BCA Risk Management & Mitigation 3 — Questions and Answers
Question 1: A manufacturing firm relies on a single supplier for its primary raw material. The BCA appraiser should classify this as:
- Operational concentration risk (Correct answer)
- Systematic market risk
- Interest rate risk
- Litigation risk
Correct answer: Operational concentration risk
Dependence on a single supplier creates operational concentration risk, as any disruption to that supplier directly halts production.
Question 2: Which financial instrument is commonly used to mitigate foreign exchange risk in cross-border business transactions?
- Forward contracts or currency options (Correct answer)
- Equity swaps
- Convertible debt
- Asset-backed securities
Correct answer: Forward contracts or currency options
Forward contracts and currency options lock in exchange rates or provide the right to exchange at a set rate, protecting against adverse currency movements.
Question 3: In a risk-adjusted discount rate model, which scenario would most appropriately call for a LOWER company-specific risk premium?
- The company has no documented internal controls
- The company has diversified revenue streams and strong management depth (Correct answer)
- The company is in a highly regulated startup phase
- The company recently lost its top sales executive
Correct answer: The company has diversified revenue streams and strong management depth
Diversified revenues and depth of management reduce the idiosyncratic risks that drive up company-specific risk premiums.
Question 4: A technology firm's core product is protected by a patent expiring in two years. An appraiser should:
- Ignore this as it does not affect current earnings
- Reflect increased risk and potential revenue decline in the forecast beyond year two (Correct answer)
- Capitalize the patent at cost and amortize
- Reduce the working capital requirement
Correct answer: Reflect increased risk and potential revenue decline in the forecast beyond year two
Patent expiration exposes the company to competition, which should be modeled as increased risk and declining competitive advantage in future cash flow projections.
Question 5: Environmental liability risk in a business valuation is MOST appropriately addressed by:
- Adding a deduction to the equity value or applying a risk premium (Correct answer)
- Increasing the revenue growth rate
- Reducing the cost of goods sold assumption
- Applying a higher terminal growth rate
Correct answer: Adding a deduction to the equity value or applying a risk premium
Known or probable environmental liabilities should either be deducted from indicated value or reflected as a specific risk premium in the discount rate.
Question 6: Which risk management framework is most commonly referenced in enterprise risk management for businesses subject to valuation?
- COSO ERM Framework (Correct answer)
- GAAP Revenue Recognition Standards
- SEC Regulation FD
- FASB ASC 820 Fair Value Hierarchy
Correct answer: COSO ERM Framework
The COSO Enterprise Risk Management Framework provides a structured approach to identifying, assessing, and managing risk across organizations.
Question 7: A business with high fixed costs relative to variable costs faces elevated risk during revenue downturns because:
- Fixed costs can be easily reduced when sales fall
- Operating leverage magnifies the impact of revenue declines on profitability (Correct answer)
- Variable costs increase proportionally with sales volume
- High fixed costs indicate strong competitive positioning
Correct answer: Operating leverage magnifies the impact of revenue declines on profitability
High operating leverage means that a given percentage decline in revenue produces a larger percentage decline in operating income, amplifying downside risk.
BCA Risk Management & Mitigation 3
A manufacturing firm relies on a single supplier for its primary raw material.
The BCA appraiser should classify this as: