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标题: Equity Valuation【Reading 40】Sample [打印本页]
作者: RobertA    时间: 2012-3-31 12:57     标题: [2012 L2] Equity Valuation【Session 12- Reading 40】Sample

Free cash flow to the firm valuation uses which discount rate?
A)
After-tax cost of debt.
B)
Cost of equity.
C)
Weighted average cost of capital.


Free cash flow to the firm valuation uses the opportunity cost relevant to the overall firm, which is the weighted average cost of capital.
作者: RobertA    时间: 2012-3-31 12:58

In the stable-growth FCFE model, an extremely low value can result from all of the following EXCEPT:
A)
capital expenditures are too high relative to depreciation.
B)
the expected growth rate is too high for a stable firm.
C)
the required rate of return is too high for a stable firm.


If the expected growth rate is too high for a stable firm, the value obtained using the stable-growth FCFE model will be extremely high.
作者: RobertA    时间: 2012-3-31 12:58

If a firm is valued using FCFF, the relevant discount rate is the:
A)
before-tax cost of equity.
B)
before-tax weighted average cost of capital.
C)
after-tax weighted average cost of capital.


Since the FCFF is the cash available to all the investors, the after-tax weighted average cost of capital should be used as the discount rate in FCFF models.
作者: RobertA    时间: 2012-3-31 12:58

Valuation with free cash flow to equity and free cash flow to the firm:
A)
both use the cost of equity.
B)
both use the after-tax cost of debt.
C)
use different discount rates.


Free cash flow to the firm uses the weighted average cost of capital and free cash flow to equity uses the cost of equity. The key is to use a discount rate that reflects the opportunity cost of the indicated investor group.
作者: RobertA    时间: 2012-3-31 13:03

What is the most likely reason that you get an extremely low value from the three-stage FCFE model? Capital expenditures are significantly:
A)
higher than depreciation in the stable-growth phase.
B)
less than depreciation during the high-growth phase.
C)
higher than depreciation during the high-growth phase.


If capital expenditures estimates are significantly higher than depreciation for the stable growth period, then the three-stage FCFE model might result in an extremely low value. One possible solution for the problem is to grow the capital expenditures more slowly than deprecation in the transition period to narrow the difference. Another is to assume that capital expenditures and depreciation will offset when growth normalizes.
作者: RobertA    时间: 2012-3-31 13:04

Free cash flow (FCF) approaches are the best source of value when:
A)
FCFs track profitability closely over the analyst's forecast horizon.
B)
a firm is paying a dividend that is higher than the industry average.
C)
a firm has preferred stock.


FCF approaches are best when those flows are a good indication of a firm’s profitability over the analyst’s forecast horizon.
作者: RobertA    时间: 2012-3-31 13:04

Mark Washington, CFA, uses a two-stage free cash flow to equity (FCFE) discount model to value Texas Van Lines. His analysis yields an extremely low value, which he believes is incorrect. Which of the following is least likely to be a cause of this suspect valuation estimate?
A)
The cost of equity estimate in the stable growth period is too high for a stable firm.
B)
Earnings are temporarily depressed because of a one-time extraordinary accounting charge in the most recent fiscal year.
C)
The forecast of working capital as a percentage of revenues in the stable growth period is not large enough to maintain the long-term sustainable growth rate.


The larger the estimate of working capital as a percentage of revenues, the larger the investment in net working capital, and the lower the FCFE in the stable period. A low stable-period FCFE estimate will result in a low estimate of value today. The solution is to use a working capital ratio closer to the long-run industry average.
If the cost of equity estimate in the stable growth period is too high, the terminal value will be too low. Because the terminal value typically makes up a large portion of the current value, this will cause the current value estimate to be too low. The solution is to use a cost of equity estimate based on a beta of one.
If earnings are temporarily depressed, all the FCFE estimates will be low, and the current value estimate will be low. The solution is to use an estimate of long-run normalized earnings.
作者: RobertA    时间: 2012-3-31 13:10

Free cash flow (FCF) approaches are the best source of value when:
A)
a firm has no preferred stock.
B)
a firm has significant minority interest.
C)
dividends are paid but do not reflect the company's capacity to pay dividends.


FCF approaches are best when dividends are paid but do not appear to be representative of the firm’s capacity to pay them. Both remaining responses have nothing to do with the decision.
作者: RobertA    时间: 2012-3-31 13:12

Free cash flow approaches are the best source of value when:
A)
dividends are not paid.
B)
a firm has significant minority interest.
C)
return on assets is falling.


Free cash flow approaches are best when dividends are not paid. Both remaining responses have nothing to do with the decision.
作者: RobertA    时间: 2012-3-31 13:12

When using the two-stage FCFE model, if increases in working capital appear too high the analyst should:
A)
use changes that are based upon a working capital ratio that is closer to the industry average.
B)
normalize them to be equal to zero.
C)
switch to a three-stage model.


The best solution is to use changes that are based upon a working capital ratio that approximates the industry average. The problem will not be eliminated by switching to a three-stage FCFE model.
作者: RobertA    时间: 2012-3-31 13:12

When using the two-stage FCFE model, if increases in working capital appear too high the analyst should:
A)
use changes that are based upon a working capital ratio that is closer to the industry average.
B)
normalize them to be equal to zero.
C)
switch to a three-stage model.


The best solution is to use changes that are based upon a working capital ratio that approximates the industry average. The problem will not be eliminated by switching to a three-stage FCFE model.
作者: RobertA    时间: 2012-3-31 13:13

Free cash flow to equity valuation uses which discount rate?
A)
Cost of equity.
B)
Weighted average cost of capital.
C)
After-tax cost of debt.


Free cash flow to equity valuation uses the opportunity cost relevant to stockholders, which is the cost of equity.
作者: RobertA    时间: 2012-3-31 13:13

Michael Ballmer is an equity analyst with New Horizon Research. The firm has historically relied on dividend and residual income valuation models to value equity, but the firm’s director of research, Doug Leads, has decided that the firm needs to incorporate free cash flow valuations into its practices. Therefore, Leads decides to send Ballmer to a seminar on free cash flow valuation.
Upon his return from the convention, Ballmer is excited to share his newfound knowledge with his co-workers. Ballmer is asked to give a debriefing to New Horizon’s team of equity analysts, where he makes the following statements:
Statement 1:Free cash flow to the firm is the amount of the firm's cash flow that is free for the firm to use in making investments after cash operating expenses have been covered.
Statement 2:Free cash flow to equity, then, is the amount of the firm’s cash flow that is free for equity holders after covering cash operating expenses, working capital and fixed capital investments, interest principal payments to bondholders, and required divided payments.
Statement 3:One of the benefits of free cash flow valuation is that the value of the firm and the value of equity can be found by discounting free cash flow to the firm and free cash flow to equity, respectively, by the WACC.

