis introduces students to the techniques and tools used to evaluate the financial health and performance of businesses through their published financial reports. The course covers the interpretation of balance sheets, income statements, and cash flow statements, with a focus on ratio analysis, trend analysis, and benchmarking against industry standards. Students will learn to assess profitability, liquidity, solvency, and operational efficiency, gaining insights for decision-making by various stakeholders such as investors, creditors, and management. The course also addresses limitations of financial statements, the impacts of accounting choices, and the importance of non-financial information in comprehensive business analysis.
Recommended Textbook
Valuation Measuring and Managing the Value of Companies 6th Edition by McKinsey
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576 Verified Questions
576 Flashcards
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Chapter 1: Why Value Value
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Sample Questions
Q1) Which of the following was most responsible for the Internet boom and bust?
A)The Y2K bug.
B)Increased foreign competition.
C)A misapplication of the principle of leverage.
D)A single-minded focus on growth at any cost.
Answer: D
Q2) Which of the following have been found to occur in companies that adopt long-term value-creation policies?
I.Higher customer satisfaction.
II.Higher number of acquisitions.
III.Better treatment of former employees.
IV.A higher level of corporate responsibility.
A)I and II only.
B)I,III,and IV only.
C)II and III only.
D)III and IV only.
Answer: B
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Page 3
Chapter 2: Fundamental Principles of Value Creation
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Sample Questions
Q1) When ROIC equals the cost of capital,there is no relationship between growth and value.
A)True
B)False
Answer: True
Q2) Focusing on improving earnings and short-term cash flow will consequently lead to value creation.
A)True
B)False
Answer: False
Q3) When a company has an ROIC greater than its cost of capital,faster growth increases value,but when it has an ROIC less than its cost of capital,what is the effect on value?
A)Faster growth creates value.
B)Faster growth destroys value.
C)Growth doesn't impact value creation.
D)None of the above are true.
Answer: B
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4
Chapter 3: Conservation of Value and the Role of Risk
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Sample Questions
Q1) The conservation of value principle states that anything that does not increase cash flows does not increase value.
A)True
B)False
Answer: True
Q2) Changes in accounting techniques that decrease reported profits will necessarily decrease the value of a firm.
A)True
B)False
Answer: False
Q3) Since diversifiable risks are not priced into the cost of capital,executives can ignore such risks.
A)True
B)False
Answer: False
Q4) A company cannot create value through sale-leaseback transactions.
A)True
B)False Answer: False
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Chapter 4: The Alchemy of Stock Market Performance
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Sample Questions
Q1) What is the zero-growth return?
A)10.0 percent.
B)14.4 percent.
C)3.0 percent.
D)7.0 percent.
Q2) What was the expected return on the investment as on January 1,2014?
A)110 percent.
B)10 percent.
C)20 percent.
Q3) Which of the following are problems with expressing total returns to shareholders (TRS )in the traditional three-component format?
I.It does not distinguish the source of earnings growth.
II.It excludes return from moves in the overall market.
III.It does not account for the impact of financial leverage.
IV.It does not recognize that dividend yield can affect future earnings.
A)I and II only.
B)I,III,and IV only.
C)II,III,and IV only.
D)III and IV only.
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Chapter 5: The Stock Market Is Smarter Than You Think
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Sample Questions
Q1) Which of the following are properties that should lead to firms having higher value in the stock market?
I.Higher P/E.
II.First-in,first-out (FIFO )accounting.
III.Higher growth.
IV.ROIC greater than the cost of capital.
A)I and II only.
B)I,II,and III only.
C)III and IV only.
D)II,III,and IV only
Q2) Growth stocks have higher expectations for earnings growth and consistently have been found to have earnings growth significantly higher than value stocks.
A)True
B)False
Q3) Empirical research shows that goodwill impairments have no impact on a company's share price at the time of the impairment.
