DCF Quiz Basic Practice Questions and Correct Answers
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Course
Discounted Cash Flow
Institution
Discounted Cash Flow
1. Conceptually, a DCF analysis consists of a "near future" value (over 5-10 years) and a "far future" value (the company's value past that period), both of which are discounted back to their present values and summed up. a. True b. False i. Explanation: The correct answer choice is A. The "near fu...
DCF Quiz Basic Practice Questions and
Correct Answers
1. Conceptually, a DCF analysis consists of a "near future" value (over 5-10 years) and
a "far future" value (the company's value past that period), both of which are discounted
back to their present values and summed up.
a. True
b. False ✅i. Explanation: The correct answer choice is A. The "near future" value
consists of the projected Free Cash Flows over the next 5 to 10 years, until the
company reaches a steady state. The "far future" value represents the Free Cash Flows
generated in the final year of the projection until perpetuity, and is approximated by the
Terminal Value, which can be calculated using two differed approaches. Both values
are discounted back to present and added together to determine Enterprise (or Equity)
value, depending on which type of Free Cash Flows is projected.
2. Which of the following steps do you complete in a DCF analysis?
a. Project cash flows in the "near future" period
b. Project cash flows in the "far future" period
c. Determine the appropriate discount rate to discount cash flows by
d. Add together all the discounted cash flows to determine the NPV ✅Explanation: All
of the above entail the steps necessary in
completing a DCF analysis. As mentioned before, the value of the company consists of
two components: 'near future' period cash flows and 'far future' period cash flows. For
the former we can project these cash flows within a 5 to 10 year period. For the latter,
we need to approximate these cash flows by estimating the Terminal Value. Once both
'near future' and 'far future' cash flows are estimated, we calculate the appropriate
discount rate to determine their present values. Finally, once everything is discounted to
present value we add together the two figures to obtain Enterprise (or Equity) value,
depending on which type of FCF we projected.
3. How
Cash Flow analysis?
is a Dividend Discount Model different from a conventional Discounted
a. Dividends are discounted instead of Free Cash Flow
b. Cost of Equity is used as the discount rate instead of WACC
c. Terminal Value is based on a P / BV or P / E multiple instead of
EV/EBITDA
d. None of the above ✅Explanation: All of the statements above are correct
differences
when doing a DDM instead of a DCF. Answer choice A is correct as dividends are used
in place of Free Cash Flow (dividends are assumed to be a proxy for FCF for some
types of companies, such as banks and insurance firms). Answer choice B is correct
, because in a DDM we only discount cash flows at Cost of Equity, NOT the overall
WACC - since dividends only go to equity investors, we're calculating Equity Value and
using Cost of Equity. Answer choice C is correct because we want to use an Equity
Value-based multiple, such as P / E or P / BV, as opposed to an Enterprise Value-
based multiple when using a DDM.
4. All of the following equations below are the correct definition of Unlevered Free Cash
Flow (Free Cash Flow to Firm) EXCEPT:
a. EBIT * (1 - Tax Rate) + Non-Cash Charges - Change in Operating Assets and
Liabilities - CapEx
b. CFO + Net Interest Expense * (1 - Tax Rate) - CapEx
c. Net Income + Net Interest Expense * (1 - Tax Rate) + Non-Cash
Charges - Change in Operating Assets and Liabilities - CapEx
d. Net Income + Non-Cash Charges - Change in Operating Assets and
Liabilities - CapEx - Mandatory Debt Repayments
e. None of the above (i.e. these are all correct) ✅Explanation: The correct answer
choice is D. Unlevered Free
Cash Flow can be defined in more than one way, and answer choices A, B, and C are
all correct definitions of unlevered FCF. Answer choice D, on the other hand, is NOT the
definition of Unlevered FCF but rather is the correct formula for Levered free cash flow
(since it includes interest payments and debt repayment).
5. Which sections of the Cash Flow Statement do we generally exclude when
calculating Free Cash Flow?
a. Cash Flow from Operations (CFO)
b. Cash Flow from Investing (CFI), except for CapEx
c. Cash Flow from Financing (CFF)
d. None of the above - we need all these sections when calculating FCF ✅Explanation:
When calculating Unlevered FCF we only take CapEx from CFI and exclude everything
else in that section as well as CFF. The idea is that we are trying to only include
recurring, predictable items. And in the case of Levered FCF, we still exclude almost
everything from CFI and CFF sections (with the exception of CapEx in FI and
mandatory debt repayments in CFF). Most other items in CFI and CFF are usually one-
time, non-recurring items (e.g. debt and equity issuances, sales of assets and
securities) that in the majority of cases do not represent recurring, predictable sources
or uses of cash for the company.
6. In a valuation context, using Unlevered FCF in a DCF gets you Enterprise Value,
whereas using Levered FCF gets you Equity Value.
a. True
b. False ✅Explanation: The correct answer choice is A. The statement above is true.
This is the case is because Unlevered FCF is available to all investors in the firm (both
debt and equity), whereas Levered FCF included interest payments and mandatory debt
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