Question

1. Assume that an analyst forecast about the free cash flow of a firm at the end of 2020 is $5,311 million. The required rate of return is 10% and analyst expects the free cash flow to grow at 4%. What should be the continuing value for this firm?

1. $ 53,110 million.
2. $132,775 million.
3. $ 92,057 million
4. $ 88,517 million.

2. Screening stocks based on the number of analysts following a particular stock is known as:

1. Price screens.
2. Momentum screens.
3. Insider trading screens.
4. Neglected stocks screens.

3. The most uncertain (speculative) part of a valuation is:

1. Free cash flow.
2. Continuing value.
3. Cash investment.
4. None of the above.

4. Which of the following is not a motivation to manipulate earnings?

1. Reduce tax obligation.
2. Remain in compliance with debt covenants.
3. Meet analyst expectation.
4. All of the above.

Answer 1

Answer:

D. 88517 million

Valuation of the firm using free cash flow = Expected Free cash flow for the next year / (Required Rate of return - Growth rate)
Valuation = 5311 / (10% - 4%) = $88517 million
[Since the year in which we are standing is not given in the question, therefore, we have assumed that the forecast that is given of 2020 belongs to next year.]

A. Price Screen
The major screen which is based on the number of analysts following a particular stock where stocks are purchased when the prices are dropped and the stocks are sold when the prices increase.

D. None of the above.
The long term growth rate is highly uncertain and therefore, it is considered as the most speculative part of the valuation and any valuation done by using long term growth rate are considered highly uncertain.

A. Reduce Tax Obligation
Rest other options provide a motivation to manipulate earnings except for reducing tax obligations.
Managers can manipulate earnings to meet the analyst expectation on the assumption that investors are too naive to understand such manipulation. Whether the company is able to meet its debt obligations and compliance with debt covenants may affect the management's decisions to manipulate earnings.