A)True
B)False
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7
Chapter 6: Return on Invested Capital
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Sample Questions
Q1) Cereal manufacturers have been successful at branding their products,while meat producers have been unable to do so to a large degree.Based on this fact,which of the following is the most accurate concerning the pricing advantage that cereal manufacturers have over meat producers?
A)The ROIC for cereal manufactures is less than that of meat producers because branding does not create value and branding has a cost.
B)The ROIC for cereal manufactures is equal to that of meat producers because the costs and benefits reach an equilibrium.
C)The ROIC for cereal manufactures is twice as high as that of meat producers.
D)The ROIC for cereal manufactures is three times as high as that of meat producers.
Q2) Competitive advantages based on brands,as in the consumer goods industry,are often more important for long-term value creation than advantages based on product quality or innovation.
A)True
B)False
Q3) List and briefly explain the five sources of price premiums.
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Chapter 7: Growth
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Sample Questions
Q1) While the pace of growth can vary greatly across products,the pattern of growth is usually the same for almost all products and services.
A)True
B)False
Q2) Average industry revenue growth varies considerably across industries,but the growth rates among companies in the same industry are fairly uniform.
A)True
B)False
Q3) Incremental innovation will rarely create lasting value.
A)True
B)False
Q4) Which of the following is LEAST likely to result in above-average,long-run value creation?
A)Create new markets through new products.
B)Attract new customers into the market.
C)Convince existing customers to buy more of a product.
D)Gain market share from rivals through product promotion.
Q5) Explain the "portfolio treadmill" effect and what it means for a firm that wishes to sustain growth.
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Chapter 8: Frameworks for Valuation
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Sample Questions
Q1) Given the following information,compute the estimated value per share.
\[\begin{array} { | l | r | }
\hline \text { Present value of cash flow: } & \$ 33 \mathrm {~m} \\
\hline \text { Midyear adjustment factor: } & \$ 1.2 \mathrm {~m} \\
\hline \text { Value of tax Ioss c amy-forwards: } & \$ 2.9 \mathrm {~m} \\
\hline \text { Value of debt: } & \$ 14.4 \mathrm {~m} \\
\hline \begin{array} { l }
\text { Value of capitalized operating } \\
\text { leases: }
\end{array} & \$ 5.2 \mathrm {~m} \\
\hline \text { Number of shares outstanding: } & 2.5 \mathrm {~m} \\
\hline \end{array}\]
A)$5.80
B)$6.04
C)$7.00
D).$7.92
Q2) List the four basic steps in valuing a company's common equity using the enterprise discounted cash flow methodology.
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Chapter 9: Reorganizing the Financial Statements
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Sample Questions
Q1) In computing free cash flow,include investments in capitalized operating leases in gross investment.
A)True B)False
Q2) What are Dolphin's NOPLAT and ROIC for the current year,using average invested capital?
A)$82,13.6 percent.
B)$108.9,18.1 percent.
C)$92,15.4 percent.
D)$85,14.1 percent.
Q3) How will an increase in invested capital (IC )in a given year affect free cash flow (FCF )and ROIC if all other things are kept equal?
A)It will decrease both FCF and ROIC.
B)It will increase both FCF and ROIC.
C)It will increase FCF but decrease ROIC.
D)It will decrease FCF but increase ROIC.
Q4) Pension assets are considered an operating asset and part of invested capital.
A)True B)False
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Chapter 10: Analyzing Performance
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Sample Questions
Q1) With regard to the interest coverage ratio,which of the following is the most accurate?
A)If near-term bankruptcy is an issue,EBITDA can be used to measure survival only over the short term.
B)EBITDA should be used to measure survival over both the short and the long term.
C)EBITA should be used to measure survival only in the short term (vs.long term).
D)None of the above are true.
Q2) The company's ability to meet short-term obligations is measured with ratios that incorporate three measures of earnings.Which of the following is NOT one of those measures of earnings?
