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ABV practice questions

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Question 1Business valuation

Which valuation approach estimates value by reference to the prices of comparable businesses or transactions?

  1. The income approach
  2. The market approach Correct answer.
  3. The liquidation approach
  4. The cost approach

Explanation

The market approach derives value from observed prices of similar assets or businesses, using multiples or comparable transactions. The income approach discounts expected future benefits, and the cost approach measures the cost to replace or reproduce the asset.

Question 2Business valuation

In a discounted cash flow model, the discount rate should reflect which of the following?

  1. The expected inflation rate only
  2. The risk of the expected cash flows being realized Correct answer.
  3. The historical average return of the client's industry
  4. The company's book value of equity

Explanation

A discount rate converts expected future cash flows to present value and must compensate for the time value of money and the risk specific to those cash flows. It is a forward-looking required return, not a historical average or a book figure.

Question 3Business valuation

Which premise of value assumes a hypothetical sale in an orderly market with reasonable exposure and a willing buyer and seller?

  1. Liquidation value
  2. Fair value Correct answer.
  3. Investment value
  4. Going-concern value

Explanation

Fair market value assumes a hypothetical willing buyer and willing seller, both reasonably informed, in an open and unrestricted market with reasonable exposure. Liquidation assumes forced or distressed sale, and investment value is specific to a particular owner.

Question 4Business valuation

A valuation analyst capitalizes next year's expected cash flow of $500,000 using a capitalization rate of 12.5%. What is the indicated value?

  1. $4,500,000
  2. $5,000,000
  3. $4,000,000 Correct answer.
  4. $625,000

Explanation

Direct capitalization divides a single normalized benefit stream by the capitalization rate: $500,000 / 0.125 = $4,000,000. The rate expresses the relationship between value and a single period's benefit.

Question 5Business valuation

Which financial statement item is most directly affected by adding back non-cash depreciation when estimating cash flow?

  1. Book value of inventory
  2. Gross margin percentage
  3. Revenue
  4. Operating cash flow Correct answer.

Explanation

Depreciation reduces accounting net income but does not consume cash, so it is added back when deriving cash flow from net income. This increases operating cash flow relative to reported earnings.

Question 6Business valuation

The weighted average cost of capital is computed by weighting the cost of equity and the after-tax cost of debt using which basis?

  1. The ratio of revenue to total assets
  2. The company's dividend payout ratio
  3. Target or market-value capital structure weights Correct answer.
  4. Historical book values

Explanation

WACC weights each capital component by its proportional market value, often using a target capital structure, because market values reflect the actual financing mix supporting the business. Book values are generally not used because they may not reflect economic claims.

Question 7Business valuation

Which of the following best describes a minority (non-controlling) interest in a private company?

  1. A position that always receives a control premium
  2. A claim senior to all debt obligations
  3. A position that carries the right to force a sale of the entire company
  4. An ownership position that lacks the ability to direct company decisions Correct answer.

Explanation

A minority interest represents an ownership stake insufficient to control the entity's operating and financial decisions. Because it lacks control, it may be subject to a discount relative to a controlling interest.

Question 8Business valuation

An analyst applies a marketability discount to a privately held equity interest primarily because of which characteristic?

  1. The presence of a controlling ownership stake
  2. The interest's lack of a ready public trading market Correct answer.
  3. The company's high reported profitability
  4. The company's use of accrual accounting

Explanation

A marketability (liquidity) discount reflects the difficulty of converting an ownership interest into cash quickly at a known price. Private interests lack the ready market that publicly traded shares enjoy.

Question 9Business valuation

A company reports net income of $2,000,000, depreciation of $300,000, capital expenditures of $500,000, and an increase in net working capital of $100,000. What is its free cash flow to the firm before any interest adjustments?

  1. $1,700,000 Correct answer.
  2. $2,300,000
  3. $2,500,000
  4. $1,900,000

Explanation

Free cash flow is net income plus non-cash charges less capital expenditures and working capital investment: $2,000,000 + $300,000 - $500,000 - $100,000 = $1,700,000. Reinvestment needs reduce the cash available to capital providers.

Question 10Business valuation

Under the guideline public company method, an analyst typically selects valuation multiples based on which measure?

