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Question 1

1. Which of the following is not true about generally accepted accounting principles (GAAP)?

a. GAAP provide specific guidelines as to how to account for specific events impacting the financial performance of the firm.
b. The scrupulous application GAAP accounting rules ensures consistency in comparing one firm’s financial performance to another.
c. It is customary for definitive agreements of purchase and sale to require that a target company represent that its financial books are kept in accordance with GAAP.
d. GAAP guarantees that a firm’s financial books are accurate.
e. Differences between how a firm records actual financial transactions and how they should be recorded based on GAAP may indicate fraud or mismanagement.

Answer 1

d. GAAP guarantees that a firm’s financial books are accurate.

Question 1

2. Which of the following is not true about common size financial statements?

a. Such statements are used to uncover data irregularities.
b. Such statements are constructed by calculating the percentage each line item of the income statement, balance sheet, and cash flow statement is of annual sales.
c. Such statements are useful for comparing businesses of different sizes in the same industry at different moments in time.
d. Common size statements applied over a number of consecutive periods may be used to determine if the target firm is deferring necessary spending.
e. Common size statements may be calculated for both quarterly and annual financial data.

Answer 1

c. Such statements are useful for comparing businesses of different sizes in the same industry at different moments in time.

Question 2

3. Target is a wholly owned subsidiary of MegaCorp Inc. MegaCorp supplies a number of services to target. Target sells some of its products to other MegaCorp subsidiaries. Target also buys products from other MegaCorp subsidiaries that are used as inputs in producing Target’s products. Which of the following adjustments should the acquirer make to Target’s financial statements before valuing the firm?

a. Deduct the actual cost of services required by Target that are being supplied by the parent without charge from target’s cost of sales.
b. Deduct the difference between the cost of products purchased from other MegaCorp subsidiaries at below market prices and the actual market prices for such products from Target’s cost of sales.
c. Deduct the difference between the cost of products purchased from other MegaCorp subsidiaries at above market prices and actual market prices from Target’s cost of sales
d. A and B only.
e. None of the above.

Answer 2

c. Deduct the difference between the cost of products purchased from other MegaCorp subsidiaries at above market prices and actual market prices from Target’s cost of sales

Question 3

Real Cool Autos acquired Automotive Industries in a transaction that produced an NPV of $3.7 million.
This NPV represents
a. Synergy
b. Book value
c. Investment value
d. Diversification
e. None of the above

Answer 3

a. Synergy

Question 4

. A target firm’s standalone value is best defined by which of the following statements:
a. What a business would be worth as part of another firm
b. What a business would be worth as a going concern following a takeover bid
c. What a business would be worth as a going concern in the absence of a takeover bid
d. What the target is worth after the closing date following a takeover
e. None of the above

Answer 4

c. What a business would be worth as a going concern in the absence of a takeover bid

Question 5

Value drivers are best described by which of the following statements:
a. Variables which exert the greatest impact on firm value
b. Only involve revenue-related variables
c. Only involve cost-related variables
d. Refer to the weighted average cost of capital and cost of equity only
e. None of the above

Answer 5

a. Variables which exert the greatest impact on firm value

Question 6

Financial models are said to be in balance when
a. Net income is positive
b. Total assets equal total liabilities plus shareholders’ equity
c. Total assets equal total liabilities less shareholders’ equity
d. Cash flow is positive
e. None of the above

Answer 6

b. Total assets equal total liabilities plus shareholders’ equity

Question 7

Which of the following is true of pro forma financial statements?
a. Pro forma statements purport to show what the combined firms would look adjusted for synergy
and the terms of the deal
b. Pro forma statements are the same as GAAP statements
c. Pro forma statements show what the combined firms would look excluding the effects of synergy
d. a and b only
e. None of the above

Answer 7

a. Pro forma statements purport to show what the combined firms would look adjusted for synergy
and the terms of the deal

Question 8

Financial modeling may be applied in which of the following situations:
a. Business valuation
b. Management decision making
c. Capital budgeting
d. Financial statement analysis
e. All of the above