A)Earnings before interest,taxes,and amortization (EBITA).
B)Earnings before interest,taxes,depreciation,and amortization (EBITDA).
C)Earnings before interest,taxes,amortization,and preferred dividends (EBITAD).
D)Earnings before interest,taxes,depreciation,amortization,and rental expense (EBITDAR).
Q3) Leverage measures the company's ability to meet obligations over the long term.
A)True
B)False
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Chapter 11: Forecasting Performance
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Sample Questions
Q1) If a company forecasts that its capital expenditures will be smooth,then in forecasting depreciation,it is better to use the percentage of revenues approach than the percentage of property,plant,and equipment (PP&E )approach.
A)True
B)False
Q2) Large Corporation owns less than 20 percent of Small Corporation.Which of the following are true?
I.Large Corp.records asset sales of Small Corp.
II.The investment in Small Corp.is marked to market.
III.Large Corp.records dividends received from Small Corp.
IV.In forecasting entries for Small Corp. ,Large Corp.should use a traditional driver like cash flows.
A)I and II only.
B)I and III only.
C)II and III only.
D)III and IV only.
Q3) The explicit forecast period must be long enough for the company to reach a steady state.List the two characteristics that define that steady state.
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Chapter 12: Estimating Continuing Value
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Q1) In making forecasts to estimate the value of a company,at the point where competition has eliminated abnormal returns,then it is appropriate to set RONIC equal to WACC.
A)True
B)False
Q2) Which of the following are common pitfalls or mistakes in estimating continuing value?
I.Naive base-year extrapolation.
II.Naive overconservatism.
III.Purposeful overconservatism.
IV.Liquidation value overconservatism.
A)I and II only.
B)I,II,and III only.
C)II,III,and IV only.
D)III and IV only.
Q3) In the continuing-value formula for a company,the growth rate g should be based on long-term real interest rates.
A)True
B)False
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Page 14
Chapter 13: Estimating the Cost of Capital
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Sample Questions
Q1) To estimate a company's beta,using an industry-derived unlevered beta relevered to the company's target capital structure is preferred to directly estimating a company-specific beta.
A)True
B)False
Q2) A firm has 1,200,000 shares of stock outstanding with a price per share equal to $14.There are 10,000 bonds outstanding,priced at $1,125 each.The cost of equity is 14 percent,the cost of debt is 8 percent,and the corporate tax rate is 40 percent.What is the WACC?
A)10.3 percent.
B)10.8 percent.
C)9.8 percent.
D)8.8 percent.
Q3) You are analyzing a distressed bond with one year to maturity.If the probability of default rises for this bond,the yield to maturity will likely increase,while the cost of debt will likely decrease.
A)True
B)False
Q4) Briefly explain the two methods of estimating market returns.
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Chapter 14: Moving From Enterprise Value to Value Per Share
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Sample Questions
Q1) In evaluating employee stock options,the exercise value approach provides:
A)A lower bound of valuation,and using it can undervalue the firm.
B)An upper bound of valuation,and using it can undervalue the firm.
C)A lower bound of valuation,and using it can overvalue the firm.
D)An upper bound of valuation,and using it can overvalue the firm.
Q2) Which of the following is best categorized as a hybrid claim against a company as opposed to a debt equivalent?
A)Employee stock options.
B)Securitized receivables.
C)Unfunded pension liabilities.
D)Long-term operating provisions.
Q3) For loans to nonconsolidated subsidiaries and other companies,an analyst can estimate the asset's value by using the reported book value if the loan was made using fair market terms and if the borrower's credit risk and general interest rates have not changed significantly since the loan was made.
A)True
B)False
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Page 16
Chapter 15: Analyzing the Results
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Sample Questions
Q1) A colleague recommends a shortcut to value the company in the preceding question.Rather than compute each scenario separately,the colleague recommends averaging each input,such that growth equals 5 percent and ROIC equals 15 percent.This will lead to the same enterprise value as found in that question.