  1. The number of employees
  2. The company's credit rating
  3. The subject company's book value per share
  4. A pricing metric such as EBITDA or revenue Correct answer.

Explanation

Guideline public company multiples relate an observed market price to an operating or financial metric such as EBITDA, EBIT, or revenue. The multiple is then applied to the subject company's corresponding metric.

Question 11Business valuation

A company expects free cash flow to the firm of $1,200,000 next year, growing at 3% annually in perpetuity, with a WACC of 11%. Using the Gordon growth model, what is the indicated enterprise value?

  1. $15,000,000 Correct answer.
  2. $10,909,091
  3. $9,230,769
  4. $12,000,000

Explanation

The Gordon growth formula values a growing perpetuity as next year's cash flow divided by the spread between the discount rate and growth: $1,200,000 / (0.11 - 0.03) = $15,000,000. The growth rate reduces the effective capitalization rate.

Question 12Business valuation

When estimating the cost of equity using the capital asset pricing model, the market risk premium represents which of the following?

  1. The default spread on the company's debt
  2. The excess return of the market portfolio over the risk-free rate Correct answer.
  3. The company's dividend yield
  4. The expected long-term inflation rate

Explanation

CAPM expresses the cost of equity as the risk-free rate plus beta times the market risk premium, where the premium is the expected market return in excess of the risk-free rate. Beta scales that premium for the company's systematic risk.

Question 13Business valuation

An analyst unlevers a comparable company's beta of 1.20, which has a debt-to-equity ratio of 0.50 and a 25% tax rate. Using the Hamada relationship, what is the unlevered beta?

  1. 0.80
  2. 1.07
  3. 1.50
  4. 0.96 Correct answer.

Explanation

The Hamada formula gives levered beta = unlevered beta x [1 + (1 - tax rate) x debt/equity]. Solving: 1.20 / [1 + 0.75 x 0.50] = 1.20 / 1.375 = 0.96, which removes the effect of the comparable's leverage.

Question 14Business valuation

Which adjustment is most appropriate when a private company's owner takes above-market compensation?

  1. Ignore compensation because it is discretionary
  2. Capitalize the excess compensation as an asset
  3. Deduct the excess compensation from earnings
  4. Add the excess compensation back to earnings Correct answer.

Explanation

Normalizing adjustments restate earnings to what a typical owner-operator would require. Above-market owner compensation is added back because it represents a distribution of earnings rather than a true operating expense.

Question 15Business valuation

The excess earnings method of valuing an intangible asset is best described as which of the following?

  1. Multiplying revenue by an industry royalty rate
  2. Comparing the asset to recent IPO prices
  3. Discounting the asset's replacement cost over its useful life
  4. Capitalizing the earnings remaining after a fair return on all other contributing assets Correct answer.

Explanation

The excess earnings method isolates the earnings attributable to the subject intangible after deducting fair returns on working capital and other tangible and intangible assets, then capitalizes or discounts that residual. It reflects the contribution of the specific asset.

Question 16Business valuation

A valuation analyst estimates a control premium of 25% and a marketability discount of 20%. Applying these sequentially to a minority, marketable value of $1,000,000, what is the resulting value of a controlling, non-marketable interest?

  1. $1,000,000 Correct answer.
  2. $1,200,000
  3. $1,050,000
  4. $1,250,000

Explanation

Applying a 25% control premium gives $1,250,000, and then applying a 20% marketability discount gives $1,000,000. Sequential application of premiums and discounts depends on the order and base to which each is applied.

Question 17Business valuation

Which of the following is a key limitation of the guideline transaction method?

  1. It cannot be applied to any private company
  2. It requires a public stock price for the subject company
  3. It relies solely on projected cash flows
  4. Transaction data may include synergies that inflate the implied multiples Correct answer.

Explanation

Observed transaction prices often embed synergies or control premiums specific to the acquirer, so multiples derived from them may overstate the value of a standalone subject company. Analysts must assess comparability and adjust accordingly.

Question 18Business valuation

A company has invested capital of $5,000,000 and earns a return on invested capital of 12%, while its WACC is 9%. What is the approximate economic value added?

  1. $600,000
  2. $450,000
  3. $150,000 Correct answer.
  4. $270,000

Explanation

Economic value added equals invested capital times the spread between return on invested capital and WACC: $5,000,000 x (12% - 9%) = $150,000. Positive EVA indicates the company earns more than its cost of capital.

