Name: Date:

Instructor: Score: /140

TRUE OR FALSE. Write TRUE if the statement is true and the word FALSE if you find the statement
inconsistent with the truth. – 40 pts.
________1. Many investors and analysts find that the best estimate for the value of the company or an
asset is the value of the returns that it will yield or income that it will generate.
________2. Income is based on the amount of money that the company or the assets will generate over
the period of time.
________3. In income-based valuation, investors consider two opposing theories: the dividend
irrelevance theory and the bird-in-hand theory.
________4. The dividend irrelevance theory was introduced by Modigliani and Myron Gordon that
supports the belief that the stock prices are not affected by dividends or the returns on the stock but
more on the ability and sustainability of the asset or company.
________5. Bird-in-the-hand theory believes that dividend or capital gains has an impact on the price of
the stock.
________6. Bird-in-the-hand theory is also known as dividend relevance theory developed by Miller and
John Lintner.
________7. Earning accretion is the additional value inputted in the calculation that would account for
the increase in value of the firm due to other quantifiable attributes like potential growth, increase in
prices, and even operating efficiencies.
________8. Earnings dilution will increase value if there are future circumstances that will affect the firm
negatively.
________9. Equity control premium is the amount that is added to the value of the firm in order to gain
control of it.
________10. Precedent transactions, on the other hand, are previous deals or experiences that can be
similar with the investment being evaluated.
________11. In income-based approach, a key driver is the cost of capital or the required return for a
venture.
________12. Cost of capital can be computed through (a) Weighted Average Cost of Capital or (b) Capital
Asset Pricing Model.
________13. The average cost of capital formula can be used in determining the minimum required
return.
________14. WACC may also include other sources of financing like Preferred Share and Retained
Earnings.
________15. The cost of equity may be also derived using Capital Asset Pricing Model.
________16. The cost of capital is a major driver in determining the equity value using income-based
approaches.
________17. The most conventional way to determine the value of the asset is through its economic value
added.
________18. In Mathematics, economic value added (EVA) is a convenient metric in evaluating
investment as it quickly measures the ability of the firm to support its cost of capital using its earnings.
________19. EVA is the excess of the company earnings after deducting the cost of capital.
________20. The general concept of EVA is that the higher the excess earnings is better for the firm.
________21. Cost of debt is tax-exempt, hence, there is tax benefit from it.
________22. Cost of equity is riskier as compared to the cost of debt which is variable.
________23. One of the elements that must be considered in using EVA is the reasonableness of earnings
or returns.
________24. The value of the company can also be associated with the anticipated returns or income
earnings based on the historical earnings and expected earnings.
________25. In capitalization of earnings method, earnings are typically interpreted as resulting cash
flows from operations, but net income may also be used if cash flow information is not available.
________26. In capitalized earnings method, the value of the asset or the investment is determined using
the anticipated earnings of the company divided by the capitalization rate (i.e., cost of capital)
________27. Capitalized earnings method provides for the relationship of (1) estimated earnings of the
company; (2) expected yield or the required rate of return; (3) estimated equity value.
________28. In the capitalization of earnings method, if earnings are fixed in the future, the capitalization
rate will be applied directly to the projected fixed earnings.
________29. Another scenario in the capitalization earnings method is that the future earnings are not
constant and vary every year, the suggested approach is to determine average of earnings of all the
anticipated cash flows.
________30. Capitalized earnings only represent the assets that actually generate income or earnings and
also includes value of the idle assets.
________31. While this method is simple and convenient, one of the limitations of capitalization of
earnings is that this does may not fully account for the future earnings or cash flows thereby resulting
to over or undervaluation.
________32. One of the elements that must be considered in using EVA is the appropriate cost of capital.
________33. While this method is simple and convenient, one of the limitations of capitalization of
earnings is the ability to incorporate contingencies.
________34. While this method is simple and convenient, one of the limitations of capitalization of
earnings is that assumptions used to determine the cash flows may not hold true since the projections
are based on a limited time horizon.
________35. Discounted Cash Flows is the most popular method of determining the value. This is
generally used by the investors, valuators and analyst because this is the most sophisticated approach
in determining the corporate value.
________36. Discounted Cash Flows is more verifiable since this allows for a more detailed approach in
valuation.
________37. The discounted cash flows model calculates the equity value by determining the present
value of the projected net cash flows of the firm.
________38. There isn’t a perfect method to determine a company’s value, which is why assessing a
company’s future earnings has some drawbacks.
________39. The Income-based approach is favorable since it is easy to apply and makes use of real-world
transactions to derive a value. If a business is worth what someone is willing to pay for it, then the
market approach is the most appropriate methodology to determine that value.
________40. The mechanics of Income based approach involve finding a price multiple of the benchmark,
i.e., price to earnings ratio, EV to EBITDA, price to book value, etc. The price multiple is then multiplied
with the relevant financial metric of the business being valued to arrive at a valuation estimate.

