Case Chapter Five 2015v1 Review Questions
BV: Income and Asset Approaches
CAPITALIZATION/DISCOUNT RATES
BUSINESS VALUATIONS: APPLICATIONS AND CALCULATIONS USING THE INCOME AND ASSET APPROACHES CHAPTER 5 REVIEW QUESTIONS
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
Chapter Five – 35 2015.v1
CAPITALIZATION/DISCOUNT RATES
BV: Income and Asset Approaches
BV: APPLICATIONS AND CALCULATIONS USING THE INCOME AND ASSET APPROACHES CHAPTER REVIEW QUESTIONS Chapter 5: Capitalization/Discount Rates 1.
When using the Build-Up Method, which of the following would be used as “Equity Risk Premium”? a. b. c. d.
2.
Regarding the equity risk premium and size premiums found in the Ibbotson data, which of the following statement(s) is correct? a. b. c. d.
3.
b. c. d.
This risk measures the uncertainty of returns arising from other factors such as industry and individual company factors. This risk measures the well-balanced rate of return that the investor wants. This risk measures the stability of long-term historical returns. This risk measures the size premium risk of mid-cap equities.
Which of the following would not be considered a Company Specific Factor when calculating specific company risk premium? a. b. c. d.
5.
The specific company risk is also considered systematic risk. The short-term arithmetic average equity risk premium is the best proxy for today’s equity risk premium. The Ibbotson premiums are not industry specific. You do not have to calculate specific company risk when the company you value does not approach the size of a publicly traded company.
The specific company risk is also defined as the unsystematic risk? What does this risk measure? a.
4.
Short-term expected risk on large equity securities on the S&P 500 Expected mid-capitalization equity size premium Long-term U.S. Treasury Bond Yield Long-horizon expected equity risk premium: Large company stock returns minus long-term government bond income returns
The expected return on the security Abnormal present or pending competition Pending regulatory changes Concentration of customer base
By definition, the Build-Up Method using Ibbotson or Duff & Phelps data calculates a rate to be applied to which of the following? a. b. c. d.
After-Tax Net Income After-Tax Net Cash Flows Pre-Tax Net Income EBITDA
36 – Chapter Five 2015.v1
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
BV: Income and Asset Approaches
6.
What method for determining a capitalization or discount rate is based on the theory that investors in risky assets require a rate of return above and beyond a risk-free rate as compensation for bearing the risk associated with holding the investment? a. b. c. d.
7.
Build-Up Modified CAPM WACC RRCM
Which of the following is probably the most commonly used market method to describe the price of a share of stock? a. b. c. d.
8.
CAPITALIZATION/DISCOUNT RATES
WACC Dividend/Price S & P 500 Price/Earnings Ratio
What is the primary argument against using the Price/Earnings Ratio method to value closely held companies? a. b. c. d.
Large, diversified, publicly traded companies are not reasonably comparable for a smaller closely held business. P/E ratios are based on earnings after interest and taxes. P/E ratios are the inverse of the capitalization rate. P/E ratios are difficult to calculate for public companies.
10. Which of the following statements are true for the RRCM (buildup summation capitalization method)? a. b. c. d.
This build-up method uses the large-capitalization and small-capitalization premiums from Ibbotson. RRCM risk factors are Competition, Financial Strength, Management Ability and Depth, and Profitability and Stability of Earnings. The RRCM method is favored over Ibbotson or CAPM for valuing small businesses. No working paper documentation is required with the RRCM method.
11. The following is the primary formula for the Build-Up Method using Ibbotson data: a. b. c. d.
Rf + ERP + IRPi + SP + SCR Rf +B(ERm-Rf)+SP Rf +B(ERm-Rf)+SP+SCR (ke x We) + (Kd/(pt)(1-t)x Wd)
12. The Size Premium found in the Ibbotson data is: a. b. c. d.
The return an investor would have received in excess of the return on Treasury securities by the S&P 500. The extra return a willing investor would expect to receive over the large equity security by investing in smaller equity securities. Risk associate with specific industries. Risk associated with characteristics of the Company.
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
Chapter Five – 37 2015.v1
CAPITALIZATION/DISCOUNT RATES
BV: Income and Asset Approaches
13. Using the Build-Up Method to determine the capitalization rate for the current year, a valuator would: a. b. c. d.
Do nothing. The Build-Up Method provides a capitalization rate based on current year cash flow. Divide by 1-the growth rate Multiply by 1 – growth rate. Divide by 1+ the growth rate
14. Which of the following is not an assumption of the Capital Asset Pricing Model? a. b. c. d.
Investors are risk adverse Rational investors seek to hold portfolios, which are fully diversified. Not all investors have identical investment holding periods All investors have the same expectations regarding the expected rate of return.
15. The difference between CAPM and Modified CAPM: a. b. c. d.
Modified CAPM does not include company specific risk Modified CAPM takes into consideration company specific risk Beta Size premium
16. Duff & Phelps can be used to determine: a. b. c. d.
An appropriate risk free rate The supply side adjustment The equity risk premium Company specific risk
17. Which of the following is not a criterion companies must meet to be included in the Duff & Phelps equity risk premium? a. b. c. d.
Must be included in both the CRSP and CompUSA data base Must be publicly traded for 5 years Must have sales greater than $1 Million Must have a positive 5 year EBITDA
18. Duff & Phelps has a separate equity risk premium exhibit specifically for CAPM. a. b.
True False
19. Which methodology to determine a capitalization rate, considers debt and equity of a company? a. b. c. d.
Build up Duff & Phelps Weighted Average Cost of Capital Capital Asset Pricing Model.