Answer 8

e. All of the above

Question 9

The financial modeling process used to value a firm consists of a series of steps. These include which of the following:
a. Analyzing the target firm’s historical statements to identify the primary determinants of cash flow.
b. Project three-to-five years (or more) of annual pro forma financial statements. This three-to-five
year period is called the planning period.
c. Estimating the present value projected pro forma cash flows during the planning period.
d. Estimating the terminal value.
e. All of the above

Answer 9

e. All of the above

Question 10

An increase in gross margin over time could indicate what about the firm:
a. It has been able to reduce its costs compared to sales
b. It has been able to raise prices
c. It has been able to achieve a combination of (a) and (b)
d. It was forced to lower its prices
e. a, b, or c

Answer 10

e. a, b, or c

Question 11

Which of the following future events could affect projections of a firm’s cash flow?
a. Introduction of new products by the firm
b. The emergence of products that are substitutes for the firm’s products
c. The emergence of additional competitors to the firm
d. Improvements in the firm’s productivity
e. All of the above

Answer 11

e. All of the above

Question 12

Common items found on a balance sheet include all of the following except for which of the following:’
a. Receivables
b Cost of sales
c. Inventory
d. Long-term debt
e. Payables

Answer 12

b Cost of sales

Question 13

Common items found on an income statement include all of the following except for which of the following:
a. Revenue
b. Retained earnings
c. Cost of sales
d. Sales, general and administrative expenses
e. Net income

Answer 13

b. Retained earnings

Question 14

Common items found on a cash flow statement include all of the following except for which of the following:
a. Net income
b. Change in working capital
c. Principal repayments on outstanding debt
d. Retained earnings
e. The proceeds of asset sales

Answer 14

d. Retained earnings

Question 15

Changes in the key assumptions underlying the estimation of a firm’s terminal period valuation are likely to have
a. A disproportionately large impact on the firm’s enterprise and equity values
b. A disproportionately small impact on the firm’s enterprise and equity values
c. A disproportionately large impact on the firm’s enterprise value but little impact on its equity
value
d. A disproportionately large impact on the firm’s equity value but little impact on its equity value
e. None of the above.

Answer 15

a. A disproportionately large impact on the firm’s enterprise and equity values

Question 16

When changing financial model assumptions, which of the following is true?
a. Change more than one assumption at a time
b. Make large changes in assumptions
c. Change only one assumption at a time
d. Only change assumptions impacting the income statement
e. Only change assumptions impacting the balance sheet

Answer 16

c. Change only one assumption at a time

Question 17

Which of the following statements is true?
a. A 10% increase in sales has a smaller impact on cash flow than a 10% reduction in cost of sales.
b. A 10% increase in sales has the same impact on cash flow than a 10% reduction in cost of sales.
c. A 10% increase in sales has a larger impact on cash flow than a 10% reduction in cost of sales.
d. A 10% increase in sales has a smaller impact on after-tax profits than a 10% reduction in cost of
sales.
e. None of the above

Answer 17

c. A 10% increase in sales has a larger impact on cash flow than a 10% reduction in cost of sales.

Question 18

1. Which of the following are often true about the challenges of valuing private firms?
   a. There is a lack of analyses generated by sources outside of the company.
   b. Financial reporting systems are often inadequate.
   c. Management depth and experience is often limited.
   d. Reported earnings are often understated to minimize taxes.
   e. All of the above.

Answer 18

e. All of the above.

Question 19

2. In valuing private businesses, the U.S. tax courts have historically supported the use of which valuation method for purposes of estate valuation?
   a. Discounted cash flow
   b. Comparable company method
   c. Tangible book value method
   d. A combination of a and c
   e. All of the above

Answer 19

b. Comparable company method

Question 20

3. All of the following are true of reverse mergers except for.
   a. May be used to take a private firm public
   b. May represent an effective alternative to an IPO
   c. Commonly use private equity placements for financing
   d. Requires 2 years of audited financial statements to take a private firm public
   e. A and B

Answer 20

d. Requires 2 years of audited financial statements to take a private firm public

Question 21

Which of the following is not true of liquidity or marketability risk or discount?
a. It is measurable.
b. It is believed to have declined in recent years
c. The magnitude of the discount or risk is inversely related to the size of the investor’s equity ownership in the business.
d. The magnitude of the discount or risk is directly related to the size of the investor’s equity ownership in the business.
e. It is important to adjust the discount rate for liquidity risk.