A)True
B)False
Q2) Adjustments in the dividend payout ratio should be used to ensure that the model is technically correct.
A)True
B)False
Q3) When using the scenario approach,an analyst should not shortcut the process by deducting the face value of debt from the scenario-weighted value of operations,because this would seriously underestimate the equity value,as the value of debt is different in each scenario.
A)True
B)False
Q4) In creating scenarios that will determine a firm's future cash flow and present value in a sensitivity analysis,list the four categories of assumptions the analyst should critically review.
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Chapter 16: Using Multiples
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Sample Questions
Q1) Given the following inputs,compute the value-to-EBITA ratio: tax rate = 34%,growth rate = 5%,ROIC = 12%,and WACC = 8%.
A)3.14×
B)9.17×
C)12.83×
D)17.00×
Q2) Assuming the tax rate remains constant,what will be the effect on the value-to-EBITA ratio of doubling the following inputs: growth,ROIC,and WACC?
A)The value-to-EBITA ratio will fall,but the amount is uncertain.
B)The value-to-EBITA ratio will decrease by 50 percent.
C)The value-to-EBITA ratio will increase,but the amount is uncertain.
D)The value-to-EBITA ratio will double.
Q3) Increasing growth while holding ROIC,the tax rate,and WACC constant will:
A)Increase the value-to-EBITA ratio.
B)Not affect the value-to-EBITA ratio.
C)Decrease the value-to-EBITA ratio.
D)Have an undetermined effect on the value-to-EBITA ratio.
Q4) List the three requirements for carrying out a useful analysis of comparable multiples.
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Chapter 17: Valuation by Parts
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Sample Questions
Q1) Using EBITA instead of NOPLAT is a best practice for testing the sum-of-the-parts valuation based on multiples of peers.
A)True
B)False
Q2) Human resources costs should be allocated to business units based on the number of employees in the units.
A)True
B)False
Q3) If an analyst estimates the NOPLAT for each of the divisions in a three-division firm at $50 million,$30 million,and $20 million,respectively,it's safe to assume that the divisions contribute 50,30,and 20 percent,respectively,to overall firm value.
A)True
B)False
Q4) There is undisputed evidence that conglomerate firms trade at a discount relative to a portfolio of pure-play firms.
A)True
B)False
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Chapter 18: Taxes
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Q1) Usually,a company will record a DTL during the year of an acquisition and then draw down the DTL as the intangible amortizes.
A)True
B)False
Q2) Which of the following are operating deferred tax assets or deferred tax liabilities?
I.Nondeductible intangibles.
II.Tax loss carryforwards.
III.Accelerated depreciation.
IV.Pension and postretirement benefits.
V.Warranty reserves.
A)I,II,and IV.
B)III and V.
C)I,III,and V.
D)II,IV,and V.
Q3) All deferred tax liabilities (DTLs )are classified as debt.
A)True
B)False
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20
Chapter 19: Non-operating Items, Provisions, and Reserves
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Q1) The size of a nonoperating expense or one-time charge mentioned in a management discussion and analysis (MD&A )note might determine if it should be included in the adjustment to NOPLAT.
A)True
B)False
Q2) Product returns and warranties are nonoperating provisions that do not affect NOPLAT.
A)True
B)False
Q3) Which of the following are typical nonoperating expenses?
I.Amortization expense.
II.Restructuring charges.
III.Litigation expenses.
IV.Purchased research and development (R&D).
A)I and II only.
B)I,II,and III only.
C)III and IV only.
D)I,II,III,and IV.
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21
Chapter 20: Leases and Retirement Obligations
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Q1) Researchers at Ohio State University found that interest rates on unrated,unsecured debt were explained better by credit statistics adjusted for operating leases.
A)True
B)False
Q2) Investors,lenders,and rating agencies tend to interpret operating leases the same as traditional debt.
