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The subject of this chapter is (lie relationship between (lie merger market and the public stock market and the implications of (hat relationship that is, the extent to which an income approach to valuation, based on cost of capital, produces a minority value or a control value.
MULTIPLE CHOICE QUESTIONS
1. In w7hich of the following metliods of estimating the cost of equity capital are data gathered from transactions in public stock?
a. The build-up method and the Capital Asset Pricing Model (CAPM) but not the discounted cash flow (DCF) method.
b. The build-up method and fhe DCF method but not CAPM.
c. CAPM and the DCF method but not the build-up method.
d. The build-up method, CAPM, and the DCF method all gather data from transactions in public stocks.
2. Whether the income approach produces a control or a minority value:
a. Depends primarily on the nature of fhe cash flows being discounted or capitalized.
b. Depends primarily on (lie discount or capitalization rate.
c. Depends about equally on fhe nature of the cash flows and the discount or capitalization rate.
d. Is disputed, that is, there is no consensus as to the extent to which it depends primarily on the nature of (he cash flows or the discount or capitalization rate.
3. Over the period 1998 to 2001, about what percentage of takeovers of public companies were at less than the public trading price immediately prior t.o the takeover1?
a. Less than 5%.
b. Between 5% and 10%.
c. Between 10% and 15%.
d. Over 15%.
4. The cost of capital as viewed by the investor rather than the investment is a function of what standard of val ue?
a. Fair market value.
b. Investment value.
c. Fair value.
d. Intrinsic value.
5. Which of the following is the most accurate statement about the relative characteristics of the public stock market and the merger market?
a. The stock market is more liquid, has a higher tolerance for risk, and generally has a longer investment horizon.
b. The stock market is more liquid, has a lower tolerance for risk, and generally has a shorter investment horizon.
c. The stock market is more liquid, has a higher tolerance for risk, and generally has a shorter investment horizon.
d. The stock market is less liquid, has a higher tolerance for risk, and generally has a shorter investment horizon.
6. A stock selling at SIO.OO per share had net cash flow last year of SI.00 per share and net income of $1.50 per share. The estimated cost of equity capilal is 15%. Given this information, which of the following represents a conclusion that can be reached about this stock?
a. The stock is selling at minority value because it is capitalized at an unreasonably low value relative to its earnings.
b. The stock is selling at control value because it is fully valued relative to its last year's net cash flow.
c. We cannot tell whether it is at minority or control value because we don't know whether last year's net cash flow represents normalized net cash flow, nor do we know7 the expected growth rate.
d. The stock is selling at minority value because the discount rate probably is less than the capitalization rate.
7. If company cash flows are maximized and the returns distributed pro rata to all shareholders, then there may be no difference between a control value and a minority value.
8. The cost of capital is based on public stock market transactions, which are, by definition, minority interests. Therefore, the income approach to valuation, by definition, produces a minority interest value.
9. Minority stockholders can register their shares for a secondary offering but not for an initial public offering.
10. On the latest version of the traditional "levels of value" chart, tlie line that has been above "control value" is called.
11. What is tlie name of the primary source of takeover premiums for public companies?
12. Given the following:
Control value S20 pi
Minority discount 20%
Discount for lack of marketability 40%
What is tlie value of nonmarketable minority shares?
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