Answer 21

d. The magnitude of the discount or risk is directly related to the size of the investor’s equity ownership in the business.

Question 22

Corporate shells have value because they enable the buyer to
a. Avoid the cost of going public
b. Exploit intangible value such as brand name
c. A and D only
d. Provide limited liability
e. A, B, and D only

Answer 22

e. A, B, and D only

Question 23

6. Leveraged employee stock ownership plans are frequently used by owners of private businesses to
   a. Hide assets
   b. Motivate employees
   c. Sell the firm to the employees
   d. B and C
   e. A, B, and C

Answer 23

d. B and C

Question 24

All of the following are often true of privately held firms except for a. Financial data is often inaccurate and out of date b. Internal controls are ineffective c. Have limited access to capital markets and product distribution channels d. Are more easily valued than public companies e. Have limited ability to influence customers, suppliers, unions, and regulators

Answer 24

d. Are more easily valued than public companies

Question 25

Fair market value is a. The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business b. The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information c. The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information and that neither party is under duress. d. The discounted value of free cash flow to the firm e. The discounted value of free cash flow to equity investors.

Answer 25

c. The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information and that neither party is under duress.

Question 26

The discount rate may be estimated using all but the one of the following: a. The capital asset pricing model b. The share exchange ratio c. The cost of capital d. Return on total assets e. Price-to-earnings ratio

Answer 26

b. The share exchange ratio

Question 27

10. All of the following represent common sources of value in appraising private or publicly owned businesses except for a. Intellectual property b. Customer lists c. Licenses d. Contingent liabilities e. Employment contracts

Answer 27

d. Contingent liabilities

Question 28

11. Revenue Ruling 59-60 describes the general factors that the IRS and tax courts consider relevant in valuing private businesses. Of the following valuation methods, which do the IRS and tax courts view as the most important? a. Discounted cash flow b. Comparable company methods c. Tangible book value d. Replacement cost method e. All of the above

Answer 28

b. Comparable company methods

Question 29

12. The most important element(s) in selecting a business valuation professional include which of the following: (Select only one) a. Overall experience b. Demonstrated ability in the industry in which the firm to valued competes c. Degree of specialization d. Number of professional degrees e. A and B only

Answer 29

e. A and B only

Question 30

13. A business owner may overstate revenue by a. Failing to deduct from revenue products returned by customers b. Billing customers for products not ordered c. Booking the entire value of a multiyear contract in the current year d. Counting interest income as revenue e. All of the above

Answer 30

e. All of the above

Question 31

14. A business owner may overstate revenue and understate actual expenses when a. The business is about to be sold b. They are being audited by the IRS c. They are trying to minimize tax liabilities d. All of the above e. None of the above

Answer 31

a. The business is about to be sold

Question 32

15. A corporate shell may have value because a. It may enable the owner to avoid the costs of going public b. The name is widely recognized c. It could own the rights to various forms of intellectual property d. All of the above e. None of the above

Answer 32

d. All of the above

Question 33

1. Which of the following is generally not true about leveraged buyouts? a. Borrowed funds are used to pay for all or most of the purchase price, perhaps as much as 90% b. Tangible assets of the target firm are often used as collateral for loans. c. Bank loans are often secured by the target firm’s intangible assets d. Secured debt is often referred to as junk bond financing. e. C and D only

Answer 33

c. Bank loans are often secured by the target firm’s intangible assets

Question 34

1. Asset based lending is commonly used to finance leveraged buyouts. Which of the following is not true about such financing? a. The borrower generally pledges tangible assets as collateral. b. Lenders look at the target firm’s assets as their primary protection. c. Bank loans are secured frequently by receivables and inventory. d. Loans maturing in more than one year are often referred to as term loans. e. The target firm’s most liquid assets generally secure longer-term loans.