A)True B)False
Q3) Over- or underfunded pension status must be incorporated into value as a nonoperating asset or as a debt equivalent.
A)True
B)False
Q4) The interest rate for operating lease adjustments is usually higher than the firm's cost of debt.
A)True B)False
Q5) Summarize how to adjust the weighted average cost of capital (WACC )for the existence of operating leases,and comment on the likely effect on the WACC.
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Chapter 21: Alternative Ways to Measure Return on Capital
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Q1) According to U.S.Generally Accepted Accounting Principles (GAAP),which of the following must be expensed?
I.A patent developed by the firm.
II.A building.
III.Equipment.
IV.A distribution network.
A)I and II only.
B)I and IV only.
C)II and III only.
D)III and IV only.
Q2) If managers were given freedom to choose which expenses to classify as investments,which of the following is most accurate?
A)Managers will have an incentive to classify all expenses as investments.
B)Managers will have an incentive to classify no expenses as investments.
C)Managers will not have an incentive either way with respect to classifying expenses as investments.
D)Managers would most likely follow the rules established by GAAP,because they were formulated to be optimal for managers to follow.
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23
Chapter 22: Inflation
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Q1) A firm begins with nominal net working capital NWC t- = 200 and then increases it to NWC t = 250.The price index increases from IXt- = 144 to IXt = 166.Based on this information,what is the real investment in NWC in year t?
A)9.51
B)10.84
C)30.12
D)49.73
Q2) If the nominal weighted average cost of capital (WACC )is 24 percent and inflation is 16 percent,then the real WACC is closest to:
A)7 percent.
B)8 percent.
C)13 percent.
D)15 percent.
Q3) An analyst should make financial projections of income statements and balance sheets for a valuation in a high-inflation environment by simply projecting all items on a nominal basis.
A)True
B)False
Q4) What are the two indirect cash flow effects of inflation that depress value?
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Chapter 23: Cross-Border Valuation
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Q1) In the next two years,the expected inflation rates are 1 percent and 2 percent,respectively,and the real interest rates are expected to be 4 percent and 4 percent,respectively.Using this information,calculate the two-year interest rate yield as of now.
A)1.88 percent.
B)2.74 percent.
C)4.94 percent.
D)5.56 percent.
Q2) An analyst is estimating the value of a subsidiary using International Financial Reporting Standards (IFRS),and the country of the subsidiary is experiencing moderate inflation.In this case,which of the following accounting techniques is recommended?
A)Current method.
B)Temporal method.
C)Autoregressive method.
D)Inflation-adjusted current method.
Q3) List and describe the two methods for converting forecasted cash flows from one currency into another.
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25
Chapter 24: Case Study: Heineken
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Q1) When computing investment cash flows,all impairments should be subtracted to decrease property,plant,and equipment (PP&E),operating intangibles,and nonconsolidated investments.
A)True
B)False
Q2) Which of the following from the NOPLAT statement is NOT included in the amount of investments in goodwill and acquired intangibles?
A)The implied interest rate on the goodwill and acquired intangibles.
B)The annual change in the sum of goodwill and acquired intangibles.
C)The reversal of intangibles value adjustments in the invested-capital statement.
D)The sum of amortization of acquired intangibles and impairment of acquired intangibles and goodwill for the year.
Q3) When calculating gross investments,it is appropriate to add the increase in the foreign-currency translation reserve to capital expenditures to obtain the actual cash spent on capital investments.
A)True
B)False
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Chapter 25: Corporate Portfolio Strategy
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Q1) Traditional screening approaches are the best way to apply the best-owner principle.
A)True
B)False
Q2) With respect to emerging markets and developed markets,which of the following is most accurate concerning the role and importance of having influence on critical stakeholders in determining who is the best owner of a business?
A)It can be important in the case of developed markets and is more rarely important in the case of emerging markets.
B)It can be important in the case of emerging markets and is more rarely important in the case of developed markets.