As part of his presentation, Ballmer includes a short example of how to calculate free cash flow to equity. The figures from his example are included below.
Figure 1: Example Balance Sheet
20X220X1
Cash$632$245
Accounts receivable$208$105
Inventory$8,249$8,209
Current assets$9,089$8,559
Gross PPE$22,499$22,722
Accumulated depreciation($3,251)($2,875)
Total assets$28,337$28,406
Accounts payable$4,864$4,543
Short-term debt$2,491$2,996
Current liabilities$7,355$7,539
Long-term debt$4,528$5,039
Common stock$729$735
Retained earnings$15,725$15,093
Total liabilities and owner's equity$28,337$28,406

Figure 2: Example Cash Flow From Operations
20X220X1
Net income$1,783$2,195
Depreciation$1,733$1,667
WCInv($178)$357
Cash flow from operations$3,694$4,219

After discussing the calculation of free cash flow to the firm and free cash flow to equity from historical information, Ballmer proceeds to explain the major approaches for forecasting free cash flow. He focuses his discussion on forecasting the components of free cash flow as this method is more flexible. During his presentation, several of the analysts notice that the formula for forecasting free cash flow to equity does not include net borrowing. They bring this to Ballmer’s attention, and he states that he will look into the formula and send out an updated presentation after the meeting.
A week after the meeting, Jonathan Hodges approached Ballmer regarding two issues he had while applying free cash flow based valuations. The first issue that Hodges had was that he calculated the equity value of a firm using both free cash flow to equity based and dividend-based valuations and arrived at different values. The second issue that Hodges came across was the effect of a change in a firm’s target leverage on FCFE. One of the firms that Hodges was analyzing may reduce leverage, and Hodges needs to know if this will affect his valuation.Regarding statements 1 and 2, are Ballmer’s interpretations of free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) CORRECT?
A)
No, neither interpretation is correct.
B)
Yes, both interpretations are correct.
C)
No, only one interpretation is correct.


Free cash flow to the firm (FCFF) is the cash flows that are free to investors after cash operating expenses (including taxes but excluding interest expense), working capital investments, and fixed capital investments have been made. Free cash flow to equity (FCFE) is FCFF less interest payments to bondholders and net borrowing from bondholders. (Study Session 12, LOS 40.a)
Is Ballmer’s third statement regarding the computation of firm value and equity value CORRECT?
A)
No, free cash flow to equity should be discounted at the required return on equity.
B)
Yes.
C)
No, both free cash flow to the firm and free cash flow to equity should be discounted at the required rate of return on equity.


The value of a firm is the expected future free cash flow to the firm (FCFF) discounted at the firm’s weighted average cost of capital (WACC). The value of the firm’s equity is the expected future free cash flow to equity discounted at the required return on equity. (Study Session 12, LOS 40.d)
Based on figures 1 and 2, the 20X2 free cash flow to equity (FCFE) for Ballmer’s example firm is:
A)
$3,222.
B)
$2,901.
C)
$3,406.

Free cash flow to equity (FCFE) can be computed as:
FCFE = CFO − FCInv + net borrowing

Based on the figures included in the example, fixed capital investment (FCInv) is –$223 (= $22,499 − $22,722) and net borrowing is –$1,016 (= $2,491 + $4,528 − $2,996 − $5,039).
FCFE is therefore: FCFE = $3,694 + $223 − $1,016 = $2,901. (Study Session 12, LOS 40.d)

Which of the following statements regarding forecasting FCFE using the components of free cash flow method and net borrowing is most accurate?
A)
The target debt-to-asset ratio accounts for the financing of new investment in fixed capital and working capital.
B)
Investment in fixed capital and net borrowing are assumed to offset each other.
C)
Net income already accounts for interest expense; therefore, net borrowing is not needed.


When forecasting FCFE, it is common to assume that a firm will maintain a target debt-to-asset ratio for new investments in fixed capital and working capital. Based on this assumption, the formula for forecasting FCFE is:
FCFE = NI − [(1 − DR) × (FCInv − Dep)] − [(1 − DR) × WCInv]

By multiplying the fixed capital and working capital investments by one minus the target debt-to-asset ratio, you are left with the investment amount less the amount financed by debt, which is the net borrowing amount. Therefore, this formula accounts for net borrowing through the target debt-to-asset ratio. (Study Session 12, LOS 40.e)

Should dividend-based and free cash flow from equity (FCFE) based valuations result in different equity values for a firm?
A)
No, both models should result in the same value.
B)
Yes, dividend-based valuations would be higher for firms with large, consistent dividends.
C)
Yes, the free cash flow from equity valuation would be higher if there were a premium associated with control of the firm.


The ownership perspectives of dividend-based and FCFE based valuations are different. Dividend-based valuations take the perspective of minority shareholders, while FCFE based valuations take the perspective of an acquirer who will assume a controlling position in the firm. If investors were willing to pay a premium for a controlling position in the firm, then the equity value computed under the FCFE approach would be higher. (Study Session 12, LOS 40.b)
Which of the following statements regarding the effect a decrease in leverage has on a firm’s free cash flow from equity (FCFE) is most accurate?
A)
FCFE is unaffected by changes in leverage.
B)
Current year FCFE increases, but future FCFE will be reduced.
C)
Current year FCFE decreases, but future FCFE will be increased.


Changes in leverage do have a small effect on FCFE. A decrease in leverage will cause the current year FCFE to decrease through the repayment of debt. Future FCFE will be increased because interest expense will be lower. (Study Session 12, LOS 40.g)
作者: RobertA    时间: 2012-3-31 13:14

An analyst is performing an equity valuation for a minority equity position in a dividend paying multinational. The appropriate model for this analysis is most likely:
A)
FCFE approach.
B)
The Dividend Discount approach.
C)
FCFF approach.


The dividend discount model is most appropriate for valuing a minority equity position in a dividend-paying company. The free cash flow approach looks to the source of dividends from the perspective of an owner that has control rather than directly at dividends.
作者: RobertA    时间: 2012-3-31 13:14

A control perspective is most consistent with which of the following valuation approaches?
A)
Free cash flow (FCF).
B)
Dividends.
C)
Price to enterprise value.


Dividend policy can be changed by the buyer of a firm. Thus, the FCF perspective looks to the source of dividends in a position of control rather than directly at dividends. The price to enterprise value approach does not focus on cash flows.
作者: RobertA    时间: 2012-3-31 13:15

The ownership perspective implicit in the free cash flow to equity valuation approach is of:
A)
control.
B)
a preferred stockholder.
C)
a minority position.


Dividend policy can be changed by the buyer of a firm. Thus, the free cash flow perspective looks to the source of dividends in a position of control rather than directly at dividends.
作者: RobertA    时间: 2012-3-31 13:15

The ownership perspective implicit in the dividend valuation approach is of:
A)
control.
B)
a common stockholder.
C)
a preferred stockholder.


