Test Questions & Answers Using Multiples Chapter 16 6e

Chapter: Chapter 16: Using Multiples

Multiple Choice

1. 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.

Response: []

2. Which of the following is true in using EBIT, EBITA, or EBITDA when estimating a firm’s value?

a) EBIT is superior to both EBITA and EBITDA.

b) EBITA is superior to both EBIT and EBITDA.

c) EBITDA is superior to both EBIT and EBITA.

d) There is not a clear superiority of one measure over the others. It depends on the type of firm being analyzed.

Response: []

3. In estimating and comparing value, the price-to-earnings (P/E) multiple has two major flaws. Which of the following are those flaws?

I. It is in squared currency units.

II. The P/E is affected by a company’s capital structure.

III. The earnings (net income) are calculated after nonoperating items.

IV. The market measure of price usually has significant error.

a) I and II only.

b) I and III only.

c) II and III only.

d) III and IV only.

Response: []

4. Given that the value-to-EBITA ratio of a company is 11.2 and the projected EBITA growth is 4.2 percent, what is the P/E-to-growth (PEG) ratio?

a) 2.67

b) 4.70

c) 3.75

d) 6.86

Response: [PEG ratio = 11.2/4.2 = 2.67]

5. 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×

Response: [Value-to-EBITA = (1 – 0.34) * (1 – 0.05/0.12)/(0.08 – 0.05) = 0.1283 or 12.83×]

6. Given the following inputs, compute the value-to-EBITA ratio: tax rate = 34%, growth rate = 4%, ROIC = 10%, and WACC = 9%.

a) 5.40×

b) 7.92×

c) 8.83×

d) 11.20×

Response: [Value-to-EBITA = (1 – 0.34) * (1 – 0.04/0.10)/(0.09 – 0.04) = 7.92×]

7. Which of the following are reasons that the value-to-EBITA ratio is superior to the price-to-earnings ratio as a multiple to aid in valuation?

I. The P/E is distorted by capital structure.

II. The P/E is distorted by inflation.

III. The P/E is distorted by nonoperating gains and losses.

IV. The P/E is distorted by dividend payouts.

a) I and III only.

b) II and III only.

c) II and IV only.

d) I, III, and IV only.

Response: []

8. A firm has $600 market value of equity and $300 market value of debt. The firm also has $100 in nonconsolidated subsidiaries and $50 in excess cash. If the firm’s expected EBITA is $100, what is the value-to-EBITA ratio?

a) 7.5×

b) 9.0×

c) 11.0×

d) 6.9×

Ans [a]

Response: [(600 + 300 – 100 – 50)/100 = 7.5×]

9. 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.

Ans [b]

Response: []

True/False

10. Increasing growth and ROIC by the same amount while holding taxes and WACC constant will decrease the value-to-EBITA ratio.

Response: [It will increase it.]

11. In estimating and comparing value, empirical evidence shows that forward-looking multiples are more accurate predictors of value than are historical multiples.

Response: []

12. In estimating value creation, analysts should use EBITA rather than EBITDA, because depreciation is a noncash item whereas amortization is not.

Response: [They are both noncash items.]

13. Nonfinancial ratios such as value to web site hits, value to unique visitors, and value to number of subscribers had some explanatory power for assessing Internet company stock prices in the early years of the wave of Internet companies.

Response: []

Short Answer

14. List the three requirements for carrying out a useful analysis of comparable multiples.

2. Calculate the multiple in a consistent manner, which means basing the numerator (value) and denominator (earnings) on the same underlying assets.

3. Use the right peer group, where the best set is a set of industry peers, at least to start.]

True/False

15. ComboCo, a large U.S. company, operates in two areas: high tech and retail clothing. To value this firm using multiples analysis, one should use a peer group of other large U.S. diversified companies.

Response: [This approach is not appropriate, because the valuation depends on the types of areas/subindustries of the peers. If they are diversified in different areas, they won’t be comparable. A better approach would be to compare companies with similar segments, or triangulate the results with companies in those areas.]

16. The enterprise value (EV)-to-revenue multiple is useful in valuing most companies.

Response: [The EV-to-revenue multiple is not useful in valuing most companies, because it is not showing value related to profitability.]

17. The EV-to-revenue multiple is useful in valuing some companies.

Response: [The EV-to-revenue multiple is useful in valuing some special situations, such as for start-up companies, where profits are negative or a sustainable margin level can’t be estimated, and for industries with highly volatile profit margins, where you believe that over the long term the companies will have roughly similar profit margins.]