C)It is usually not important,and it is never a reason a given firm might be the best owner of a given business.
D)It is equally important in both developed and emerging markets.
Q3) Define corporate governance and describe the evidence of the role it can play in value creation from studies of the returns of private equity firms investing in companies.
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Chapter 26: Performance Management
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Q1) Which of the following are aspects of the firm that diagnostics of organizational health typically measure?
I.Its culture and values.
II.The depth of management talent.
III.The skills and capabilities of the company.
IV.Its ability to retain employees and keep them satisfied.
A)I,II,and III only.
B)I,III,and IV only.
C)II,III,and IV only.
D)I,II,III,and IV.
Q2) In performance management,because of potential conflicts of interest,operating managers should not be involved in the setting of targets and in reading the measures in pursuing targets.
A)True
B)False
Q3) Managers must regularly revisit the targets they set for each value driver.As their business environment changes,so will the limits of what they can achieve.
A)True
B)False
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Chapter 27: Mergers and Acquisitions
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Q1) About one-third of all acquisitions create value,about one-third destroy value,and for the remaining third it is not clear whether value is created or destroyed.
A)True
B)False
Q2) The analysis of cost savings requires an industry-specific business system.Which of the following are requirements of an insightful industry-specific business system?
I.It uses a top-down approach.
II.It uses detail to identify the precise source of the savings.
III.It assigns each cost item of the target to one segment of the business system.
IV.It assigns the savings within the bidder's organization in the appropriate segments in the business system.
A)I and II only.
B)I and III only.
C)II,III,and IV only.
D)I,II,III,and IV.
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29
Chapter 28: Divestitures
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Q1) Which of the following is the best definition of a trade sale?
A)Sale of part or all of a business to a strategic or financial investor.
B)A trade of a subsidiary's assets for other physical assets to avoid taxes.
C)Sale of all shares of a subsidiary to new shareholders in the stock market.
D)A combination of part or all of a business with other industry players,other companies in the value chain,or venture capitalists.
Q2) Executives seem to shy away from divestitures and usually delay them too long.
A)True
B)False
Q3) With respect to their effect on divestures,which of the following is most accurate concerning legal,contractual,and regulatory barriers?
A)They are one of the reasons that divestitures are rarer than acquisitions.
B)They are typically not large enough to distort the value-creation potential of divestitures.
C)They are generally a problem only for larger divestitures,and smaller divestures are not affected by them.
D)They are an established hurdle that most companies address before the process to determine the viability of the divestiture.
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Chapter 29: Capital Structure, Dividends, and Share
Repurchases
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Q1) Which of the following is the most important factor in determining a company's credit rating?
A)Size.
B)Coverage.
C)Tax bracket.
D)Use of a complex capital structure.
Q2) Describe how leverage can cause business erosion.
Q3) Which of the following is the correct order of financing choices according to the pecking-order theory,starting with the most preferred choice?
A)Internal funds,debt,equity.
B)Debt,equity,internal funds.
C)Internal funds,equity,debt.
D)Equity,internal funds,debt.
Q4) Although academic researchers have investigated the issue for decades,there is still no clear model for deciding a company's optimal leverage ratio (i.e. ,the leverage that would create most value for shareholders).
A)True
B)False
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Chapter 30: Investor Communications
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Q1) Which of the following is NOT a way that managers of most companies could improve their communication to investors?
A)Increase their understanding of their investor base.
B)Respond more actively to analysts' comments and the changing P/E ratio of the firm.
C)Tailor communications to the investors that matter most in determining share price.
D)Engage in a systematic analysis to determine if there really is a material discrepancy between their company's intrinsic value and its market value.
Q2) Which of the following is true with respect to earnings guidance?
A)There is usually a change in total returns to shareholders in the first year that managers begin to offer earnings guidance.
B)It has been proven that earnings guidance can increase liquidity.
