Chapter 4 Practice Question Answers
1. Answer: B. A relative valuation analysis produces an assessment of a company’s value, relative to its peers. The analysis often involves a comparable companies analysis, choice A. In producing the range of values, outliers are removed, choice C. The analysis does not involve forecasting cash flows.
2. Answer: B. In a comparable companies analysis, the ultimate set of comps is typically a group of five to ten companies in the same industry as the target that are most similar to the target in terms of their business and financial characteristics. Niche markets, however, do not always have similar comparables. In this case, the group of comparables can be expanded by looking at distributors of the same niche products and similar companies that are in other niche markets.
3. Answer: D. A proposed acquisition’s accretion or dilution to the buyer’s EPS may be assessed by subtracting the buyer’s EPS from the EPS of the combined entities post-acquisition:
proposed acquisition accretion/dilution = future EPS – buyer’s stand-alone EPS
The process of projecting pro forma EPS for the combined entity and comparing it to the buyer’s stand-alone EPS is known as accretion/dilution analysis.
4. Answer: B. In this example, the high and low values are clearly outliers and should be dropped. The median of the remaining values is $50 million, and a 20% range around this value would be $40 million to $60 million (50 x 0.20 = 10; 50 – 10 = 40; 50 + 10 = 60). Since the investor proposes purchasing 60% percent of Alpha, you must multiply each of these endpoint values by 0.60, producing a range of $24 million to $36 million (40 x 0.60 = 24; 60 x 0.6 = 36).
5. Answer C. Premiums paid represents the percentage mark-up that a buyer pays over the market price of the target company’s securities. It is calculated by dividing the purchase price by the market