Scott, Inc., is planning to invest $120,000 in a 10-year *Solutions are computed using present value tables.

Due to
project. Scott estimates that the annual cash inflow, net of rounding errors, the solution may be slightly different if a calculator
income taxes, from this project will be $20,000. Scott's is used.
desired rate of return on investments of this type is 10%.
Information on present value factors is as follows: Year Present value of an annuity in arrears of $1 at 15%
1 $0.870
At 10% At 12% 2 $1.626
Present value of $1 for 10 periods 0.386 0.322 3 $2.284
Present value of an annuity of $1 for 10 4 $2.856
6.145 5.650
periods 5 $3.353
Scott's expected rate of return on this investment is: 6 $3.785
A 12%.
The initial investment would be $30,000. It would be
B less than 10%, but more than 0%. depreciated on a straight-line basis over six years with no
C 10%. salvage. The before tax annual cash inflow due to this
D less than 12%, but more than 10%. investment is $10,000, and the income tax rate is 40% paid
the same year as incurred. The desired rate of return is 15%.
The true rate of return is that rate which equates the present All cash flows occur at year-end.
value of the future returns with the cost of the investment.
PV = FV × PVIF How much would Apex have had to invest five years ago at
120,000 = 20,000 × PVIF 15% compounded annually to have $30,000 now?
120,000 ÷ 20,000 = PVIF
6.000 = PVIF A $17,160
As the factor is between the factors for 10% and 12%, the
The answer cannot be determined from the information
rate of return is less than 12% and more than 10%. B
given.
C $14,910
On January 1, Year 1, Liberty Company sold one of its D $12,960
product lines to Bell Corporation in an “arms length” The present value factor for an annuity of n years is equal to
transaction. Bell signed a noninterest bearing note requiring the sum of the individual, single sum, present value factors
payment of $20,000 annually for 10 years. The first payment for each of the n years. Therefore, the difference between
was made on January 1, Year 1. The prevailing rate of the present value annuity factors for n and n − 1 years is
interest for this type of note at date of issuance was 12%. equal to the present value factor of a single sum to be
Information on present value factors is as follows:* received at the end of the nth year.
*Solutions are computed using present value tables. Due to PV annuity factor for five years @ 15% = 3.353
rounding errors, the solution may be slightly different if a
PV annuity factor for four years @ 15% = 2.856
calculator is used.
PV factor for a single sum five years, 15% 0.497
Present value of Present value of ordinary The present value of 30,000 to be received five years from
Period
$1 at 12% annuity of $1 at 12% now given an interest rate of 15% compounded annually is
determined as follows:
9 0.361 5.328
 PV = FV × PV factor
10 0.322 5.650  PV = $30,000 × 0.497
 PV = $14,910
Liberty should record the above sale in January, Year 1 at:
A $126,560.
B $106,560.
C $133,000. When using the discounted cash flow method to evaluate a
D $113,000. business combination, what is the appropriate assumption
Present value of the sale: about longevity of the target firm?
Payment 1/1/Year 1 $ 20,000 A Three to five years
Present value of nine future payments B Product's projected useful life
$20,000 × 5.328 $106,560 C Industry average firm life
$126,560 D Indefinite life

