CHAPTER 10
FORECASTING FREE CASH FLOWS
LEARNING OBJECTIVES
1.
How to build a free cash flow valuation model.
2.
Why the assumptions that drive the valuation model must be reasonable and internally consistent.
3.
How to set assumptions for a valuation model.
4.
How to refine a valuation model.
5.
How to prepare a sensitivity analysis.
TRUE/FALSE QUESTIONS
1.
Forecasting is more of an art than a science, and since it is subjective, it is difficult and prone to error.
(moderate, L.O. 1, Introduction, true)
2.
Many acquisitions are failures simply because the buyer overpays for the target firm.
(moderate, L.O. 1, Introduction, true)
3.
There are several “official” ways to forecast the line items included in the free cash flow forecast.
(moderate, L.O. 2, Section 1, false)
4.
Reasonableness means the forecasted numbers are logical in relation to each other.
(easy, L.O. 2, Section 1, false)
5.
Net revenues (sales) projections are often one of the most important variables affecting value.
(moderate, L.O. 2, Section 1, true)
6.
Revenue in the first year of the forecast does not depend on actual revenue or an assumed growth rate.
(moderate, L.O. 2, Section 1, false)
7.
The concepts of reasonableness and internal consistency require the analyst to build the model using
cause-and-effect relationships.
(moderate, L.O. 3, Section 2, true)
8.
Using the Gordon Growth Model, an analyst can forecast a finite number of periods explicitly and
assume a regular pattern of cash flows after that point.
(moderate, L.O. 3, Section 2, false)
9.
Once a firm has lost its competitive advantage, it will not be able to find positive net present value
projects.
(difficult, L.O. 3, Section 2, true)
10.
Historical relationships are not generally used for setting forecast assumptions.
(moderate, L.O. 3, Section 2, false)
11.
A valuation model is a way to quantify the valuation implications of the assumptions an analyst makes
about what the future holds for a firm.
(difficult, L.O. 3, Section 2, true)
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