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DCF Valuation Test exam with complete solutions 2024_2025
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DCF Valuation Test exam with complete solutions 2024_2025
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DCF Valuation Test exam with completesolutions 2024/2025
1. What's the point of valuation? WHY do you value a company? - ANSWER-You
value a company to determine its Implied Value according to your views of it.
If this Implied Value is very different from the company's Current Value, you
might be able to
invest in the company and make money if its value changes.
If you are advising a client company, you might value it so you can tell
management the price
that it might receive if the company sells, which is often different from its Current
Value.
2. But public companies already have Market Caps and Share Prices. Why bother
valuing
them? - ANSWER-Because a company's Market Cap and Share Price reflect its
Current Value according to "the
market as a whole" - but the market might be wrong!
You value companies to see if the market's views are correct or incorrect.
3. What are the advantages and disadvantages of the 3 main valuation
methodologies? - ANSWER-Public Comps are useful because they're based on
real market data, are quick to calculate and
explain, and do not depend on far-in-the-future assumptions.
However, there may not be truly comparable companies, the analysis will be less
accurate for
volatile or thinly traded companies, and it may undervalue companies' long-term
potential.
Precedent Transactions are useful because they're based on the real prices that
companies
have paid for other companies, and they may better reflect industry trends than
Public Comps.
,However, the data is often spotty and misleading, there may not be truly
comparable
transactions, and specific deal terms and market conditions might distort the
multiples.
DCF Analysis is the most "correct" methodology according to finance theory, it's
less subject to
market fluctuations, and it better reflects company-specific factors and long-term
trends.
However, it's also very dependent on far-in-the-future assumptions, and there's
disagreement
over the proper calculations for key figures like the Cost of Equity and WACC.
4. Which of the 3 main methodologies will produce the highest Implied Values? -
ANSWER-This is a trick question because almost any methodology could
produce the highest Implied
Values depending on the industry, time period, and assumptions.
Precedent Transactions often produce higher Implied Values than the Public
Comps because of
the control premium - the extra amount that acquirers must pay to acquire sellers.
But it's tough to say how a DCF stacks up because it's far more dependent on
your assumptions.
The best answer is: "A DCF tends to produce the most variable output since it's
so dependent
on your assumptions, and Precedent Transactions tend to produce higher values
than the
Public Comps because of the control premium."
5. When is a DCF more useful than Public Comps or Precedent Transactions? -
ANSWER-You should pretty much always build a DCF since it IS valuation - the
other methodologies are
supplemental.
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But it's especially useful when the company you're valuing is mature and has
stable, predictable
cash flows, or when you lack good Public Comps or Precedent Transactions.
6. When are Public Comps or Precedent Transactions more useful than the DCF?
- ANSWER-If the company you're valuing is early-stage, and it is impossible to
estimate its future cash
, flows, or if the company has no path to positive cash flows, you have to rely on
the other
methodologies.
These other methodologies can also be more useful when you run into problems
in the DCF,
such as an inability to estimate the Discount Rate or extremely volatile cash
flows.
7. Which one should be worth more: A $500 million EBITDA healthcare company
or a $500
million EBITDA industrials company?
Assume the growth rates, margins, and all other financial stats are the same. -
ANSWER-In all likelihood, the healthcare company will be worth more because
healthcare is a less asset-
intensive industry. That means the company's CapEx and Working Capital
requirements will be
lower, and its Free Cash Flow will be higher (i.e., closer to EBITDA) as a result.
Healthcare, at least in some sectors, also tends to be more of a "growth industry"
than
industrials.
The Discount Rate might also be higher for the healthcare company, but the lower
asset
intensity and higher expected growth rates would likely make up for that.
However, this answer is an extreme generalization, so you would need more
information to
make a real decision.
8. How do you value an apple tree? - ANSWER-The same way you value a
company: Comparables and a DCF. You'd look at what similar apple
trees have sold for, and then calculate the expected future cash flows from this
tree.
You would then discount these cash flows to Present Value, discount the
Terminal Value to PV,
and add up everything to determine the apple tree's Implied Value.
The Discount Rate would be based on your opportunity cost - what you might be
able to earn
each year by investing in other, similar apple trees.
9. People say that the DCF is an intrinsic valuation methodology, while Public
Comps and
Precedent Transactions are relative valuation.
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