Which of the following is not a common reason that business

combinations take place?
A Increase revenue
B Decrease costs
C Expand market share
D Government regulation
PQR manufactures and sells e-readers. The company wants
The Apex Company is evaluating an investment proposal for to acquire XYZ, which manufactures the LCD screens that
the current year. The relevant data follow.* are used in the e-readers. PQR is an all-equity-financed
company with 5 million shares in issue and a cost of capital
of 12%.
The finance division of PQR is valuing XYZ using the DCF ZSW? You should use the time value of money factors
technique, and has the following information: below.
PV of Single Sum, n PV of ordinary annuity, n
Expected post-tax cash flows of PQR 0.621 3.791
= 5, I = 10% = 5, I = 10%
Year 1 2 3 4 5 onward
Cash flows FV of Single Sum, n = FV of ordinary annuity, n
240,000 200,000 280,000 100,000 260,000 1.611 6.105
($) 5, I = 10% = 5, I = 10%
PV factor
0.893 0.797 0.712 0.636 0.567 A $275,840
(12%)
What is the valuation of XYZ? B $473,840
A $784,100 C $566,400
B $2,012,600 D $368,400
C $801,790
D $2,950,767 The HEA Company is considering purchasing the ARO
Company. HEA estimates that ARO will generate net cash
flows of $60,000 per year at the end of each of the next 5
Year 1 2 3 4 5 Total years and the terminal value of all cash flows after year 5
Cash (including non-operating assets) is estimated to be $500,000
flows 240,000 200,000 280,000 100,000 260,000 as of the end of year 5.
($) If HEA uses a discount rate of 10% to value this acquisition
and pays $480,000 for ARO, how much net value is it
PV
creating for its shareholders? You should use the time value
factor 0.893 0.797 0.712 0.636 0.567
of money factors below.
(12%)
PV of Single Sum, n PV of ordinary annuity, n
PV of 0.621 3.791
= 5, I = 10% = 5, I = 10%
cash
214,320 159,400 199,360 63,600 147,420 784,100
flows FV of Single Sum, n = FV of ordinary annuity, n
($) 1.611 6.105
5, I = 10% = 5, I = 10%
PV of cash flows until Year 5 = $784,100.
Beyond Year 5, the cash flows continue to infinity; this has a A $320,000
present value of: B $691,800
 $260,000 ÷ 0.12 = $2,166,667.
C $57,960
 $2,166,667 has a present value today of:
$2,166,667 × 0.567 = $1,228,500. D $537,960
 Total present value, or value of the company =
$784,100 + $1,228,500 = $2,012,600.
The EWY Company is considering purchasing the NTD
Company. EWY estimates that NTD will generate net cash
flows of $80,000 per year at the end of each of the next 5
years. In addition, the terminal value of all cash flows after
The DAF Company is considering purchasing the CTN year 5 (including non-operating assets) is estimated to be
Company. DAF estimates that CTN will generate net cash $350,000 as of the end of year 5.
flows of $90,000 per year at the end of each of the next five If EWY uses a discount rate of 10% to value this acquisition
years. In addition, the terminal value of all cash flows after and pays $450,000 for NTD, how much net value is it
Year 5 (including nonoperating assets) is estimated to be creating for its shareholders? You should use the time value
$600,000 as of the end of Year 5. If CTN demands a of money factors below.
purchase price of $750,000, should DAF make the
PV of Single Sum, n PV of ordinary annuity, n
purchase? Assume DAF uses a discount rate of 10% to 0.621 3.791
= 5, I = 10% = 5, I = 10%
value this acquisition. You should use the time value of
money factors below. FV of Single Sum, n = FV of ordinary annuity, n
1.611 6.105
5, I = 10% = 5, I = 10%
PV of Single Sum, n PV of ordinary annuity,
0.621 3.791
= 5, I = 10% n = 5, I = 10%
A $300,000
FV of Single Sum, n FV of ordinary annuity, n B $70,630
1.611 6.105 C $602,250
= 5, I = 10% = 5, I = 10%
D $520,630
A Yes, because CTN is worth $941,190 The KUG Company is considering purchasing the JKH
B No, because CTN is only worth $600,000 Company. KUG estimates that JKH will generate net cash
C No, because CTN is only worth $713,790 flows of $50,000 per year at the end of each of the next five
D Yes, because CTN is worth $822,600 years. In addition, the terminal value of all cash flows after
The ASL Company is considering purchasing the ZSW Year 5 (including nonoperating assets) is estimated to be
Company. ASL estimates that ZSW will generate net cash $300,000 as of the end of Year 5. If KUG uses a discount
flows of $40,000 per year at the end of each of the next 5 rate of 10% to value this acquisition, what is the maximum
years and the terminal value of all cash flows after year 5 amount it should be willing to pay for JKH? You should use
(including non-operating assets) is estimated to be $200,000 the time value of money factors below.
as of the end of year 5.
PV of Single Sum, n PV of ordinary annuity,
If ASL uses a discount rate of 10% to value this acquisition, 0.621 3.791
= 5, I = 10% n = 5, I = 10%
what is the maximum amount it should be willing to pay for
FV of Single Sum, n FV of ordinary annuity, n LDE has a relatively decentralized company culture, and
1.611 6.105
= 5, I = 10% = 5, I = 10% D the target also has a relatively decentralized company
culture.
A $375,850
B $189,550
The QUG Company is trying to decide whether it should
C $186,300
acquire another company. It performs a discounted cash flow
D $489,550
analysis and determines that the value of the target is
$750,000. The target company has indicated that the
The HSW Company is considering purchasing the BGF minimum price it will accept is $690,000. Which of the
Company. HSW estimates that BGF will generate net cash following is a qualitative consideration that may result in
flows of $75,000 per year at the end of each of the next five QUG not making the purchase for $690,000?
years. In addition, the terminal value of all cash flows after
QUG thinks that the target’s management team is not as
Year 5 (including nonoperating assets) is estimated to be A
well experienced as its management team
$400,000 as of the end of Year 5. If HSW uses a discount
QUG thinks it may have overestimated the increase in
rate of 10% to value this acquisition, what is the maximum
B revenue it could generate because its products
amount it should be willing to pay for BGF? You should use
complement the target’s products
the time value of money factors below.
QUG thinks it may have overestimated the decrease in
C
PV of Single Sum, n PV of ordinary annuity, cost it could realize by eliminating duplicative fixed assets
0.621 3.791
= 5, I = 10% n = 5, I = 10% QUG has a relatively decentralized company culture, and
D
the target has a relatively centralized company culture
FV of Single Sum, n FV of ordinary annuity, n
1.611 6.105
= 5, I = 10% = 5, I = 10%
The CDL Company is trying to decide whether it should
A $775,000 acquire another company. It performs a discounted cash flow
B $532,725 analysis and determines that the value of the target is
C $684,325 $760,000. The target company has indicated that the
D $623,400 minimum price it will accept is $820,000. Which of the
following is a qualitative consideration that may result in CDL
making the purchase for $820,000?
CDL thinks it may have underestimated the increase in
The OKJ Company is trying to decide whether it should A revenue it could generate from the target’s distribution
acquire another company. It performs a discounted cash flow network.
analysis and determines that the value of the target is CDL thinks it may have underestimated the decrease in
$850,000. The target company has indicated that the B
cost it could realize by eliminating duplicative employees.
minimum price it will accept is $750,000. Which of the
CDL has a relatively decentralized company culture, and
following is a qualitative consideration that may result in OKJ C
the target has a relatively centralized company culture.
not making the purchase for $750,000?
CDL thinks that the target’s management team is well
D
OKJ is a well-established company that has been in experienced and highly qualified.
A existence for over 100 years and the target has been in
existence for less than five years.
OKJ thinks it may have overestimated the increase in Which of the following ways of evaluating business
B revenue it could generate from the target’s distribution combinations involves appraising multiple scenario options to
network. determine value creation abilities of the combined entity?
OKJ thinks it may have overestimated the decrease in A What-if analysis
C B Discounted cash flow analysis
cost it could realize by eliminating duplicative employees.
OKJ thinks that the target’s management team is well C Synergy analysis
D
experienced and highly qualified. D Cost benefit analysis

