Reading 47: Free Cash Flow Valuation - LOS f ～ Q1-4 black, class

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1．In forecasting free cash flows it is common to assume that:

A)   the firm has no non-cash expenses.

B)   existing capacity will remain the same.

C)   the firm adheres to a target capital structure.

D)   historical and future free cash flow will be the same.

2．In forecasting free cash flows it is common to assume that investment in working capital:

A)   will equal fixed capital investment.

B)   will equal earnings before interest and taxes (EBIT) less depreciation.

C)   is greater than fixed capital investment during a growth phase.

D)   will be financed using the target debt ratio.

3．The following table provides background information on a per share basis for TOY Inc. in the year 0:

Current Information:	Year 0
Earnings	$5.00
Capital Expenditures	$2.40
Depreciation	$1.80
Change in Working Capital	$1.70

TOY Inc.'s target debt ratio is 30 percent and has a required rate of return of 12 percent. Earnings, capital expenditures, depreciation, and working capital are all expected to grow by 5 percent a year in the future. Assume that capital expenditures and working capital are financed at the target debt ratio.

In year 0, what is the free cashflow to equity (FCFE) for TOY Inc.?

A)   $2.70.

B)   $4.31.

C)   $3.39.

D)   $4.53.

4．A common approach to forecasting free cash flows is to:

A)   project net income and expected capital expenditures.

B)   calculate historical free cash flow and apply an expected growth rate.

C)   project earnings before interest and taxes (EBIT) and expected capital expenditures.

D)   project operating income and deduct depreciation.

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答案和详解如下：

1．In forecasting free cash flows it is common to assume that:

A)   the firm has no non-cash expenses.

B)   existing capacity will remain the same.

C)   the firm adheres to a target capital structure.

D)   historical and future free cash flow will be the same.

The correct answer was C)

A target debt ratio is usually assumed to remain constant. Historical cash flows are often projected forward with a growth rate.

2．In forecasting free cash flows it is common to assume that investment in working capital:

A)   will equal fixed capital investment.

B)   will equal earnings before interest and taxes (EBIT) less depreciation.

C)   is greater than fixed capital investment during a growth phase.

D)   will be financed using the target debt ratio.

The correct answer was D)

It is usually assumed that the investment in working capital will be financed consistent with the target debt ratio.

3．The following table provides background information on a per share basis for TOY Inc. in the year 0:

Current Information:	Year 0
Earnings	$5.00
Capital Expenditures	$2.40
Depreciation	$1.80
Change in Working Capital	$1.70

TOY Inc.'s target debt ratio is 30 percent and has a required rate of return of 12 percent. Earnings, capital expenditures, depreciation, and working capital are all expected to grow by 5 percent a year in the future. Assume that capital expenditures and working capital are financed at the target debt ratio.

In year 0, what is the free cashflow to equity (FCFE) for TOY Inc.?

A)   $2.70.

B)   $4.31.

C)   $3.39.

D)   $4.53.

The correct answer was C)

Year 0 FCFE = Earnings per share - (Capital Expenditures - Depreciation)(1 - Debt Ratio) - Change in working capital (1 - Debt Ratio) = 5.00 - (2.40 - 1.80)(1 - 0.3) - (1.7)(1 - 0.3) = 3.39.

4．A common approach to forecasting free cash flows is to:

A)   project net income and expected capital expenditures.

B)   calculate historical free cash flow and apply an expected growth rate.

C)   project earnings before interest and taxes (EBIT) and expected capital expenditures.

D)   project operating income and deduct depreciation.

The correct answer was B)

Historical free cash flows are often forecasted.