CFM Corporate Finance & Valuation Flashcards

In a leveraged buyout (LBO), the primary source of returns for the private equity buyer is:

Answer: Debt paydown, operational improvements, and multiple expansion

LBO returns come from three main drivers: paying down acquisition debt with operating cash flow, improving EBITDA through operational changes, and selling at a higher valuation multiple.

What does the term 'beta' measure in the context of the Capital Asset Pricing Model (CAPM)?

Answer: A stock's sensitivity to market-wide movements

Beta measures systematic (market) risk, indicating how much a stock's returns move relative to the overall market; a beta of 1.5 means the stock is 50% more volatile than the market.

Which of the following best describes a company's 'cost of equity' under CAPM?

Answer: Risk-free rate + beta × equity risk premium

CAPM: Cost of Equity = Rf + β × (Rm - Rf), where Rf is the risk-free rate and (Rm - Rf) is the equity risk premium, compensating investors for taking on equity risk.

What is a 'terminal value' in discounted cash flow analysis?

Answer: The present value of all cash flows beyond the explicit forecast period, assuming perpetual growth

Terminal value captures the value of cash flows beyond the projection horizon, often calculated using the Gordon Growth Model (FCF × (1+g) / (WACC - g)).

In a merger, what does the term 'accretion/dilution analysis' assess?

Answer: The impact of the transaction on the acquirer's earnings per share (EPS)

Accretion/dilution analysis determines if the acquisition increases (accretive) or decreases (dilutive) the acquirer's post-deal EPS, informing the deal's attractiveness.

Which financial concept describes the additional return investors demand for investing in equity over a risk-free asset?

Answer: Equity risk premium (ERP)

The equity risk premium (ERP) is the excess return above the risk-free rate that investors require to hold stocks, reflecting the higher risk of equity versus government bonds.