Softscape, a software developing company, is deciding

whether to merge with Technosoft, another software
developer. From the financial point of view, the merger looks
The LDE Company is trying to decide whether it should
to be very profitable for the new entity that would be created.
acquire another company. It performs a discounted cash flow
The shareholders of both the current companies would be
analysis and determines that the value of the target is
retained with their current holdings.
$840,000. The target company has indicated that the
minimum price it will accept is $880,000. Which of the
The management of Softscape, however, is worried about
following is a qualitative consideration that may result in LDE
the differences in the working styles of both the companies.
making the purchase for $880,000?
This concern is due to the fact that, unlike Softscape,
LDE thinks it may have underestimated the decrease in
Technosoft works on an “onsite − offshore” model.
A cost it could realize through economies of scale in
Which of the following qualitative factors influencing a
production.
business combination decision best describes the concern of
LDE thinks it may have underestimated the increase in the management of Softscape?
B revenue it could generate from the target’s distribution A Competitive advantage of the combined entity
network.
Strength of the top decision-makers of the combined
LDE thinks that the target’s management team is not as B
C entity
well experienced as its management team.
C Cultural fit achieved by the combined entity Increase in return on assets because of decreased
D
D Brand strength of the combined entity duplicate assets

Which of the following ways of evaluating business

combinations involves appraising multiple scenario options to
determine value creation abilities of the combined entity?
Which of the following is most appropriate about the
discounted cash flow (DCF) method that is used to value a
business?
The DCF method is based upon the real value of a
A
business.
While using the DCF technique, one needs to forecast the
B cash flows, and discount these at the entity’s discount
rate, without deducting taxation.
While using the DCF technique, only cash inflows are
C considered for being discounted using the entity’s
discount rate.
The discounted value of future cash flows, as calculated
D in the DCF technique, estimate the wealth of the
investors.

Which of the following statements is true of the business

valuation principle?
A The value of a business does not change over time.
The value of a business is solely affected by managers’
B
financing decisions.
The fair market value of a business is the value of that
C business to a hypothetical person who is knowledgeable
about the business.
Estimating the fair market value of a business always
D includes the value of synergies or the effects of any
investor-specific management style.

Gofast operates a parcel delivery service. The company is

now in the process of deciding whether to acquire Speedex,
an organization in a similar business. One of the Gofast
directors is of the opinion that on acquiring Speedex, it would
be in a better position to access low-cost debt finance.
To which of the following synergies of business combinations
is this director referring?
A Synergy from expanding into new geographic markets
B Synergy of economy of scale
C Synergy due to vertical integration
D Synergy from integration of “best practices”

Which of the following statements is true about business

valuation?
The valuation of a business is based solely on how much
A
return a business provides to its stockholders.
B There is a single value for any business.
There are different valuation models for any business,
C many of which produce different values for the same
company.
The value of a business is influenced solely by investment
D
managers’ decisions.

Which of the following is not a quantitative factor to consider

when evaluating a business combination?
A Strength of the management team
Increased margins from better pricing or lower costs of
B
goods due to quantity discounts
C Increased revenue from new products or markets