Ch32 Test Bank Answers Valuing High-Growth Companies

Chapter: Chapter 32: Valuing High-Growth Companies

Multiple Choice

1. 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.

Response: []

2. Which of the following is the recommended method for dealing with the uncertainty of high-growth companies?

a) Real options.

b) Risk premium approach.

c) Monte Carlo simulation.

d) Probability-weighted scenarios.

Response: [Real options, Monte Carlo simulation, and probability-weighted scenarios are all potential approaches. The probability-weighted scenarios approach is the recommended method because it makes the critical assumptions and interactions more transparent.]

3. In the probability-weighted scenario approach, which of the following are recommended for consideration in composing and calibrating scenario weights?

I. Competitor margins.

II. Option implied volatility.

III. Market size and market share.

IV. Historical performance of other high-growth companies.

a) I and II only.

b) I, II, and III only.

c) I, III, and IV only.

d) II, III, and IV only.

Response: []

Multiple Choice

4. An analyst computes the intrinsic values and probabilities for each of the indicated scenarios in the following table. Determine the expected value per share.

a) 13.00

b) 16.00

c) 16.80

d) 17.50

Response: [

]

5. Which of the following are correct concerning the approach the analyst should take when evaluating a high-growth company?

I. Think in terms of probabilities.

II. Begin the process by starting from the future rather than the present.

III. Understand the economics of the business model compared with peers.

IV. Remember that the DCF approach is an essential tool for understanding the value of high-growth companies.

a) I and II only.

b) I, II, and III only.

c) I and IV only.

d) I, II, III, and IV.

Response: []

6. Which of the following are true concerning the use of price-to-earnings multiples to evaluate a high-growth company?

I. They cannot be used when earnings are negative.

II. They provide insight into what drives the company’s valuation.

III. They generate imprecise results when earnings are highly volatile.

IV. They account for the unique characteristics of each company in a fast-changing environment.

a) I and II only.

b) I and III only.

c) II and III only.

d) III and IV only.

Response: []

True/False

7. When valuing a high-growth company, it is not recommended to begin with historical financial results; instead, begin with the future.

Response: []

8. 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.

Response: []

9. For a high-growth company, accounting records of current performance are likely to mix together investments and expenses, so, when possible, capitalize hidden investments, even those expensed under traditional accounting rules.

Response: []

10. Using the real-options approach to value a high-growth company has an advantage over the discounted cash flow method in that it requires fewer estimates (e.g., it does not require a long-term revenue growth rate).

Response: []

Short Answer

11. Contrast the first step in the valuation process of an established company and a high-growth company. Explain the reason for the difference in approaches.