Question 19Business valuation

When using the discounted cash flow method to value a minority interest in a private company, an analyst typically applies which sequence?

  1. Value the enterprise, then add debt to reach equity value
  2. Value the equity directly, then apply a control premium before subtracting debt
  3. Value the enterprise, then subtract debt to reach equity value, then apply any appropriate discounts Correct answer.
  4. Value the equity directly, then add debt to reach enterprise value

Explanation

A typical DCF derives enterprise value from free cash flow to the firm, then subtracts debt (and adds cash) to arrive at equity value. Entity-specific discounts are applied to the resulting equity interest as appropriate.

Question 20Business valuation

Which factor most directly increases the capitalization rate applied to a company's earnings?

  1. Lower perceived business risk
  2. Higher expected long-term growth
  3. Higher perceived business risk Correct answer.
  4. A longer historical operating history

Explanation

The capitalization rate reflects the required return less expected growth, so greater risk raises the required return and thus the capitalization rate, lowering the multiple. Higher growth would reduce the rate and increase the multiple.

Question 21Business valuation

A company's free cash flow to equity is projected at $800,000 next year and is expected to grow at 4% indefinitely. If the cost of equity is 12%, what is the indicated equity value?

  1. $8,000,000
  2. $10,000,000 Correct answer.
  3. $6,666,667
  4. $5,714,286

Explanation

Equity value equals next year's free cash flow to equity divided by the cost of equity less growth: $800,000 / (0.12 - 0.04) = $10,000,000. Using the cost of equity is appropriate because the cash flow accrues to shareholders.

Question 22Business valuation

An analyst observes that a subject company's operating margin exceeds its guideline companies' median, but its asset turnover is well below theirs. Which conclusion is most defensible?

  1. The differences must be ignored because multiples are objective
  2. A profitability or efficiency adjustment to the selected multiple may be warranted Correct answer.
  3. The subject should trade at the same multiple because the differences offset exactly
  4. The subject company must be overvalued

Explanation

Differences in profitability and efficiency affect the appropriate multiple, so analysts often adjust selected multiples to reflect the subject's relative performance. Multiples are not applied mechanically when fundamentals differ.

Question 23Business valuation

A company has debt with a market value of $4,000,000, equity with a market value of $6,000,000, a pre-tax cost of debt of 6%, a cost of equity of 14%, and a 25% tax rate. What is its WACC?

  1. 0.0960 Correct answer.
  2. 0.1080
  3. 0.1200
  4. 0.1020

Explanation

After-tax cost of debt is 6% x (1 - 0.25) = 4.5%. Weighting by market values: 0.40 x 4.5% + 0.60 x 14% = 1.8% + 8.4% = 10.2%, or 0.1020. Market-value weights reflect the current financing mix.

Question 24Business valuation

Under the asset-based approach, which adjustment is typically made to the book value of a company's property, plant, and equipment?

  1. Restate the assets to fair market value as of the valuation date Correct answer.
  2. Retain book value because it approximates fair value
  3. Reduce the assets by the company's tax rate
  4. Increase the assets by the historical inflation rate

Explanation

The asset-based approach restates recorded assets and liabilities to fair market value, which may differ materially from depreciated book values. The resulting net asset value reflects the economic worth of the balance sheet.

Question 25Business valuation

An analyst values a controlling interest using a discounted cash flow and then must value a minority interest in the same company. Which treatment is most consistent with accepted practice?

  1. Apply a discount for lack of control to the controlling-interest value Correct answer.
  2. Increase the discount rate to reflect the minority position
  3. Apply no discount because the entity value is the same
  4. Add a control premium to the controlling-interest value

Explanation

A value derived on a controlling basis reflects the ability to direct the business, so a minority interest is generally valued by applying a discount for lack of control. The discount captures the absence of those prerogatives.

Question 26Business valuation

Which valuation standard of value assumes a hypothetical buyer and seller, neither under compulsion, both with reasonable knowledge of the facts?

  1. Investment value
  2. Liquidation value
  3. Intrinsic value
  4. Fair market value Correct answer.

Explanation

Fair market value is defined around a hypothetical willing buyer and willing seller, both acting without compulsion and each reasonably informed. Investment value instead reflects the specific circumstances of a particular owner, and liquidation value assumes a forced disposition.