Answer 34

e. The target firm’s most liquid assets generally secure longer-term loans.

Question 35

3. Security provisions and protective covenants are included in loan documents to increase the likelihood that the interest and principal of outstanding loans will be repaid in a timely fashion. Which of the following is not true about security provisions and protective covenants? a. Security features include the assignment of payments due under a specific contract to the lender. b. Negative covenants include limits on the amount of dividends that might be paid c. Limitations on the amount of working capital that the borrower can maintain. d. Periodically, financial statements must be sent to lenders. e. Automatic loan repayment acceleration if the borrower is in default on any loans outstanding

Answer 35

c. Limitations on the amount of working capital that the borrower can maintain.

Question 36

2. Asset based lending is commonly used to finance leveraged buyouts. Which of the following is not true about such financing? a. The borrower generally pledges tangible assets as collateral. b. Lenders look at the target firm’s assets as their primary protection. c. Bank loans are secured frequently by receivables and inventory. d. Loans maturing in more than one year are often referred to as term loans. e. The target firm’s most liquid assets generally secure longer-term loans.

Answer 36

e. The target firm’s most liquid assets generally secure longer-term loans.

Question 37

4. Which of the following is not true about junk bonds? a. Junk bonds are either unrated or rated below investment grade by the credit rating agencies b. Typically yield about 1-2 percentage points below yields on U.S. Treasury debt of comparable maturities. c. Junk bonds are commonly used source of “permanent” financing in LBO transactions d. During recessions, junk bond default rates often exceed 10% e. Junk bond default risk on non-investment grade bonds tends to increase the longer the elapsed time since the original issue date of the bonds

Answer 37

b. Typically yield about 1-2 percentage points below yields on U.S. Treasury debt of comparable maturities.

Question 38

5. Which of the following characteristics of a firm would limit the firm’s attractiveness as a potential LBO candidate? a. Substantial tangible assets b. High reinvestment requirements c. High R&D requirements d. B and C e. All of the above

Answer 38

d. B and C

Question 39

6. Premiums paid to LBO firm shareholders average a. 20% b. 70% c. 5% d. Less than typical mergers e. More than typical mergers

Answer 39

e. More than typical mergers

Question 40

7. Factors that are most likely to contribute to the magnitude of premiums paid to LBO target firm shareholders are a. Tax benefits b. Improved operating efficiency c. Improved decision making d. A, B, and C e. A and C only

Answer 40

d. A, B, and C

Question 41

8. Which of the following is not true about attractive LBO candidates? a. Most assets tend to be encumbered b. Have low leverage c. Have predictable cash flow d. Have assets that are not critical to the ongoing operation of the firm e. Are in mature, moderately growing industries

Answer 41

a. Most assets tend to be encumbered

Question 42

9. Which of the following is generally not considered a characteristic of a financial buyer? a. Focus on short-to-intermediate returns b. Concentrate on actions that enhance the ability of target firm’s ability to generate cash flow to satisfy debt service requirements c. Intend to own the business for very long periods of time d. Manage the business to maximize return to equity investors e. All of the above

Answer 42

c. Intend to own the business for very long periods of time

Question 43

10. Which of the following are commonly used sources of funding for leveraged buyouts? a. Secured debt b. Unsecured debt c. Preferred stock d. Seller financing e. All of the above

Answer 43

e. All of the above

Question 44

11. Fraudulent conveyance is best described by which of the following situations: a. A new company spun off by its parent to the parent’s shareholders that enters bankruptcy is found to have been substantially undercapitalized when created b. An acquiring company pays too high a price for a target firm c. A company takes on too much debt d. A leveraged buyout is taken public when its operating cash flows are increasing e. None of the above