PROBLEMS. Instruction: Read and solve the following problems below. Write your final answers on the
space provided after the question or statement. Provide your solutions. No solution, no points. 100 pts.
1. ABC Company for the last ten years, has earned and had cash flows of about P600,000 every year. As
per the predictions of the company’s earnings, the same cash flow would continue for the foreseeable
future. The expenses for the business every year is about P400,000 only. Based on the available public
information, a P4 million Treasury Bond has a prevailing return of P40,000 quarterly. Using
Capitalization of Earnings approach, what is the value of ABC Company? ___________________
2. DEF, Inc. plans to sell its business and has used Capitalization of Earnings to be an appropriate
valuation method with a stable cash flow of P1,500,000 for the last 5 years. Forecast shows that similar
level of cash flow would continue in the next several years. With the stability of the business, it was
sold to XYZ, Inc. for P7,000,000 with a premium of P1,000,000. Similar instruments based on the
available data is a Treasury Note with a determined quarterly interest rate. Annual operating expenses
is P600,000. Compute for the capitalization rate used by DEF, Inc. _______________________
3. Goku is looking to buy a property that costs P500,000, and can be leased out for P4,500 a month. He
has done some research and has determined that the net operating expenses to be P24,000 per year.
 His desired cap rate is 6%. What is the appraisal value of this property using the capitalization of
earnings approach? __________________________
4. GHI, Inc. expects to generate earnings over the next five years of P50,000; P60,000; P65,000; P70,000
and P75,000. Using the Capitalization of Earnings Method, what is the estimated value of the firm
using 8% required rate of return? __________________
5. Using Capital Asset Pricing Method (CAPM), compute for the cost of capital (equity) with risk-free rate
of 4%, market return of 8% and Beta of 1.5. _________________
6. With risk-free rate of 5%, Beta of 1.5, market return of 8%, prevailing credit spread of 3%, tax rate of
30% and Equity ratio of 30%, compute for the weighted average cost of capital. _________________
7. The appropriate WACC of a firm is 6.43%. With risk-free rate of 4%, market return of 8%, prevailing
credit spread of 3%, tax rate of 30% and Equity ratio of 30%, compute for the after-tax cost of debt.
_________________
8. JKL Corp. is planning to expand and new projects is expecting to earn an average of P375,000 annually.
If the project requires for P5,000,000 investment at 10% cost of capital. Compute for the Economic
Value Added. ______________________
9. MNO Corp. is planning to expand and new projects is expected to have an EVA of P200,000. The
annual cost of capital at 10% amounts to P400,000. What is the average monthly earning projected
for this project? ___________________
10. The appropriate WACC of a firm is 6.77%. With market return of 8%, prevailing credit spread of 3%,
tax rate of 30% and Equity ratio of 30%, what is the risk-free rate of the firm with Beta of 1.5?
________________
11. Philippines Inc. purchased a capital expenditure amounting to P1,500 and reported revenue of
P125,000 and operating expenses is P50,000. The company incurred P500 for interest. If the
depreciation is P5,000, how much is the Net Cash Flows? Tax Rate is 30%. _______________________
12. Nagbabalik Inc. purchased an investment and expected to earn:
Year Net Cash Flows
1 P500,000
2 600,000
3 900,000
Terminal Value 1,800,000

Assuming a 10% discount factor, how much is the net present value based on the foregoing question,
considering an additional investment is P2,000,000. __________________________

Items 13-15 are based on the following data:

Queennie Inc. reported the following prospective information:
2020 2021 2022
Revenues 750,000 1,200,000 1,600,000
Cost of Goods Sold 400,000 650,000 900,000
Operating Expenses 150,000 200,000 300,000

Income tax rate is at 30%. Capital investment of P150,000 is expected to be spent every year while working
capital investment is at P40,000. Depreciation of property is at P200,000 yearly.
13. How much is the projected net cash flows for 2021? ___________________
14. How much is the projected net income for 2022? _____________________
15. How much is the EBITDA in 2020? __________________________________

Items 16-19 are based on the following data:

Tulog Corporation is preparing the following financial information for presentation to prospective
investors.
2020 2021 2022
Revenues 1,000,000 1,500,000 2,000,000
 Cost of Goods Sold 500,000 700,000 1,100,000
Operating Expenses 300,000 500,000 700,000

Corporate income tax rate is 30%. Tulog Company is looking at a 5% constant growth on net cash flows
after the three-year historical forecast they prepared. Weighted average cost of capital is 8%. The
operating expenses include annual depreciation of P250,000. Tulog Company has long-term debt
amounting to P1,000,000. Tulog Company projected that it will need additional P50,000 every year to
support increasing working capital requirements and P120,000 for capital investments.
16. How much is the net cash flow of Tulog Company in 2020? __________________
17. How much is the terminal value recognized after the three-year forecast period? ________________
18. What is the net cash flow to the firm? ______________________
19. What is the net cash flow to equity? ________________________

20. ABC Company reported the following revenues in the last 5 years.
Year 1 Year 2 Year 3 Year 4 Year 5
1,800,000 2,500,000 2,320,000 2,800,000 3,000,000

What is the compounded annual growth rate of the revenues reported by ABC Company?
______________

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