Question 27Business valuation

In the income approach, the capitalization rate applied to a single period of normalized earnings is best described as which of the following?

  1. The discount rate plus the expected long-term growth rate
  2. The risk-free rate plus the equity risk premium
  3. The discount rate minus the expected long-term growth rate Correct answer.
  4. The weighted average cost of capital multiplied by the tax rate

Explanation

A capitalization rate converts one period of earnings into value and equals the discount rate less the sustainable long-term growth rate. Adding growth would overstate the rate and understate value.

Question 28Business valuation

A valuation analyst is selecting a valuation date for a business interest. Which principle governs that choice?

  1. The value reflects facts known or knowable as of the valuation date Correct answer.
  2. The value reflects only events after the valuation date
  3. The value reflects the buyer's plans regardless of timing
  4. The value reflects all events occurring before the report is issued

Explanation

A valuation is struck as of a specific date and reflects information known or reasonably knowable at that date. Subsequent events are generally excluded unless they confirm conditions existing on the valuation date.

Question 29Business valuation

Which financial statement adjustment is most commonly required before applying a market multiple to a private company's earnings?

  1. Excluding depreciation from operating expenses
  2. Removing nonrecurring items to derive normalized earnings Correct answer.
  3. Converting accrual accounting to cash basis entirely
  4. Adding back all selling expenses

Explanation

Normalizing earnings removes nonrecurring, unusual, or non-operating items so the earnings base reflects sustainable operations. Multiples derived from guideline companies reflect ongoing earnings, so the subject must be measured on a comparable basis.

Question 30Business valuation

Which method estimates the value of a business by reference to the prices paid in actual acquisitions of similar companies?

  1. Adjusted net asset method
  2. Guideline public company method
  3. Guideline transaction method Correct answer.
  4. Dividend discount method

Explanation

The guideline transaction method draws multiples from observed prices in mergers and acquisitions of comparable businesses. The guideline public company method instead uses trading prices of publicly traded shares.

Question 31Business valuation

A valuation analyst is valuing a controlling interest and must decide whether to apply a control premium. Which premise supports applying it?

  1. The interest conveys the ability to direct the business and its cash flows Correct answer.
  2. The interest is freely tradable on a public exchange
  3. The interest lacks the ability to influence management
  4. The interest is subject to a right of first refusal

Explanation

A control premium reflects the incremental value of the power to direct operations and deploy cash flows. It is applied when the subject interest actually carries that authority.

Question 32Business valuation

Which of the following best describes the role of the price-to-earnings multiple in business valuation?

  1. It relates revenue to total assets
  2. It relates total invested capital to book equity
  3. It relates enterprise value to earnings before interest and taxes
  4. It relates equity market value to earnings available to equity holders Correct answer.

Explanation

A price-to-earnings multiple compares equity value to net income, both of which accrue to equity holders. Enterprise-value multiples instead use pre-interest measures such as EBIT or EBITDA.

Question 33Business valuation

In a discounted cash flow model, which cash flow measure is discounted at the weighted average cost of capital?

  1. Dividends paid
  2. Net income
  3. Free cash flow to the firm Correct answer.
  4. Free cash flow to equity

Explanation

Free cash flow to the firm is the cash available to all capital providers and is discounted at the WACC to derive enterprise value. Equity-level measures are discounted at the cost of equity instead.

Question 34Business valuation

A company has normalized earnings of $1,500,000 and an appropriate capitalization rate of 15%. Using the capitalization of earnings method, what is the indicated value?

  1. $15,000,000
  2. $225,000
  3. $10,000,000 Correct answer.
  4. $1,725,000

Explanation

Value under the capitalization method equals normalized earnings divided by the capitalization rate, so $1,500,000 divided by 0.15 equals $10,000,000. Multiplying earnings by the rate would be an incorrect operation.

Question 35Business valuation

An analyst values a private company using an enterprise value multiple of 8.0 times EBITDA. EBITDA is $3,000,000 and the company has debt of $5,000,000 and cash of $1,000,000. What is the indicated equity value?

