CFM CFM Valuation Methods & DCF Modeling 1 — Questions and Answers
Question 1: In a Discounted Cash Flow (DCF) model, which rate is used to discount projected free cash flows back to present value?
- Internal Rate of Return (IRR)
- Weighted Average Cost of Capital (WACC) (Correct answer)
- Return on Equity (ROE)
- Cost of Debt
Correct answer: Weighted Average Cost of Capital (WACC)
The WACC reflects the blended cost of all capital sources and is the standard discount rate applied to unlevered free cash flows in a DCF model.
Question 2: What does the terminal value in a DCF model represent?
- The total debt outstanding at the end of the projection period
- The present value of all cash flows beyond the explicit forecast horizon (Correct answer)
- The residual book value of assets at the end of year five
- The sum of depreciation and amortization over the projection period
Correct answer: The present value of all cash flows beyond the explicit forecast horizon
Terminal value captures the value of a business beyond the explicit forecast period, often representing the majority of total DCF value.
Question 3: Which of the following is the correct formula for unlevered free cash flow (UFCF)?
- Net Income + Depreciation - CapEx - Change in Working Capital
- EBIT × (1 - Tax Rate) + D&A - CapEx - Change in NWC (Correct answer)
- EBITDA - Interest Expense - Taxes - CapEx
- Revenue - COGS - SG&A - CapEx
Correct answer: EBIT × (1 - Tax Rate) + D&A - CapEx - Change in NWC
UFCF starts with after-tax EBIT, adds back non-cash charges, then subtracts capital expenditures and the change in net working capital.
Question 4: When using the Gordon Growth Model to calculate terminal value, which assumption is most critical?
- The marginal tax rate applied to EBIT
- The perpetual growth rate of free cash flows (Correct answer)
- The beta used in the CAPM equation
- The length of the explicit forecast period
Correct answer: The perpetual growth rate of free cash flows
The perpetual growth rate (g) has an outsized impact on terminal value because small changes compound indefinitely in the perpetuity formula.
Question 5: In comparable company analysis (Comps), which multiple is most useful for comparing companies with different capital structures?
- Price-to-Earnings (P/E)
- Price-to-Book (P/B)
- EV/EBITDA (Correct answer)
- Dividend Yield
Correct answer: EV/EBITDA
EV/EBITDA is capital-structure-neutral because enterprise value and EBITDA are both pre-debt metrics, making cross-company comparisons more meaningful.
Question 6: A company has an enterprise value of $500M and equity value of $300M. What does the $200M difference most likely represent?
- The company's goodwill balance
- Net debt (total debt minus cash) (Correct answer)
- Accumulated other comprehensive income
- Deferred tax liabilities only
Correct answer: Net debt (total debt minus cash)
Enterprise Value = Equity Value + Net Debt, so the bridge between EV and equity value is primarily net debt (debt minus cash).
CFM CFM Valuation Methods & DCF Modeling 1
In a Discounted Cash Flow (DCF) model, which rate is used to discount projected free cash flows back to present value?