Question

Which of the following statements is/are correct? I. Going-concern value of a firm is equal to the present value of expected net income. II. When a buyer values a target firm, the appropriate discount rate is the buyer’s weighted-average cost of capital. III. The liquidation value estimate of terminal value usually vastly understates a healthy company’s terminal value. IV. The value of a firm’s equity equals the discounted cash flow value of the firm minus all liabilities.

Answer 1

Answer: The statements:  "I. Going-concern value of a firm is equal to the present value of expected net income." and "III. The liquidation value estimate of terminal value usually vastly understates a healthy company’s terminal value." are CORRECT.

Explanation: I- To determine an investment decision THE ECONOMIC VALUE OF A RUNNING COMPANY is a key factor, so a company uses the net present value (NPV) of future income from the investment. To calculate it, the company uses the discounted present value (VPD) of the net return flow (future project income) taking into account an interest rate, and compares it against the investment made.

III- If the company is profitable and growing, the terminal value is lower (underestimated) than the value of the company in activity.

If the company has losses and is in decline, the terminal value is greater (overestimated) than the value of the company in activity.