  1. $18,000,000
  2. $29,000,000
  3. $24,000,000
  4. $20,000,000 Correct answer.

Explanation

Enterprise value is 8.0 times $3,000,000, or $24,000,000. Equity value equals enterprise value minus debt plus cash, giving $24,000,000 minus $5,000,000 plus $1,000,000, or $20,000,000.

Question 36Business valuation

A subject company's beta is estimated at 1.30, the risk-free rate is 4%, and the equity risk premium is 6%. Using the capital asset pricing model, what is the cost of equity?

  1. 10.0%
  2. 11.8% Correct answer.
  3. 12.4%
  4. 7.8%

Explanation

CAPM cost of equity equals the risk-free rate plus beta times the equity risk premium, or 4% plus 1.30 times 6%, which equals 11.8%. The beta scales only the risk premium, not the risk-free rate.

Question 37Business valuation

An analyst applies a 10% lack-of-control discount to a $2,000,000 pro rata equity value. What is the resulting value?

  1. $1,800,000 Correct answer.
  2. $2,200,000
  3. $200,000
  4. $1,818,182

Explanation

A discount reduces value by the stated percentage, so $2,000,000 times (1 minus 0.10) equals $1,800,000. Dividing by 1.10 would be the wrong operation for applying a discount.

Question 38Business valuation

A company reports depreciation and amortization of $400,000, capital expenditures of $650,000, and an increase in net working capital of $100,000. Starting from EBITDA, what net adjustment is needed to arrive at free cash flow to the firm?

  1. Subtract $150,000
  2. Subtract $750,000
  3. Subtract $350,000 Correct answer.
  4. Add $350,000

Explanation

From EBITDA, non-cash charges are removed and cash investments are deducted: minus $400,000 D&A, minus $650,000 capital expenditures, and minus $100,000 working capital, a net subtraction of $350,000. Capital expenditures and working capital consume cash, while adding back D&A offsets part of the charge.

Question 39Business valuation

A comparable company has an equity beta of 1.40, a debt-to-equity ratio of 0.60, and a 25% tax rate. Using the Hamada formula, what is the unlevered beta?

  1. 1.22
  2. 1.40
  3. 0.97
  4. 1.00 Correct answer.

Explanation

Unlevering divides the levered beta by one plus (1 minus tax rate) times debt-to-equity: 1.40 divided by (1 plus 0.75 times 0.60), which is 1.40 divided by 1.45, or approximately 0.97. The result should be lower than the levered beta because financial risk is removed.

Question 40Business valuation

An analyst values a company using the market approach and finds the subject has lower gross margins, slower receivables turnover, and higher customer concentration than the median guideline company. How should these findings affect the selected multiple?

  1. Use the highest multiple in the range to be conservative
  2. Use the median without adjustment because the differences are qualitative
  3. Select a multiple above the median to reward the subject's smaller size
  4. Select a multiple below the median to reflect the subject's higher risk profile Correct answer.

Explanation

Qualitative risk differences such as weaker margins, slower collections, and customer concentration justify a multiple below the peer median. Multiples should be adjusted to reflect the subject's relative risk and growth compared with the guideline companies.

Question 41Business valuation

A private company's owner occupies a building owned personally and charges the company rent below market. How should an analyst treat this in normalizing earnings?

  1. Increase earnings by the actual rent paid
  2. Ignore the arrangement because it is a related-party transaction
  3. Add back the entire rent expense to earnings
  4. Reduce earnings by the difference between market rent and actual rent Correct answer.

Explanation

Below-market rent understates the company's true operating costs, so earnings must be reduced to reflect what an independent owner would pay. Normalization puts related-party arrangements on an arm's-length basis.

Question 42Business valuation

A company has projected free cash flow to the firm of $900,000 in year one, a WACC of 11%, and expected long-term growth of 3%. Using the Gordon growth model, what is the terminal value at the end of year one?

  1. $11,250,000 Correct answer.
  2. $30,000,000
  3. $8,181,818
  4. $12,750,000

Explanation

Terminal value equals next year's cash flow divided by the WACC minus growth, or $900,000 divided by (0.11 minus 0.03), which is $11,250,000. The numerator must be the cash flow one period after the terminal date.

Question 43Business valuation

An analyst must value a 30% non-controlling interest in a company that pays no dividends and retains all earnings for growth. Which approach is most appropriate?

