sd7-discount-rates-in-valuation - CHAPTER 7 DISCOUNT RATES...

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CHAPTER 7 DISCOUNT RATES IN VALUATION LEARNING OBJECTIVES 1. Why different valuation models use different discount rates. 2. The capital asset pricing model and how it relates to discount rates. 3. How to estimate the discount rate for each model. 4. How to alter the analysis of discount rates for private companies. TRUE/FALSE QUESTIONS 1. Different valuation models rely on different components of the firm’s cash flows because the components of cash flow belong to different capital suppliers. (moderate, L.O. 1, Section 1, true) 2. Unlevered cost of equity is the discount rate used in the adjusted present value model. (moderate, L.O. 1, Section 1, true) 3. Like other sources of capital, common equity has a promised rate of return. (easy, L.O. 1, Section 1, false) 4. The degree to which a stock’s returns are correlated with market movements is known as systematic risk. (moderate, L.O. 2, Section 1, true) 5. Beta is the variable which measures a stock’s correlation with the market. (moderate, L.O. 2, Section 1, true) 6. Diversification eliminates systematic risk. (easy, L.O. 2, Section 1, false) 7. The systematic risk of a portfolio is the total of the individual systematic risks of each stock in the portfolio. (difficult, L.O. 2, Section 1, false) 8. The volatility of an individual stock has significant effect on the volatility of a well-diversified portfolio. (moderate, L.O. 2, Section 1, false) 9. When a firm’s economic balance sheet has only core operations, debt, and common equity, the weighted- average cost of capital is the average of the after-tax cost of debt and cost of equity. (difficult, L.O. 3, Section 2, true) 10. Under the concept of negative debt, a firm that holds equal amounts of debt and nonoperating securities is viewed as not being leveraged at all. (difficult, L.O. 3, Section 2, true) 11. Under the weighted-average cost of capital, the weights of all components must equal. (moderate, L.O. 3, Section 2, true) 12. Under the weighted-average cost of capital, the discount rate for core operations is the weighted-average of the demanded return on all economic balance sheet items other than core operations. (difficult, L.O. 3, Section 2, true) 13. Analysts cannot infer the value of the unlevered beta from either the levered beta or the firm’s capital 42
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structure since no theoretical relationship among these elements exist. (moderate, L.O. 3, Section 2, false) 14. The beta for a private company is identical to the beta for a publicly held company as long as the two are of similar sizes in the same industry. (moderate, L.O. 4, Section 4, false) 15. Precision is a statistical measure of the unlevered cost of capital, and it is equal to the reciprocal of the variance. (moderate, L.O. 4, Section 4, false) MULTIPLE CHOICE QUESTIONS
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