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LOS a: Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity (FCFE). ffice ffice" />
Q1. Free cash flow to the firm (FCFF) is the cash available to:
A) all of the firm's investors.
B) bondholders and preferred stockholders.
C) bondholders.
Correct answer is A)
FCFF is the cash available to all of the firm’s investors including stockholders, bondholders, and preferred stockholders.
Q2. Which one of the following is least likely to be added to free cash flow to equity (FCFE) to calculate the free cash flow to the firm (FCFF)?
A) Principal repayments.
B) After-tax interest expense.
C) Common dividends.
Correct answer is C)
FCFF can be calculated by adding cash flows to all claim holders (investors). FCFF = FCFE + [Interest Expense × (1 ? tax rate)] + Principal Repayments ? New Debt Issues + Preferred Dividends.
Q3. An analyst will get the best estimate of the value of a firm’s equity using FCFF models, when value of equity is calculated by subtracting the:
A) market value of debt outstanding from the value of the whole firm.
B) book value of debt outstanding from the value of the whole firm.
C) market value of debt outstanding from the value of the whole firm and cost of equity is used as the discount rate in the FCFF model.
Correct answer is A)
The WACC is the appropriate discount rate to employ when using the FCFF models. To estimate the value of equity when using a FCFF model, an analyst should subtract the market value of the debt from the estimated value of the firm.
Q4. Which of the following is a condition for the value of equity obtained from free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) approaches to be same?
A) Growth rate used in both approaches should be equal.
B) Assumptions of the growth rate should be consistent in both approaches.
C) Market value of bonds should be lower than the book value.
Correct answer is B)
The value of equity from both approaches will be the same when the assumptions of growth rate are consistent in both approaches (this does not mean that same growth rate is used for both approaches, but the growth rate in earnings should reflect effect of leverage) and bonds (debt outstanding) are correctly priced.
Q5. Which of the following statements about the definition of free cash flow to the firm is TRUE? It is:
A) CFO ? FCInv ? inflows/outflows from debtholders.
B) cash available to stockholders.
C) CFO + [Int × (1 ? tax rate)] ? FCInv.
Correct answer is C)
Free cash flow to the firm is the cash available to all of the firm’s investors, including stockholders, bondholders, and preferred stockholders. It is cash flow from operations plus after-tax interest expense minus capital expenditures.
Q6. Which of the following statements about the definition of free cash flow to equity is TRUE? It is:
A) cash available to all capital suppliers.
B) cash flow from operations less capital expenditures.
C) cash flow from operations less capital expenditures less inflows/outflows from debtholders.
Correct answer is C)
Free cash flow to equity is the cash available to stockholders after funding capital requirements, working capital needs, and debt financing requirements. It is cash flow from operations less capital expenditures less payments to (and plus inflows from) debtholders.
Q7. Which of the following statements about the use of free cash flows in valuation is TRUE?
A) It is more challenging to use than dividends.
B) Free cash flow to the firm is calculated before taxes.
C) Depreciation is ignored because it is not a cash flow.
Correct answer is A)
Free cash flow is harder to use than dividends because cash flows from operations must be integrated with those from financing and investing. Free cash flows are after tax. Depreciation is considered because it overstates expenses on a cash basis.
Q8. Which of the following models least accurately value a firm’s equity?
A) Stable-growth free cash flow to the firm (FCFF) model.
B) H-model.
C) Three-stage dividend discount model (DDM) model.
Correct answer is A)
The FCFF models, unlike the FCFE or DDM models, value the whole firm rather than just the equity.
Q9. Marc Gnocci, CFA, is considering the inclusion of the common stock of Konteco Incorporated in several of his clients’ accounts. Konteco provides centralized telephone systems in remote areas of underdeveloped nations. As a result of a recent economic downturn, the price of Konteco’s stock price has declined dramatically. However, given the current economic outlook and Konteco’s long-range earnings forecast, Gnocci believes that Konteco is currently trading below its intrinsic value and has a required return of 15%. In order to determine if Konteco is indeed underpriced, and to prepare a recommendation for his clients, Gnocci has assembled the information presented in the following tables. Gnocci has decided to estimate the current value of Konteco’s stock using the free cash flow to equity (FCFE) approach. He believes that Konteco’s FCFE will grow at 20% for three years after 2006, then stabilize at 3% from 2010 onward. Gnocci assumes that Konteco’s capital expenditures, depreciation, and working capital will change in direct proportion to FCFE.
Konteco Incorporated
Income Statements for Year Ending December 31, 2006
(￡ Millions)
|
< > td> |
2006 |
2005 |
|
Net sales |
530 |
500 |
|
Costs (excluding depreciation) |
381.6 |
360.0 |
|
Depreciation |
39.8 |
37.5 |
|
Total operating costs |
421.4 |
397.5 |
|
Earnings before interest and tax |
108.6 |
102.5 |
|
Interest expense |
(16.0) |
(13.9) |
|
Earnings before taxes |
92.6 |
88.6 |
|
Taxes (40%) |
(37.0) |
(35.4) |
|
Net income before preferred dividends |
55.6 |
53.2 |
|
Preferred dividends |
(7.4) |
(6.0) |
|
Net income available for common dividends |
48.2 |
47.2 |
|
Common dividends |
29.7 |
40.8 |
|
Additions to retained earnings |
18.5 |
6.4 |
|
Number of shares |
10 |
10 |
|
Dividends per share |
2.97 |
4.08 |
Additional information for 2006
|
Fixed capital investment |
62.3 |
|
Working capital investment |
10.5 |
|
Net borrowing |
13.7 |
Konteco’s FCFE per share in 2006 is closest to:
A) ￡1.04.
B) ￡2.89.
C) ?￡1.90.
Correct answer is B)
FCFE is the cash available to common shareholders after funding capital requirements, working capital needs, and debt financing requirements.
Konteco’s 2006 FCFE per share is calculated as (all numbers are in millions of ￡):
|
Net income |
= |
48.2 |
|
+ depreciation |
= |
39.8 |
|
– capital expenditures |
= |
62.3 |
|
– investment in working capital |
= |
10.5 |
|
+ net borrowing |
= |
13.7 |
|
FCFE |
= |
28.9 |
|
÷ number of common shares |
= |
10 |
|
FCFE2006 per share |
= |
￡2.89 |
Q10. The current share value of Konteco’s common stock using the FCFE approach is closest to:
A) ￡42.83.
B) ￡26.17.
C) ￡37.61.
Correct answer is C)
This is a two-stage FCFE growth model application. To determine the current per-share value using the two-stage FCFE approach, it is necessary to compute (1) the present value of the FCFE for each of the high-growth years (2007, 2008, and 2009) and (2) the present value of the terminal value of the FCFE at the end of high-growth period (year 2010).
Since all components of FCFE are expected to grow at the same rate, FCFE can be projected directly using the common growth rates. (Note: watch out for this simplifying assumption on the exam.)
The two-stage FCFE model can now be applied to determine the value of Konteco’s common stock as follows. First estimate the terminal value using a single-stage FCFE model:
Then calculate the present value of the estimated cash flows, including terminal value, at 15%:
Q11. Free cash flow to the firm (FCFF) models represent the value of the firm’s future cash flow that is:
A) ultimately available to the shareholders.
B) not required for capital expenditures to maintain the operation of the firm.
C) not distributed to shareholders in the form of dividends.
Correct answer is B)
FCFF models estimate the value of the firm based on the cash flow generated by the firm’s operations that is not required to be reinvested to maintain the operations of the firm.
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发表于 2009-3-9 15:15
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