38 – Chapter Five 2015.v1
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
CAPITALIZATION/DISCOUNT RATES
BUSINESS VALUATIONS: APPLICATIONS AND CALCULATIONS USING THE INCOME AND ASSET APPROACHES CHAPTER 5 REVIEW QUESTIONS
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
Chapter Five – 35 2015.v1
CAPITALIZATION/DISCOUNT RATES
BV: Income and Asset Approaches
BV: APPLICATIONS AND CALCULATIONS USING THE INCOME AND ASSET APPROACHES CHAPTER REVIEW QUESTIONS Chapter 5: Capitalization/Discount Rates 1.
When using the Build-Up Method, which of the following would be used as “Equity Risk Premium”? a. b. c. d.
2.
Regarding the equity risk premium and size premiums found in the Ibbotson data, which of the following statement(s) is correct? a. b. c. d.
3.
b. c. d.
This risk measures the uncertainty of returns arising from other factors such as industry and individual company factors. This risk measures the well-balanced rate of return that the investor wants. This risk measures the stability of long-term historical returns. This risk measures the size premium risk of mid-cap equities.
Which of the following would not be considered a Company Specific Factor when calculating specific company risk premium? a. b. c. d.
5.
The specific company risk is also considered systematic risk. The short-term arithmetic average equity risk premium is the best proxy for today’s equity risk premium. The Ibbotson premiums are not industry specific. You do not have to calculate specific company risk when the company you value does not approach the size of a publicly traded company.
The specific company risk is also defined as the unsystematic risk? What does this risk measure? a.
4.
Short-term expected risk on large equity securities on the S&P 500 Expected mid-capitalization equity size premium Long-term U.S. Treasury Bond Yield Long-horizon expected equity risk premium: Large company stock returns minus long-term government bond income returns
The expected return on the security Abnormal present or pending competition Pending regulatory changes Concentration of customer base
By definition, the Build-Up Method using Ibbotson or Duff & Phelps data calculates a rate to be applied to which of the following? a. b. c. d.
After-Tax Net Income After-Tax Net Cash Flows Pre-Tax Net Income EBITDA
36 – Chapter Five 2015.v1
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
BV: Income and Asset Approaches
6.
What method for determining a capitalization or discount rate is based on the theory that investors in risky assets require a rate of return above and beyond a risk-free rate as compensation for bearing the risk associated with holding the investment? a. b. c. d.
7.
Build-Up Modified CAPM WACC RRCM
Which of the following is probably the most commonly used market method to describe the price of a share of stock? a. b. c. d.
8.
CAPITALIZATION/DISCOUNT RATES
WACC Dividend/Price S & P 500 Price/Earnings Ratio
What is the primary argument against using the Price/Earnings Ratio method to value closely held companies? a. b. c. d.
Large, diversified, publicly traded companies are not reasonably comparable for a smaller closely held business. P/E ratios are based on earnings after interest and taxes. P/E ratios are the inverse of the capitalization rate. P/E ratios are difficult to calculate for public companies.
10. Which of the following statements are true for the RRCM (buildup summation capitalization method)? a. b. c. d.
This build-up method uses the large-capitalization and small-capitalization premiums from Ibbotson. RRCM risk factors are Competition, Financial Strength, Management Ability and Depth, and Profitability and Stability of Earnings. The RRCM method is favored over Ibbotson or CAPM for valuing small businesses. No working paper documentation is required with the RRCM method.
11. The following is the primary formula for the Build-Up Method using Ibbotson data: a. b. c. d.
Rf + ERP + IRPi + SP + SCR Rf +B(ERm-Rf)+SP Rf +B(ERm-Rf)+SP+SCR (ke x We) + (Kd/(pt)(1-t)x Wd)
12. The Size Premium found in the Ibbotson data is: a. b. c. d.
The return an investor would have received in excess of the return on Treasury securities by the S&P 500. The extra return a willing investor would expect to receive over the large equity security by investing in smaller equity securities. Risk associate with specific industries. Risk associated with characteristics of the Company.
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
Chapter Five – 37 2015.v1
CAPITALIZATION/DISCOUNT RATES
BV: Income and Asset Approaches
13. Using the Build-Up Method to determine the capitalization rate for the current year, a valuator would: a. b. c. d.
Do nothing. The Build-Up Method provides a capitalization rate based on current year cash flow. Divide by 1-the growth rate Multiply by 1 – growth rate. Divide by 1+ the growth rate
14. Which of the following is not an assumption of the Capital Asset Pricing Model? a. b. c. d.
Investors are risk adverse Rational investors seek to hold portfolios, which are fully diversified. Not all investors have identical investment holding periods All investors have the same expectations regarding the expected rate of return.
15. The difference between CAPM and Modified CAPM: a. b. c. d.
Modified CAPM does not include company specific risk Modified CAPM takes into consideration company specific risk Beta Size premium
16. Duff & Phelps can be used to determine: a. b. c. d.
An appropriate risk free rate The supply side adjustment The equity risk premium Company specific risk
17. Which of the following is not a criterion companies must meet to be included in the Duff & Phelps equity risk premium? a. b. c. d.
Must be included in both the CRSP and CompUSA data base Must be publicly traded for 5 years Must have sales greater than $1 Million Must have a positive 5 year EBITDA
18. Duff & Phelps has a separate equity risk premium exhibit specifically for CAPM. a. b.
True False
19. Which methodology to determine a capitalization rate, considers debt and equity of a company? a. b. c. d.
Build up Duff & Phelps Weighted Average Cost of Capital Capital Asset Pricing Model.
38 – Chapter Five 2015.v1
© 1995–2015 by National Association of Certified Valuators and Analysts (NACVA). All rights reserved. Used by Institute of Business Appraisers with permission of NACVA for limited purpose of collaborative training.
