Ch14 + Moving From Enterprise Value To | Test Bank + Answers

Chapter: Chapter 14: Moving from Enterprise Value to Value per Share

Multiple Choice

1. In estimating value per share of common stock of a company, for which of the following is book value a reasonable approximation for evaluating the asset or liability?

I. Excess real estate.

II. Discontinued operations.

III. Floating rate debt.

IV. Employee stock options.

a) I and II only.

b) I and III only.

c) II and III only.

d) III and IV only.

Response: []

2. A corporation has 5 million shares outstanding. Using the following information, calculate the value per share.

DCF of operations = $780m

Financial subsidiary = $60m

Employee stock options = $6m

Bonds = $333m

Securitized receivables = $3m

Operating leases = $11m

The value per share is closest to:

a) $85.4

b) $97.4

c) $99.6

d) $101.0

Response: [Value of the firm = $780m + $60m – $6m – $333m – $3m – $11m = $487m. Value per share = $487m/(5m shares) = $97.40/share]

3. A corporation has 5 million shares outstanding. Using the following information, calculate the value per share.

DCF of operations = $858m

Financial subsidiary = $66m

Employee stock options = $6.6m

Bonds = $366.3m

Securitized receivables = $3.3m

Operating leases = $12.1m

The value per share is closest to:

a) $97.4

b) $107.1

c) $101.0

d) $105.4

Response: [Value of the firm = $858m + $66m – $6.6m – $366.3m – $3.3m – $12.1m = $535.7m. Value per share = $535.7m/(5m shares) = $107.1/share]

4. Which of the following approaches are methods for evaluating convertible debt?

I. Market value.

II. Multiples value.

III. Black-Scholes value.

IV. Conversion value.

a) I and II only.

b) I and III only.

c) I, III, and IV only.

d) II, III, and IV only.

Response: []

5. 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.

Response: []

6. In the estimation of value process, which of the following are true concerning discontinued operations?

I. The earnings from discontinued operations are explicitly shown in the income statement.

II. The net asset position of discontinued operations is disclosed on the balance sheet.

III. For an outside analyst, the most recent book value usually serves as a good estimate of the value of discontinued operations.

IV. The value of discontinued operations should be modeled as part of free cash flow or included in the DCF value of operations.

a) I, II, and III only.

b) II and III only.

c) I and IV only.

d) I, II, III, and IV.

Response: []

True/False

7. The multiples valuation of a subsidiary is most appropriate when the subsidiary is publicly traded and the parent owns less than 20 percent of the subsidiary.

Response: [If the company owns 20 to 50 percent of the subsidiary, then it is appropriate to use multiples valuation and apply an appropriate multiple to reported income.]

8. In evaluating employee stock options, the exercise value approach provides a lower bound of valuation, and using it can overvalue the firm.

Response: []

Multiple Choice

9. Which of the following are true concerning nonoperating assets that can be converted into cash on short notice and at low cost?

I. They are classified as excess cash and marketable securities.

II. Short-term losses can be deducted directly from their value, bypassing the income statement.

III. Under International Financial Reporting Standards (IFRS), they are to be reported at fair market value on the balance sheet.

IV. Under U.S. Generally Accepted Accounting Principles (GAAP), they are to be reported at fair market value on the balance sheet.

a) I and IV only.

b) I, II, and III only.

c) I, III, and IV only.

d) III and IV only.

Response: []

True/False

10. 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.

Response: []

Short Answer

11. List three alternatives to discounted cash flow (DCF) analysis when estimating the value of a subsidiary of a parent company using only the parent company’s financial information, and identify the conditions when each is recommended.

2. Multiples valuation: If the company owns 20 to 50 percent of the subsidiary, it may be appropriate to apply multiples to the subsidiary’s reported income (e.g., estimate the partial stake using a price-to-earnings and/or market-to-book multiple).

3. Tracking portfolio: For parent equity stakes below 20 percent, there may not be any information available except the investment’s original cost (i.e., book value). Thus, the analyst would estimate the subsidiary’s value based on the change in value of a portfolio of comparable stocks over the same holding period.]

Multiple Choice

12. An analyst is applying an integrated-scenario approach to evaluate operations as well as equity, and the analyst essentially treats equity as a call option on the enterprise value. It is most likely the analysis is of a company that:

a) Is highly levered.
b) Has securitized receivables.
c) Uses income smoothing.
d) Has excess pension assets or liabilities.

Response: []

13. 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.

Response: []

14. Company X controls Company Y so that Company Y’s financial statements are fully consolidated in the group accounts. With respect to Company X’s financial statements, third-party stakes in Company Y:

a) Are not of concern.
b) Are to be deducted and are called noncontrolling interest.
c) Are to be added in and are called noncontrolling interest.
d) Are illegal.

Response: []

15. For equity stakes in subsidiaries where the stake is between 20 and 50 percent of the subsidiary, the holding is recorded on the balance sheet at:

a) Market value, and the parent’s portion of the subsidiary’s profits are shown below operating profit on the parent company’s income statement.
b) Historical cost plus reinvested income, and the parent’s portion of the subsidiary’s profits are shown in the regular operating profit of the parent company.
c) Market value, and the parent’s portion of the subsidiary’s profits are shown in the regular operating profit of the parent company.
d) Historical cost plus reinvested income, and the parent’s portion of the subsidiary’s profits are shown below operating profit on the parent company’s income statement.

Response: []

16. Which of the following correctly lists the conditions when the multiples valuation of a subsidiary is appropriate?

a) The subsidiary is publicly traded, and the parent owns less than 20 percent of the subsidiary.
b) The subsidiary is not publicly traded, and the parent owns less than 20 percent of the subsidiary.
c) The subsidiary is publicly traded, and the parent owns between 20 percent and 50 percent of the subsidiary.
d) The subsidiary is not publicly traded, and the parent owns between 20 percent and 50 percent of the subsidiary.

Response: []

Short Answer

17. Given the following list, put a “+” if it increases a firm’s equity value or a “–” if it decreases the firm’s value per share of common stock.

]

Short Answer

18. Indicate in which cases book value is a reasonable approximation for evaluating the asset or liability. Answer “Yes” if book value is a reasonable approximation and “No” if it is not.

A. Floating-rate debt.

B. Outstanding bonds that are secure and actively traded.

C. Discontinued operations.

D. Stake in a publicly traded subsidiary.

E. Excess real estate.

F. Loans to nonconsolidated subsidiaries and other companies (assume interest rates and credit risk have not changed).

G. An outstanding convertible bond deep in the money.

H. Employee stock options.