The Purchase Alternative Chapter 10 Test Bank

CHAPTER 10: THE PURCHASE ALTERNATIVE

TEST BANK

A) MULTIPLE CHOICE

Select the "most correct" option:

1. "Goodwill" is classified as:

a. intellectual property.

b. licensing rights.

c. a key ratio.

d. an intangible asset.

2. The single biggest danger for the naive business buyer is:

a. overvalued assets.

b. interference from the previous owner.

c. lack of market.

d. hidden company debts.

3. On average, the risk of buying an existing business is

a. the same as for starting a brand new business.

b. higher than for starting a brand new business.

c. lower than for buying a franchise.

d. lower than for starting a brand new business.

4. Setting a value for a business by using a "price multiplier" is:

a. a discounted cash flow approach.

b. a balance sheet approach.

c. a rule of thumb approach.

d. a liquidation value approach.

5. Typically, the business valuation method showing the lowest value is:

a. discounted future earnings.

b. net book value.

c. modified book value.

d. liquidation value.

6. Which of the following is an "asset" method of business valuation?

a. liquidation value.

b. book value.

c. adjusted book value.

d. all of the above.

7. Which of the following is an "income" method of business valuation?

a. capitalization of earnings.

b. capitalized cash flow.

c. discounted cash flow.

d. all of the above.

8. A company's financial statements are interpreted by using:

a. ratio analysis.

b. business valuation.

c. the present value method.

d. the discount rate.

9. The ratio that indicates the "liquidity" of a company is:

a. the current ratio.

b. debt to equity.

c. gross margin.

d. the average collection period.

10. A negotiating plan for purchasing a business will include values for:

a. a fair market price.

b. the lowest reasonable price.

c. the maximum the buyer is willing to pay.

d. all of the above.

11. Which of the following about financial ratios is incorrect

a. Return on Assets indicate how efficiently the company is able to use its assets, as well as its purchasing and sales efficiency.

b. Average Collection Period measures how long it takes a company to collect money that is owed to it

c. The acid test ratio measures a company’s profitability

d. The current ratio measures a company’s ability to pay the bills that are due

12. Key ratios, help to build a picture of the company’s financial health. These ratios describe the company in terms of all of the following except:

a. Liquidity

b. Marketability

c. Profitability

d. Cash Management

13. Which of the following is considered to be an income method for company valuation:

a. liquidation value

b. discounted cash flow

c. replacement value

d. book value

B) TRUE OR FALSE

1. T F Cash skimming is a legal but misleading practice.

2. T F You must know your desired "rate of return" to use the Capitalization of

Earnings method.

3. T F "Asset" methods of valuation are also known as "balance sheet" methods.

4. T F Real estate agents often act as intermediaries for the sale of a business.

5. T F "Taking over" a company means buying more than 50% ownership.

6. T F It is relatively easy to change an existing negative image of a firm.

7. T F The "core" business refers to a firm's primary services/products and

primary market segments.

8. T F The critical question to ask a business seller is "what is the price?"

9. T F Buying an independent business is on average lower risk than buying a

franchise.

10. T F Present value calculations are based on the idea that money is more

valuable if received now than if received in the future.

11. T F Return on Equity is the most common measure of liquidity

12. T F In spite of the many objective methods of valuing a business, ultimately the value
of a firm is whatever price can be negotiated between a buyer and a seller

C) FILL IN THE BLANKS

1. A clause that requires a business seller to tell the buyer about anything that might

discourage the sale is called a clause.

2. Unnecessary items that a company owns are know as assets.

3. The right of a creditor to take over a particular asset is called a .

4. The alternative to buying shares of a business is to just buy the .

5. A firm's ability to pay all of its financial obligations is called .

6. Purchasing less than 50 percent ownership of a company is called _____________________. Purchasing more than 50 percent ownership of a company is called__________________________.

7. Purchase agreements will often include restrictions that prevent the old owner of a

business from entering into any form of competition with the business. This is called _____________________.

8. An operating business that is expected to continue operating into the foreseeable future is called a ____________________________.

D) SHORT ANSWER

1) Identify three negotiating tips that could be used when buying a business. Explain the importance of each.

2) Explain "rule of thumb" valuation techniques and provide one or two examples of how they work.

3. There are 2 ways that a company can be purchased. Identify and explain these two approaches.

E) ESSAY

1. Explain the concept of ratio analysis. Identify several key ratios and explain what they might indicate about the health of a company. (1 page max).

2. Explain and contrast both Asset and Income methods of business valuation giving clear examples of each. Explain how these values can be used to produce a weighted average business value. (1 page max).

3. Assess the merits and risks of buying a company. Based on your assessment, in your opinion, is buying a company the right option for you and why?

4. Identify the reasons for completing a thorough Business Assessment prior to acquisition? Which are the primary areas of review and assessment and why?

5. Outline the major provisions often included in a purchase agreement for a business.