Dividends are most relevant to the stockholders who receive them and who have little control over their amount.
作者: RobertA    时间: 2012-3-31 13:15

In computing free cash flow, the most significant non-cash expense is usually:
A)
deferred taxes.
B)
depreciation.
C)
capital expenditures.


Depreciation is usually the largest non-cash expense.
作者: RobertA    时间: 2012-3-31 13:16

Free cash flow to the firm (FCFF) adjusts earnings before interest and taxes (EBIT) by:
A)
subtracting investments in fixed capital and working capital.
B)
deducting taxes, adding back depreciation, and deducting the investments in fixed capital and working capital.
C)
adding taxes, deducting depreciation, and adding back the investments in fixed capital and working capital.


As presented in the reading: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv.
作者: RobertA    时间: 2012-3-31 13:16

Free cash flow to the firm (FCFF) adjusts earnings before interest and taxes (EBIT) by:
A)
subtracting investments in fixed capital and working capital.
B)
deducting taxes, adding back depreciation, and deducting the investments in fixed capital and working capital.
C)
adding taxes, deducting depreciation, and adding back the investments in fixed capital and working capital.


As presented in the reading: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv.
作者: RobertA    时间: 2012-3-31 13:16

Free cash flow to the firm is equal to cash flow from operations minus fixed capital investment:
A)
minus pre-tax interest expense.
B)
minus after-tax interest expense.
C)
plus after-tax interest expense.


Free cash flow to the firm is equal to cash flow from operations minus fixed capital investment plus after-tax interest expense.
作者: RobertA    时间: 2012-3-31 13:17

Which of the following items is NOT subtracted from the net income to calculate free cash flow to equity (FCFE)?
A)
Subtractions to notes payable.
B)
Additions to cash.
C)
Interest payments to bondholders.


Interest payments to bondholders are included in the income statement and are already subtracted to calculate net income.
作者: RobertA    时间: 2012-3-31 13:17


A firm currently has the following per share values:

What is the current per share free cash flow to equity (FCFE)?
A)
$97.00.
B)
$16.50.
C)
$17.00.


FCFE = CFO − FCInv + net borrowing = $49.50 − $40.00 + $7.50 = $17.00
作者: RobertA    时间: 2012-3-31 13:18

The following information pertains to the Harrisburg Tire Company (HTC) in 2000.
The firm's working capital needs are negligible, and they plan to continue to operate at their current capital structure.
The free cash flow to the firm is:
A)
$540M.
B)
$420M.
C)
$300M.


The free cash flow to the firm is:
FCFF = Net income + (Interest expense)(1 − T) − Capital expenditures + Depreciation
作者: RobertA    时间: 2012-3-31 13:18

Using the information below, value the stock of Symphony Publishing, Inc. using the free cash flow from equity (FCFE) valuation method.
The value per share of Symphony Publishing is approximately:
A)
$112.10.
B)
$11.21.
C)
$14.10.


Step 1: Calculate each year’s FCFE and discount at the required return.
Step 2: Calculate Present Value of final cash flow times FCFE multiple.
Step 3: Calculate per share value.
作者: RobertA    时间: 2012-3-31 13:19

A firm currently has sales per share of $10.00, and expects sales to grow by 25% next year. The net profit margin is expected to be 15%. Fixed capital investment net of depreciation is projected to be 65% of the sales increase, and working capital requirements are 15% of the projected sales increase. Debt will finance 45% of the investments in net capital and working capital. The company has an 11% required rate of return on equity. What is the firm’s expected free cash flow to equity (FCFE) per share next year under these assumptions?
A)
$0.77.
B)
$0.38.
C)
$1.88.


FCFE = net profit – NetFCInv – WCInv + DebtFin = $1.88 – $1.63 – 0.38 + 0.90 = 0.77
作者: RobertA    时间: 2012-3-31 13:19

SOX Inc. expects high growth in the next 4 years before slowing to a stable future growth of 3%. The firm is assumed to pay no dividends in the near future and has the following forecasted free cash flow to equity (FCFE) information on a per share basis in the high-growth period:
Year 1Year 2Year 3Year 4
FCFE$3.05$4.10$5.24$6.71

High-growth period assumptions:
Stable-growth period assumptions:
In year 5, what is the free cash flow to equity (FCFE) for SOX Inc.?
A)
$7.30.
B)
$6.90.
C)
$6.10.


In year 5, FCFE = Earnings per share − (Capital Expenditures − Depreciation)(1 − Debt Ratio) − (Change in working capital)(1 − Debt Ratio) = 8.10 − 0(1 − 0.4) − 2.00(1 − 0.4) = 6.90.
作者: RobertA    时间: 2012-3-31 13:20


On a per share basis for a firm:
What is the firm’s expected free cash flow to the firm (FCFF) per share?
A)
$2.90.
B)
$7.50.
C)
$5.90.


FCFF = EPS + net non-cash charges + after-tax interest − FCInv − WCInv
FCFF= $4.00 + 3.00 +$2.40 − $2.00 −1.50 = $5.90
作者: RobertA    时间: 2012-3-31 13:20

BOX Inc. earned $4.55 per share last year. The firm had capital expenditures of $1.75 per share and depreciation expense of $1.05. BOX Inc. has a target debt ratio of 0.25.

High-Growth PeriodTransitional PeriodStable-Growth Period
Duration2 Years5 Years
Earnings growth rate45%Will decline 8% per year to 5% in the stable-growth period5%
Growth in Capital Expenditures30%Increases by 8% per yearSame as Depreciation
Growth in Depreciation30%Increases by 13% per yearSame as Capital Expenditures
Change in Working CapitalGiven BelowGiven Below$2.25 per share in Year 8
Shareholder Required Return25%15%10%

Yr 0Yr 1Yr 2Yr 3Yr 4Yr 5Yr 6Yr 7
EPS4.556.609.5713.1116.9120.4623.1224.27
Capital Expenditures1.752.282.963.193.453.734.024.35
Depreciation1.051.371.772.012.272.562.893.27
Change in WC0.901.101.401.601.802.002.202.10
FCFE7.6311.0114.6718.0820.6221.89


In year 1, what is the free cashflow to equity (FCFE) for BOX Inc.?
A)
$5.09.
B)
$6.10.
C)
$3.35.


Year 1 FCFE = Earnings per share − (Capital Expenditures – Depreciation)(1 − Debt Ratio) − Change in working capital (1 − Debt Ratio)
Year 1 FCFE = 6.60 − (2.28 − 1.37)(1 − 0.25) – (1.1)(1 − 0.25) = 5.09
作者: RobertA    时间: 2012-3-31 13:21

Harrisburg Tire Company (HTC) forecasts the following for 2007.
The firm's working capital needs are negligible, and they plan to continue to operate at their current capital structure.The firm's estimated earnings growth rate is:
A)
4.8%.
B)
8.0%.
C)
6.4%.