Answer 44

a. A new company spun off by its parent to the parent’s shareholders that enters bankruptcy is found to have been substantially undercapitalized when created

Question 45

12. LBO investors must be very careful not to overpay for a target firm because a. Major competitors tend to become more aggressive when a firm takes on large amounts of debt b. High leverage increases the break-even point of the firm c. Projected cash flows are often subject to significant error limiting the ability of the firm to repay its debt d. A and B only e. A, B, and C

Answer 45

e. A, B, and C

Question 46

13. LBOs often exhibit very high financial returns during the years following their creation. Which of the following best describes why this might occur? a. LBOs invariably improve the firm’s operating efficiency b. LBOs tend to increase investment in plant and equipment c. The only LBOs that are taken public are those that have been the most successful d. LBOs experience improved decision making during the post-buyout period e. None of the above

Answer 46

c. The only LBOs that are taken public are those that have been the most successful

Question 47

14. Which of the following is not typically true of LBOs? a. Managers are generally also owners b. Most employees are given the opportunity to participate in profit sharing plans c. The focus tends to be on improving operational efficiency though cost cutting and improving productivity d. R&D budgets following the creation of the LBO are always increased significantly e. All of the above

Answer 47

d. R&D budgets following the creation of the LBO are always increased significantly

Question 48

15. Which of the following tends to be true of LBOs a. LBOs rely heavily on management incentives to improve operating performance b. The premium paid to target firm shareholders often exceeds 40% c. Tax benefits are predictable and are built into the purchase price premium d. The cost of equity is likely to change as the LBO repays debt e. All of the above

Answer 48

e. All of the above

Question 49

16. An investor group acquired all of the publicly traded shares of a firm. Once acquired, such shares would no longer trade publicly. Which of the following terms best describes this situation? a. Merger b. Going private transaction c. Consolidation d. Tender offer e. Joint venture

Answer 49

b. Going private transaction

Question 50

17. The management team of a privately held firm found a lender who would lend them 90 percent of the purchase price of the firm if they pledged the firm’s assets as well as their personal assets as collateral for the loan. This purchase would best be described by which of the following terms? a. Merger b. Leveraged buyout c. Joint venture d. Tender offer e. Consolidation

Answer 50

b. Leveraged buyout

Question 51

Debt restructuring of a bankrupt firm is usually accomplished in which of the following ways: a. An extension b. A composition c. A debt for equity swap d. Some combination of a, b, or c e. All of the above

Answer 51

e. All of the above

Question 52

Why would creditors be willing to give a portion of what they are owed by the debtor firm for equity in the reorganized firm? a. They are legally obligated to do so under U.S. bankruptcy law. b. Ownership in a firm is inherently more valuable than being a creditor. c. The value of the stock may in the long run far exceed the amount of debt the creditors were willing to forgive. d. Creditors understand that they can sue the firm at a later date for what they are owed. e. None of the above.

Answer 52

c. The value of the stock may in the long run far exceed the amount of debt the creditors were willing to forgive.

Question 53

All of the following are true of the bankruptcy process except for a. The debtor firm may seek protection from its creditors by initiating bankruptcy or may be forced into bankruptcy by its creditors. b. When creditors file for bankruptcy on behalf of the debtor firm, the action is said to be involuntary bankruptcy. c. Once either a voluntary or involuntary petition is filed, the debtor firm is protected from any further legal action related to its debts until the bankruptcy proceedings are completed. d. The filing of a petition triggers an automatic stay even before the court accepts the request. e. An automatic stay suspends all judgments, collection activities, foreclosures, and repossessions of property by the creditors on any debt or claim that arose before the filing of the bankruptcy petition

Answer 53

d. The filing of a petition triggers an automatic stay even before the court accepts the request.

Question 54

All of the following are true except for a. Chapter 15 deals with international or cross-border bankruptcies. b. Chapter 11 deals with reorganizing the firm. c. Chapter 7 defines the process and priorities of the liquidation process for commercial businesses. d. Chapter 11 also addresses issues pertaining to personal bankruptcy. e. A and B

Answer 54

d. Chapter 11 also addresses issues pertaining to personal bankruptcy.