  1. A book value approach using shareholders' equity
  2. A dividend discount model using a zero dividend
  3. A discounted cash flow at the firm level, then allocate to the interest and apply appropriate discounts Correct answer.
  4. A liquidation analysis of the company's assets

Explanation

When no dividends are paid, a firm-level DCF captures the value created by retained cash flows, which is then allocated to the subject interest. Discounts for lack of control and marketability are then applied to reflect the interest's characteristics.

Question 44Business valuation

Which factor would most likely justify a higher capitalization rate for a small private company relative to a large public one?

  1. A lower level of financial leverage
  2. A longer operating history and stable customers
  3. Greater company-specific risk and limited marketability Correct answer.
  4. Higher expected long-term growth in cash flows

Explanation

Higher company-specific risk and reduced marketability increase the required return, which raises the capitalization rate. A higher rate applied to the same earnings produces a lower value.

Question 45Business valuation

A company has equity value of $8,000,000, debt of $2,000,000, and cash of $1,000,000. What is its enterprise value?

  1. $9,000,000 Correct answer.
  2. $10,000,000
  3. $7,000,000
  4. $11,000,000

Explanation

Enterprise value equals equity value plus debt minus cash, or $8,000,000 plus $2,000,000 minus $1,000,000, which is $9,000,000. Debt is added because it is another claim on the enterprise, while cash offsets part of that claim.

Question 46Business valuation

An analyst uses the guideline public company method to value a controlling interest but the selected multiples are derived from minority trading prices. Which adjustment is most appropriate?

  1. Make no adjustment because the subject is a public company
  2. Apply a lack-of-control discount to the indicated value
  3. Apply a marketability discount to the multiple
  4. Apply a control premium to the indicated minority value Correct answer.

Explanation

Public trading prices reflect minority positions, so a control premium converts the minority-based indication to a controlling level. This aligns the valuation with the interest actually being valued.

Question 47Business valuation

An analyst computes a value using the income approach of $5,000,000 and the market approach of $4,000,000. The income approach is weighted 70% and the market approach 30%. What is the concluded value?

  1. $4,900,000
  2. $4,700,000 Correct answer.
  3. $4,600,000
  4. $4,500,000

Explanation

The weighted average is 0.70 times $5,000,000 plus 0.30 times $4,000,000, which equals $3,500,000 plus $1,200,000, or $4,700,000. The weights must sum to one and be applied to the respective indications.

Question 48Business valuation

A company generates free cash flow to the firm of $1,000,000, has a WACC of 10%, and can reinvest at a return on new capital of 15%. If it reinvests 60% of its cash flow, what growth rate applies under the fundamental growth relationship?

  1. 15%
  2. 9% Correct answer.
  3. 6%
  4. 10%

Explanation

Sustainable growth equals the reinvestment rate times the return on new invested capital, or 0.60 times 15%, which is 9%. This growth rate must be below the WACC for the perpetuity formula to produce a finite value.

Question 49Business valuation

An analyst values a company using a two-stage DCF. Year-one free cash flow to the firm is $500,000, growing 20% in year two and 5% thereafter, with a WACC of 12%. Which error most commonly arises in this structure?

  1. Excluding capital expenditures from the terminal year
  2. Discounting year-one cash flow twice
  3. Using the WACC to discount equity cash flows
  4. Applying the terminal growth rate to a cash flow that has not yet normalized Correct answer.

Explanation

The terminal value formula assumes a steady-state growth rate, so the terminal-year cash flow must already reflect normalized reinvestment and growth. Applying a 5% perpetuity growth to a flow still expanding at 20% overstates terminal value.

Question 50Business valuation

A company has a return on invested capital of 14% and a WACC of 10%. It reinvests 50% of its after-tax operating income. What is the value-creating growth rate and its implication?

  1. 7%, which is below WACC and supports a finite going-concern value Correct answer.
  2. 5%, which equals the WACC spread
  3. 14%, which equals the return on capital
  4. 10%, which equals the WACC

Explanation

Growth equals the reinvestment rate times the return on invested capital, or 0.50 times 14%, which is 7%. Because 7% is below the 10% WACC, the perpetuity growth model yields a finite and economically sensible terminal value.