Click for Answer and Explanation

The firm's estimated earnings growth rate is the product of its retention ratio and ROE:
g = RR × (ROE) = [(600 − 120) / 600] × (600 / 6000) = 0.08

The forecasted free cash flow to equity is:
A)
$300M.
B)
$420M.
C)
$540M.


Since working capital needs are negligible, the free cash flow to equity is:
FCFE = Net income − [1 − DR)] × [FCInv − Depreciation] − [(1 − DR) × WCInv]
FCFE = 600M − [1 − (4 / 10)] × (800M − 500M) = 420M

where:
DR = target debt to asset ratio
作者: HuskyGrad2010    时间: 2012-3-31 13:24

In forecasting free cash flows it is common to assume that:
A)
the firm has no non-cash expenses.
B)
historical and future free cash flow will be the same.
C)
the firm adheres to a target capital structure.



A target debt ratio is usually assumed to remain constant. Historical cash flows are often projected forward with a growth rate.
作者: HuskyGrad2010    时间: 2012-3-31 13:24

In forecasting free cash flows it is common to assume that investment in working capital:
A)
will be financed using the target debt ratio.
B)
is greater than fixed capital investment during a growth phase.
C)
will equal fixed capital investment.


It is usually assumed that the investment in working capital will be financed consistent with the target debt ratio.
作者: HuskyGrad2010    时间: 2012-3-31 13:25

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% and has a required rate of return of 12%. Earnings, capital expenditures, depreciation, and working capital are all expected to grow by 5% 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)
$4.31.
B)
$3.39.
C)
$2.70.


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
作者: HuskyGrad2010    时间: 2012-3-31 13:26

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.


Historical free cash flows are often used for forecasting.
作者: HuskyGrad2010    时间: 2012-3-31 13:28

The difference between the value estimate produced by the dividend discount model (DDM) and the one produced by the free cash flow to equity (FCFE) model can be accounted for by which of the following?
A)
The value in controlling the firm's dividend policy.
B)
Different sales forecast.
C)
Different estimates of model risk.


The difference between the value estimate produced by the DDM and the one produced by the FCFE model can be interpreted as the value of controlling the firm's dividend policy.
作者: HuskyGrad2010    时间: 2012-3-31 13:39

The difference between the value estimate produced by the dividend discount model (DDM) and the one produced by the free cash flow to equity (FCFE) model can be accounted for by which of the following?
A)
The value in controlling the firm's dividend policy.
B)
Different sales forecast.
C)
Different estimates of model risk.


The difference between the value estimate produced by the DDM and the one produced by the FCFE model can be interpreted as the value of controlling the firm's dividend policy.
作者: HuskyGrad2010    时间: 2012-3-31 13:39

The primary difference between the three-stage DDM and the FCFE model is:
A)
growth rate assumptions.
B)
the definition of cash flows.
C)
cost of equity.



The primary difference between the dividend discount models and the free cash flow from equity models lies in the definition of cash flows. The FCFE model uses residual cash flows after meeting all financial obligations and investment needs. The DDM uses a strict definition of cash flows to equity, that is, the expected dividends on the stock.
作者: HuskyGrad2010    时间: 2012-3-31 13:40

Currently, a firm has no outstanding debt. If the firm would add a small amount of leverage to its balance sheet, what should be the impact on the firm's value? There would be:
A)
a decrease in value due to higher interest expense.
B)
an increase in value due to interest tax shields.
C)
no change in firm value.


The amount of financial leverage used by a firm will affect its value. For small amounts of leverage, the additional bankruptcy risk will be low, and will be more than offset by the additional value of interest tax shields.
作者: HuskyGrad2010    时间: 2012-3-31 13:41

Currently, a firm has no outstanding debt. If the firm would add a small amount of leverage to its balance sheet, what should be the impact on the firm's value? There would be:
A)
a decrease in value due to higher interest expense.
B)
an increase in value due to interest tax shields.
C)
no change in firm value.


The amount of financial leverage used by a firm will affect its value. For small amounts of leverage, the additional bankruptcy risk will be low, and will be more than offset by the additional value of interest tax shields.
作者: HuskyGrad2010    时间: 2012-3-31 13:41

An analyst has prepared the following scenarios for Schneider, Inc.:
Scenario 1 Assumptions:
Scenario 2 Assumptions:

Scenario 2 FCFF

Year 0

(last year)

Year 1

Year 2

Year 3

Year 4

EBIT$15.00$17.25$19.84$22.81$23.27
Capital Expenditures6.006.907.949.13
Depreciation4.004.605.296.08
Change in Working Capital2.002.102.202.402.40
FCFF5.957.068.2511.56


Assuming that Schneider, Inc., slightly increases its financial leverage, what should happen to its firm value? The firm value should:
A)
not change because financial leverage has no relationship with firm value.
B)
increase due to the additional value of interest tax shields.
C)
decline due to the increase in risk.


For small changes in leverage, the additional value added by the interest tax shields will more than offset the additional risk of bankruptcy / financial distress. Given the tax advantage of debt, the firm's WACC should decline, not increase with small changes in leverage.
作者: HuskyGrad2010    时间: 2012-3-31 13:42

An analyst has prepared the following scenarios for Schneider, Inc.:
Scenario 1 Assumptions:
Scenario 2 Assumptions:

Scenario 2 FCFF

Year 0

(last year)

Year 1

Year 2

Year 3

Year 4

EBIT$15.00$17.25$19.84$22.81$23.27
Capital Expenditures6.006.907.949.13
Depreciation4.004.605.296.08
Change in Working Capital2.002.102.202.402.40
FCFF5.957.068.2511.56


Assuming that Schneider, Inc., slightly increases its financial leverage, what should happen to its firm value? The firm value should:
A)
not change because financial leverage has no relationship with firm value.
B)
increase due to the additional value of interest tax shields.
C)
decline due to the increase in risk.


For small changes in leverage, the additional value added by the interest tax shields will more than offset the additional risk of bankruptcy / financial distress. Given the tax advantage of debt, the firm's WACC should decline, not increase with small changes in leverage.
作者: HuskyGrad2010    时间: 2012-3-31 13:42

Which of the following statements is least accurate? A firm’s free cash flows to equity (FCFE) is the cash available to stockholders after funding:
A)
capital expenditure requirements.
B)
debt principal repayments.
C)
dividend payments.