Question 55

Which of the following are commonly used strategic alternatives for failing firms? a. Merge with another firm b. Reach out of court voluntary settlement with creditors c. File for protection from creditors from the U.S. bankruptcy court d. A, B, and C e. A and B only

Answer 55

d. A, B, and C

Question 56

To determine which strategy to pursue, the failing firm’s management needs to estimate which of the following: a. Going concern value b. Liquidation value c. Selling price of the firm d. A and B only e. A, B, and C

Answer 56

e. A, B, and C

Question 57

Financially distressed firms often are characterized by all of the following except for: a. Underinvestment in operations b. Employee layoffs c. High levels of research and development spending d. Declining product quality e. Slower payments to suppliers

Answer 57

c. High levels of research and development spending

Question 58

The leading causes of business failure include which of the following: a. Recession b. Excessive operating expenses c. Excessive leverage d. Management inexperience e. All of the above

Answer 58

e. All of the above

Question 59

Moody’s credit rating agency defines instances of default as which of the following: a. Missed or delayed payment of interest or principal b. Bankruptcy c. Receivership d. Any exchange (equity for debt) diminishing the value of what is owed to bondholders e. All of the above

Answer 59

e. All of the above

Question 60

Which of the following statements is not true? a. Technical insolvency arises when a firm is unable to meet its obligations when they come due. b. Legal insolvency occurs when a firm’s liabilities exceed the fair market value of its assets. c. A firm must be legally insolvent to enter bankruptcy. d. Bankruptcy is a legal proceeding which protects a debtor firm from its creditors. e. A firm is not considered bankrupt until its petition for bankruptcy is accepted by the court.

Answer 60

c. A firm must be legally insolvent to enter bankruptcy.

Question 61

All of the following are conditions most favorable for reaching settlement outside of bankruptcy court except for a. The debtor firm is willing to share all necessary information with its creditors b. Creditors have confidence in the debtor firm’s management. c. The debtor firm has relatively few creditors. d. The debtor firm has many creditors. e. The period of economic distress afflicting the firm is expected to be short-lived.

Answer 61

d. The debtor firm has many creditors.

Question 62

All of the following represent different forms of debt restructuring except for a. Debt extensions b. Debt compositions c. Share exchange ratios d. Debt for equity swaps e. A and D

Answer 62

c. Share exchange ratios

Question 63

All of the following are true about voluntary liquidations except for a. They can be conducted outside of court in a private auction. b. They can be done within the protection of the bankruptcy court. c. Creditors normally prefer liquidations to be conducted by the bankruptcy court. d. A trustee is assigned to sell the debtor firm’s assets as quickly as possible while obtaining the best possible price. e. If the insolvent firm is willing to accept liquidation and all creditors agree, legal proceedings are not necessary.

Answer 63

c. Creditors normally prefer liquidations to be conducted by the bankruptcy court.

Question 64

The Bankruptcy Abuse Prevention and Creditor Protection Act of 2005 is intended to achieve all of the following except: a. To reduce the maximum length of time debtors have to submit a reorganization plan b. To give debtors more time to accept or reject leases c. To limit key employee compensation d. To enable the debtor to extend the lease indefinitely as long as lease payments are made on a timely basis e. B and D only

Answer 64

e. B and D only

Question 65

All of the following are true of the bankruptcy process except for a. Creditors and the debtor-in-possession have considerable flexibility in working together. b. The purpose of creditor committees is to work with the debtor firm to develop an acceptable reorganization plan c. The bankruptcy judge may choose to ignore the objections of creditors and shareholders and accept a reorganization plan. d. The government is responsible for paying the expenses of all those who contributed to the formulation of a reorganization plan. e. The debtor firm may emerge from Chapter 11 as an ongoing concern or be merged with another firm.

Answer 65

d. The government is responsible for paying the expenses of all those who contributed to the formulation of a reorganization plan.