C)Firms that engage in earnings guidance have higher multiples such as enterprise value/EBITA.
D)When a company begins to issue earnings guidance,it does not change the likelihood of higher or lower volatility in its share price relative to companies that do not issue earnings guidance.
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Chapter 31: Emerging Markets
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Q1) In applying the CAPM in estimating the cost of capital in an emerging market,explain the three problems in estimating an appropriate risk-free rate and the recommended solution.
Q2) Using a scenario approach,an analyst finds that the estimated value of a company is $800.The business-as-usual scenario forecasts a cash flow of $40 starting next year and then growing at 6 percent forever.The cost of capital in that scenario is 10 percent.Given this information,what is the implied risk premium to add to the cost of capital to make the analyst's results consistent with the country risk premium discounted cash flow (DCF )approach?
A)0.80 percent.
B)1.00 percent.
C)1.20 percent.
D)1.25 percent.
Q3) For estimating the cost of capital in emerging markets,other models are superior to the capital asset pricing model (CAPM).
A)True
B)False
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Chapter 32: Valuing High-Growth Companies
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Q1) To estimate the size of a potential market for a high-growth company,start by assessing how the company fulfills a customer need.Then determine how the company generates (or plans to generate )revenue.
A)True
B)False
Q2) When looking into the future,the analyst should define a point in the future where the company's performance is likely to stabilize.The conditions at that point should be defined and bounded by measures of operating performance.Which of the following are those measures of operating performance?
I.Amortization.
II.Penetration rates.
III.Sustainable gross margins.
IV.Average revenue per customer.
A)I and II only.
B)I and IV only.
C)II and III only.
D)II,III,and IV only.
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Chapter 33: Cyclical Companies
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Q1) Which of the following are true concerning the properties of consensus earnings forecasts for cyclical companies?
I.They account for the cyclical nature of the firm.
II.Discounted cash flow (DCF )models are usually consistent with the facts.
III.The forecasts usually show an upward-sloping trend.
IV.The earnings and cash flow projections of the market are consistent with company performance.
A)I and II only.
B)I and III only.
C)II and III only.
D)II and IV only.
Q2) Which of the following is most accurate concerning predicting cycles and inflection points?
A)It is easy to predict both cycles and their inflection points.
B)It is easy to predict cycles,but it is difficult to predict inflection points.
C)It is difficult to predict cycles and more difficult to predict their inflection points.
D)It is hard to predict cycles,but once in a cycle,the inflection points are easy to predict.
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Chapter 34: Banks
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Q1) Which of the following is most often the largest source,in absolute value terms,of loan losses for a bank?
A)Mortgage losses.
B)Credit card losses.
C)Bond default losses.
D)Business loan losses.
Q2) Which of the following correctly ranks the sources of income for European banks over the period 1988-2013?
A)Commission income > interest income > trading income.
B)Interest income > commission income > trading income.
C)Commission income > trading income > interest income.
D)Trading income > interest income > commission income.
Q3) The tax penalty on equity is a minor cost to a bank,and to simplify results,it can usually be left out of the valuation process.
A)True
B)False
Q4) Explain why analysts estimating the values of banks should not use the discounted cash flow from operations method.What method should an analyst use?
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Chapter 35: Flexibility
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Q1) A project has a 50/50 chance of generating either a positive cash flow of $1 per year forever or a zero cash flow.The discount rate is 5 percent.If the initial cost is $10,what is the NPV with the option to stop after the first year?
A)-$10
B)$0
C)$10
D)$20
Q2) Flexibility is typically more relevant in the valuation of individual businesses and projects,as it mostly concerns detailed decisions related to production,capacity investment,marketing,and research and development (R&D).
A)True
B)False
Q3) Construction of a replicating portfolio can be used to value an option embedded in an investment opportunity.
A)True
B)False
Q4) List the two contingent valuation approaches.Identify which one is more sophisticated and explain when the less sophisticated approach might be preferred.
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