A firm’s FCFE is the cash available to stockholders after funding capital expenditures and debt principal repayments.
作者: HuskyGrad2010    时间: 2012-3-31 13:43

The repurchase of 20% of a firm’s outstanding common shares will cause free cash flow to the firm (FCFF) to:
A)
remain the same.
B)
increase.
C)
decrease.


Share repurchases are a use of free cash flows, not a source. FCFF is cash flow that is available to all capital suppliers. Notice the conspicuous absence of repurchases in the following: FCFF = CFO + Int (1 – tax rate) – FCInv.
作者: HuskyGrad2010    时间: 2012-3-31 13:43

An increase in financial leverage will cause free cash flow to equity (FCFE) to:
A)
increase in the year the borrowing occurred.
B)
decrease in the year the borrowing occurred.
C)
decrease or increase, depending on its circumstances.


An increase in financial leverage will increase net borrowing and, hence, increase FCFE in the year the borrowing occurred because: FCFE = FCFF – [interest expense] (1 – tax rate) + net borrowing
作者: HuskyGrad2010    时间: 2012-3-31 13:43

The repayment of a significant amount of outstanding debt will cause free cash flow to equity (FCFE) to:
A)
decrease.
B)
increase.
C)
remain the same.


Debt repayment will decrease net borrowing and, hence, decrease FCFE because: FCFE = FCFF – [interest expense] (1 – tax rate) + net borrowing.
作者: HuskyGrad2010    时间: 2012-3-31 13:44

Optimal capital structure is the mix of debt and equity that will maximize the value of the firm and minimize:
A)
interest expense.
B)
weighted average cost of equity.
C)
weighted average cost of capital (WACC).


The optimal capital structure is the mix of debt and equity that will maximize the value of the firm and minimize the WACC.
作者: HuskyGrad2010    时间: 2012-3-31 13:45

Ignoring any costs related to financial distress, if a firm increases its financial leverage, the value of the firm should:
A)
increase because the FCFF will increase.
B)
decrease because the required rate of return on debt is lower than that of equity.
C)
increase because the weighted average cost of capital will be lower due to interest tax shields.


When a firm adds leverage, its value may increase due to the tax shields on interest expense and the generally lower cost of debt. In theory, there is an optimal capital structure. If the amount of debt employed is greater than the optimal, the costs associated with risk of bankruptcy or financial distress begin to outweigh the advantage of interest tax shields.
作者: HuskyGrad2010    时间: 2012-3-31 13:45

Which of the following is least likely to change as the firm changes leverage?
A)
Free cash flows to firm (FCFF).
B)
Free cash flows to equity (FCFE).
C)
Weighted average cost of capital (WACC).


The FCFFs are normally unaffected by the changes in leverage, as these are the cash flows before the debt payments.
作者: HuskyGrad2010    时间: 2012-3-31 13:46

Dividends paid out to the shareholders:
A)
may be higher than free cash flow to equity FCFE.
B)
are always equal to free cash flow to equity (FCFE).
C)
are always less than free cash flow to equity (FCFE).


Dividends represent the cash that the firm chooses to pay to the shareholders and the amount of the dividend is subject to the discretion of the firm. Dividends can be equal to, lower or higher than FCFE. For example, sometimes firms may pay dividends in years when there is a net loss.
作者: HuskyGrad2010    时间: 2012-3-31 13:46

Which of the following statements regarding dividends and free cash flow to equity (FCFE) is least accurate?
A)
Required returns are higher in FCFE discount models than they are in dividend discount models, since FCFE is more difficult to estimate.
B)
FCFE discount models usually result in higher equity values than do dividend discount models (DDMs).
C)
FCFE can be negative but dividends cannot.




Although FCFE may be more difficult to estimate than dividends, the required return is based on the risk faced by the shareholders, which would be the same under both models.
作者: HuskyGrad2010    时间: 2012-3-31 13:47

In what ways are dividends different from free cashflow to equity (FCFE)?
A)
Dividends are often viewed as "sticky." Managers are reluctant to radically change the dividend payout policy while FCFE often has immense variability.
B)
Companies often use FCFE as a signal of positive future growth prospects while dividends are not used for signaling.
C)
There is no difference. Dividends must equal FCFE.


Dividends and the FCFE are often different and dividends are used as a signal to the market not FCFE. Dividends viewed as sticky is the true statement.
作者: HuskyGrad2010    时间: 2012-3-31 13:47

If the investment in fixed capital and working capital offset each other, free cash flow to the firm (FCFF) may be proxied by:
A)
earnings before interest and taxes (EBIT).
B)
net income plus non-cash charges plus after-tax interest.
C)
net income plus after-tax interest.


The answer is indicated by the definition of FCFF: FCFF = NI + NCC + Int (1 – tax rate) – FCInv – WCInv. The relationship between net income and FCFF is indicated by: NI = EBIT (1 – tax rate) – Int (1 – tax rate).
作者: HuskyGrad2010    时间: 2012-3-31 13:47

If the investment in fixed capital and working capital offset each other, free cash flow to the firm (FCFF) may be proxied by:
A)
after-tax EBIT plus non-cash charges.
B)
earnings before interest and taxes (EBIT).
C)
net income plus after-tax interest.


The answer is indicated by the definition of FCFF: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv, which assumes that depreciation is the only non-cash charge. Further: FCFF = NI + NCC + Int (1 – tax rate) – FCInv – WCInv.
作者: HuskyGrad2010    时间: 2012-3-31 13:48

Assuming that the investment in fixed capital and working capital offset each other, free cash flow to the firm (FCFF) may be proxied by net income if:
A)
non-cash charges and interest charges are zero.
B)
earnings before interest and taxes (EBIT) equals depreciation.
C)
non-cash charges and interest charges are equal.


The answer is shown by the relationship between FCFF and net income: FCFF = NI + NCC + Int (1 – tax rate) – FCInv – WCInv. Further: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv, which assumes that depreciation is the only non-cash charge.
作者: HuskyGrad2010    时间: 2012-3-31 13:48

The three-stage FCFE model might result in an extremely high value if:
A)
the growth rate in the stable-period is equal to that of GNP.
B)
the growth rate in the stable-period is too high.
C)
the growth rate in the stable-period is too low.


If the growth rate in the stable-period is too high or the high-growth and transition periods are too long, the three-stage FCFE model might result in an extremely high value.
作者: HuskyGrad2010    时间: 2012-3-31 13:49

The two-stage FCFE model is suitable for valuing firms that:
A)
are in an industry with significant barriers to entry.
B)
have very high but declining growth rate in the initial stage.
C)
have moderate growth in the initial phase that declines gradually to a stable rate.


The two-stage FCFE model is suitable for valuing firms in industries with significant barriers to entry. Where these are present it is possible for the firm to maintain a high growth rate during an initial phase of low competition, and that the rate will drop sharply to a normalized rate when competition ultimately appears.
作者: HuskyGrad2010    时间: 2012-3-31 13:54

The stable-growth free cash flow to equity (FCFE) model is best suited for which of the following types of companies? Companies:
A)
growing at a rate similar or less than the nominal growth rate of the economy.
B)
with patents that will not expire for 20 or more years.
C)
with significant barriers to entry.


Companies growing at a rate similar to or less than the nominal growth rate of the economy are best suited for the Stable Growth FCFE Model. The three-stage FCFE model is most suited to analyzing firms currently experiencing high growth that will face increasing competitive pressures over time, leading to a gradual decline in growth to a stable level. The two-stage model is best suited to analyzing firms in a high growth phase that will maintain that growth for a specific period, such as firms with patents or firms in an industry with significant barriers to entry.
作者: HuskyGrad2010    时间: 2012-3-31 13:56

Which of the following free cash flow to the firm (FCFF) models is most suited to analyze firms that are growing at a faster rate than the overall economy?
A)
High growth FCFF model.
B)
Two-stage FCFF model.
C)
No growth FCFF model.


The two-stage FCFF model is most suited for analyzing firms growing at a rate faster than the overall economy. The two-stage model assumes a high rate of growth for an initial period, followed by an immediate jump to a constant, stable growth rate.
作者: HuskyGrad2010    时间: 2012-3-31 13:57

Which of the following free cash flow to equity (FCFE) models is most suited to analyze firms in an industry with significant barriers to entry?
A)
Two-stage FCFE Model.
B)
FCFE Perpetuity Model.
C)
Stable Growth FCFE Model.


The two-stage FCFE model is most suited for analyzing firms in high growth that will maintain that growth for a specific period, such as firms with patents or firms in an industry with significant barriers to entry.
作者: HuskyGrad2010    时间: 2012-3-31 13:58

Which of the following free cash flow to equity (FCFE) models is most suited to analyze firms in an industry with significant barriers to entry?
A)
Two-stage FCFE Model.
B)
FCFE Perpetuity Model.
C)
Stable Growth FCFE Model.


The two-stage FCFE model is most suited for analyzing firms in high growth that will maintain that growth for a specific period, such as firms with patents or firms in an industry with significant barriers to entry.
作者: HuskyGrad2010    时间: 2012-3-31 13:58

The two-stage (stable growth) free cash flow to equity (FCFE) and free cash flow to the firm (FCFF) models typically assume:
A)
a high-growth rate for n years and then a constant growth rate forever thereafter.
B)
the required rate of return is less than the growth rate in the last stage.
C)
the required rate of return equals the growth rate in the last stage.


The two-stage model using either FCFE or FCFF typically assumes a high-growth rate for n years and then a constant growth rate forever thereafter. Multi-stage models assume that the required rate of return exceeds the growth rate in the last stage.
作者: HuskyGrad2010    时间: 2012-3-31 13:59

Which of the following statements regarding the FCFF models is most accurate? The two-stage FCFF model is more useful than the stable-growth FCFF model when the firm is growing at a rate:
A)
significantly lower than that of the overall economy.
B)
not significantly higher than that of the overall economy.
C)
significantly higher than that of the overall economy.


The two-stage FCFF model is more useful in valuing a firm that is growing at a rate significantly higher than the overall economy. Since this cannot persist indefinitely, growth will eventually slow to a stable growth rate consistent with that of the economy.
作者: HuskyGrad2010    时间: 2012-3-31 13:59

The stable-growth free cash flow to the firm (FCFF) model is most useful in valuing firms that:
A)
are growing at a rate significantly lower than that of the overall economy.
B)
have capital expenditures that are not significantly higher than depreciation.
C)
have capital expenditures that are significantly higher than depreciation.


The stable-growth FCFF model is useful for valuing firms that are expected to have growth rates close to that of the overall economy. Since the rate of growth approximates that for the overall economy, these firms should have capital expenditures that are not significantly different than depreciation.
作者: HuskyGrad2010    时间: 2012-3-31 14:00

Which of the following is most useful in analyzing firms that have high leverage and high growth?
A)
Two-stage free cash flow to the firm (FCFF) model.
B)
Stable-growth free cash flow to the firm (FCFF) model.
C)
Two-stage free cash flow to equity (FCFE) model.


Of the cash flow valuation models mentioned above, the two-stage FCFF model is most useful in analyzing the firms that have high leverage and high growth. The high growth will make the stable growth models inapplicable, while the high leverage makes the FCFF model more attractive.
作者: HuskyGrad2010    时间: 2012-3-31 14:01

A firm in stable growth phase should have:
A)
a growth rate higher than that of the economy and a required rate of return that is greater than the market rate of return.
B)
capital expenditures that are less than the depreciation expense.
C)
a required rate of return close to the market rate of return and capital expenditures that are not too large relative to depreciation expense.


A firm that is in a stable growth phase should have growth rate close to that of the economy, and the cost of equity should approximate the required rate of return on the market. In addition, the capital expenditures should not be disproportionately large relative to the depreciation expense
作者: HuskyGrad2010    时间: 2012-3-31 14:01

The one-stage (stable growth) free cash flow models assume:
A)
the required rate of return exceeds the growth rate.
B)
the required rate of return is less than the growth rate.
C)
a constant growth rate for n years and a high growth rate forever thereafter.


The one-stage model using either free cash flow to equity (FCFE) or free cash flow to the firm (FCFF) assumes that the required rate of return exceeds the growth rate. If this was not the case, the model would produce an unrealistic negative price.
作者: HuskyGrad2010    时间: 2012-3-31 14:02

Which of the following types of company is the E-Model, a three-stage free cash flow to equity (FCFE) Model, best suited for? Companies:
A)
with patents or firms in an industry with significant barriers to entry.
B)
growing at a rate similar to or less than the nominal growth rate of the economy.
C)
in high growth industries that will face increasing competitive pressures over time, leading to a gradual decline in growth to a stable level.


The three-stage FCFE model, or E-Model, is most suited to analyzing firms currently experiencing high growth that will face increasing competitive pressures over time, leading to a gradual decline in growth to a stable level. The two-stage model is best suited to analyzing firms in a high growth phase that will maintain that growth for a specific period, such as firms with patents or firms in an industry with significant barriers to entry. Companies growing at a rate similar to or less than the nominal growth rate of the economy are best suited for the Stable Growth FCFE Model. A firm that pays out all of its earnings as dividends will have a growth rate of zero (remember g = RR × ROE) and would not be valued using the three-stage FCFE model.
作者: HuskyGrad2010    时间: 2012-3-31 14:02

Which of the following statements about the three-stage FCFE model is most accurate?
A)
There is a transition period where the growth rate is stable.
B)
There is a final phase when growth rate starts to decline.
C)
There is a transition period where the growth rate declines.


In the three-stage FCFE model, there is an initial phase of high growth, a transition period where the growth rate declines, and a steady-state period where growth is stable.
作者: HuskyGrad2010    时间: 2012-3-31 14:03

A three-stage free cash flow to the firm (FCFF) is typically appropriate when:
A)
growth is currently high and will move through a transitional stage to a steady-state growth rate.
B)
the required rate of return is less than the growth rate in the last stage.
C)
growth is currently low and will move through a transitional stage to a final stage wherein growth exceeds the required rate of return.


The three-stage model using either FCFE or FCFF typically assumes that growth is currently high and will move through a transitional stage to a steady-state growth rate. Multi-stage models assume that the required rate of return exceeds the growth rate in the last stage.
作者: HuskyGrad2010    时间: 2012-3-31 14:03

Which of the following types of companies is the two-stage free cash flow to equity (FCFE) model best suited for? Companies:
A)
growing at a rate similar to or less than the nominal growth rate of the economy.
B)
in high growth industries that will face increasing competitive pressures over time, leading to a gradual decline in growth to a stable level.
C)
with patents or firms in an industry with significant barriers to entry.


The two-stage model is best suited to analyzing firms in a high growth phase that will maintain that growth for a specific period, such as firms with patents or firms in an industry with significant barriers to entry. Companies growing at a rate similar to or less than the nominal growth rate of the economy are best suited for the single-stage FCFE Model. Companies in high growth industries correspond to the three-Stage FCFE Model.
作者: anshultongia    时间: 2012-3-31 14:14

In using FCFE models, the assumption of growth should be:
A)
independent from the assumptions of other variables.
B)
consistent with assumptions of other variables.
C)
only consistent with the assumptions of capital spending and depreciation.


The assumption of growth should be consistent with assumptions about other variables. Net capital expenditures (capital expenditures minus depreciation) and beta (risk) used to calculate required rate of return should be consistent with assumed growth rate.
作者: anshultongia    时间: 2012-3-31 14:15

The following information was collected from the financial statements of Bankers Industrial Corp. for the year ended December 31, 2000.

Bankers is currently operating at their target debt ratio of 40%. The firm’s tax rate is 40%.


The free cash flow to the firm (FCFF) for the current year is:
A)
$2.39 million.
B)
$3.57 million.
C)
$2.31 million.


The FCFF for the current year is $2.39m = [$6.0m(1 − 0.40)] + $0.63m − $1.25m − $0.59m.
The appropriate discount rate used in valuing Bankers using FCFF will be:
A)
12.12%.
B)
16.00%.
C)
6.30%.


The appropriate discount rate to be used is the weighted average cost of capital (WACC), and this is 12.12% = (0.60 × 0.16) + [0.40 × 0.105 × (1 − 0.40)].
The estimated value of the firm is:
A)
$37.61 million.
B)
$49.95 million.
C)
$46.68 million.


The value of Bankers using stable-growth FCFF model is $49.95 million, calculated as:
FCFF = $2.39m = [$6.0m(1 − 0.40)] + $0.63m − $1.25m − $0.59m.
WACC = 12.12% = (0.60 × 0.16) + [0.40 × 0.105 × (1 × 0.40)].
Estimated value = $49.95 million = ($2.39m × 1.07) / (0.1212 − 0.07)
作者: anshultongia    时间: 2012-3-31 14:15

The value of stock under the two-stage FCFE model will be equal to:
A)
present value (PV) of FCFE during the extraordinary growth period plus the terminal value.
B)
present value (PV) of FCFE during the extraordinary growth and transitional periods plus the PV of terminal value.
C)
present value (PV) of FCFE during the extraordinary growth period plus the PV of terminal value.


The value of stock under the two-stage FCFE model will be equal to the present value of FCFE during the extraordinary growth period plus the present value of the terminal value at the end of this period.
作者: anshultongia    时间: 2012-3-31 14:16

SOX, Inc., expects high growth in the next 4 years before slowing to a stable future growth of 3%. The firm is assumed to pay no dividends in the near future and has the following forecasted free cash flow to equity (FCFE) information on a per share basis in the high-growth period:

Year 1Year 2Year 3Year 4
FCFE$3.05$4.10$5.24$6.71


High-growth period assumptions:
Stable-growth period assumptions:
What is the present value on a per share basis for SOX, Inc.?
A)
$64.24.
B)
$77.15.
C)
$70.49.


The required rate of return in the high-growth period is (r) = 0.04 + 1.3(0.06) = 0.118.
The required rate of return in the stable-growth period is (r) = 0.04 + 1.0(0.06) = 0.10.
The Present Value (PV) of the FCFE in the high-growth period is (3.05 / 1.118) + (4.10 / 1.1182) + (5.24 / 1.1183) + (6.71 / 1.1184) = 14.06.
The Terminal Price = Expected FCFEn + 1 / (r − gn) with FCFEn + 1 = FCFE in year 5 = Earnings per share − (Capital Expenditures − Depreciation)(1 − Debt Ratio) − (Change in working capital)(1 − Debt Ratio) = 8.10 − 0(1 − 0.4) − 2.00(1 − 0.4) = 6.90.
The Terminal Price = 6.90 / (0.10 − 0.03) = 98.57.
The PV of the Terminal Price = (98.57 / 1.1184) = 63.09.
The value of a share today is the PV of the FCFE in the high-growth period plus the PV of the Terminal Price = 14.06 + 63.09 = 77.15.
作者: anshultongia    时间: 2012-3-31 14:17

Using the stable growth free cash flow to the firm (FCFF) model, what is the value of Quality Builders under the assumptions contained in the table below?

Quality Builders

Free Cash Flow to the Firm

Year 0

EBIT$500   
Depreciation$200   
Capital Spending$300   
Working Capital Additions$30   
Tax Rate40%   
Assumed Constant Growth Rate in Free Cash Flow5%   
Weighted-average Cost of Capital11%   

A)
$6,475.00.
B)
$2,975.00.
C)
$2,833.33.


The stable growth FCFF model assumes that FCFF grows at a constant rate forever. FCFF in Year 0 is equal to EBIT(1 − tax rate) + Depreciation − Capital Spending − Working Capital Additions = 500(1 − 0.4) + 200 − 300 − 30 = 170. The Firm Value = FCFF1 / (r − gn) = 170(1.05) / (0.11 − 0.05) = $2,975.
作者: anshultongia    时间: 2012-3-31 14:18

Beachwood Builders merged with Country Point Homes in December 31, 1992. Both companies were builders of mid-scale and luxury homes in their respective markets. In 2004, because of tax considerations and the need to segment the businesses between mid-scale and luxury homes, Beachwood decided to spin-off Country Point, its luxury home subsidiary, to its common shareholders. Beachwood retained Bernheim Securities to value the spin-off of Country Point as of December 31, 2004.
When the books closed on 2004, Beachwood had $140 million in debt outstanding due in 2012 at a coupon rate of 8%, a spread of 2% above the current risk free rate. Beachwood also had 5 million common shares outstanding. It pays no dividends, has no preferred shareholders, and faces a tax rate of 30%. When valuing common stock, Bernhiem’s valuation models utilize a market risk premium of 11%.
The common equity allocated to Country Point for the spin-off was $55.6 million as of December 31, 2004. There was no long-term debt allocated from Beachwood.
The Managing Director in charge of Bernheim’s construction group, Denzel Johnson, is prepping for the valuation presentation for Beachwood’s board with Cara Nguyen, one of the firm’s associates. Nguyen tells Johnson that Bernheim estimated Country Point’s net income at $10 million in 2004, growing $5 million per year through 2008. Based on Nguyen’s calculations, Country Point will be worth $223.7 million in 2008. Nguyen decided to use a cost of equity for Country Point in the valuation equal to its return on equity at the end of 2004 (rounded to the nearest percentage point).
Nguyen also gives Johnson the table she obtained from Beachwood projecting depreciation (the only non-cash charge) and capital expenditures:

$(in millions)

2004 2005 2006 2007 2008
Depreciation56565
Capital Expenditures7891012

Looking at the numbers, Johnson tells Nguyen, “Country Point’s free cash flow (FCF) will be $25 million in 2006.” Nguyen adds, “That’s FCF to the Firm (FCFF). FCF to Equity (FCFE) will be lower.”
Regarding the statements by Johnson and Nguyen about FCF in 2006:
A)
only Johnson is incorrect.
B)
both are incorrect.
C)
only Nguyen is incorrect.


To estimate FCF, we can construct the following table using the table given and the information about growth in net income:

$(in millions)


2004
2005
2006
2007
2008

Net Income
10
15
20
25
30

Plus: Depreciation
5
6
5
6
5

Less: Capital Expenditures
7
8
9
10
12

Free Cash Flow
8
13
16
21
23

The estimated free cash flow for 2006 is $16 million. Johnson's statement is incorrect. Since none of Beachwood's debt is allocated to Country Point, all the financing is in the form of equity, so FCFF and FCFE are equal. Nguyen's statement is also incorrect. (Study Session 12, LOS 40.j)

If FCInv equals Fixed Capital Investment and WCInv equals Working Capital Investment, which statement about FCF and its components is least accurate?
A)
FCFE = (EBIT × (1 − tax rate)) + Depreciation − FCInv − WCInv.
B)
FCFF = (EBITDA × (1 − tax rate)) + (Depreciation × tax rate) − FCInv − WCInv.
C)
WCInv is the change in the working capital accounts, excluding cash and short-term borrowings.


The correct version of this equation is:
FCFF = (EBIT × (1 − tax rate)) + Depreciation − FCInv − WCInv (Study Session 12, LOS 40.j)

What is the cost of capital that Nguyen used for her valuation of Country Point?
A)
17%.
B)
18%.
C)
15%.


Since there is no debt allocated to Country Point, the cost of capital will equal the cost of equity. Nguyen said that she used a cost of equity equal to Country Point’s Return on Equity (ROE) at year-end, rounded to the nearest percentage point. Since the net income at the end of 2004 was $10 million and the allocated common equity was $55.6 million, the return of equity is (10 million / 55.6 million) = 18%. (Study Session 18, LOS 62.c)
Given Nguyen’s estimate of Country Point’s terminal value in 2008, what is the growth assumption she must have used for free cash flow after 2008?
A)
7%.
B)
9%.
C)
3%.


We know the terminal value in 2008 is $223.7 million. We can calculate the free cash flow in 2008 to be $23 million (= $30 million net income + $5 million depreciation − $12 million capital expenditures). (See the table in question 1). Thus, we can solve for the estimated growth rate:

Terminal value = [CF@2008 × (growth rate + 1)] / (discount rate − growth rate)
223.7 million = ($23 million × (growth rate + 1)) / (0.18 − growth rate)
223.7 million × (0.18 − growth rate) = 23 million × (growth rate + 1)
40.266 − (223.7 × growth rate) = 23 million + (23 × growth rate)
17.266 = 246.7 × (growth rate)
growth rate = 0.07

Nguyen’s growth rate assumption is 7% per year. (Study Session 12, LOS 40.c)

The value of beta for Country Point is:
A)
1.09.
B)
1.27.
C)
1.00.


The risk free rate is (8% − 2%) = 6%. We are told that the market risk premium is 11%, and we calculated the cost of equity (required return) to be (10 million / 55.6 million =) 18%. Since we know the risk-free rate, the market risk premium, and the discount rate, we can use the capital asset pricing model to solve for beta:

Required rate of return = 0.18 = 0.06 + (b × 0.11)
0.18 – 0.06 = b × 0.11
0.12 = b × 0.11
b = 1.09

(Study Session 12, LOS 40.c)

What is the estimated value of Country Point in a proposed spin-off?
A)
$162.6 million.
B)
$144.5 million.
C)
$178.3 million.


Using the discounted cash flow approach on the levels of cash flow we calculated (see the table in question 1):

Firm value = ($13 / 1.181) + ($16 / 1.182) + ($21 / 1.183) + ($23 / 1.184) + ($223.7 / 1.184)
=$11.0 + $11.5 + $12.8 + $11.9 + $115.4
= $162.6 million

(Study Session 12, LOS 40.c)
作者: anshultongia    时间: 2012-3-31 14:18

A firm's free cash flow to the firm (FCFF) in the most recent year is $80M and is expected to grow at 3% per year forever. If the firm has $100M in debt financing and its weighted average cost of capital is 10%. The value of the firm's equity using the single-stage FCFF model is:
A)
$1,177M.
B)
$1,077M.
C)
$1,043M.


The value of the firm's equity is equal to the value of the firm minus the value of the debt. Firm value = $80M × 1.03 / (0.10 − 0.03) = $1,177M, so equity value is $1,177M − $100M = $1,077M.
作者: anshultongia    时间: 2012-3-31 14:19

An analyst has prepared the following scenarios for Schneider, Inc.:
Scenario 1 Assumptions
Scenario 2 Assumptions

Scenario 2 FCFF

Year 0

(last year)

Year 1

Year 2

Year 3

Year 4

EBIT$15.00$17.25$19.84$22.81$23.27
Capital Expenditures6.006.907.949.13
Depreciation4.004.605.296.08
Change in Working Capital2.002.102.202.402.40
FCFF5.957.068.2511.56


Given the assumptions contained in Scenario 2, what is the value of the firm?
A)
$70.39.
B)
$81.54.
C)
$96.92.


Use the two-stage FCFF model to value the firm. The Terminal Value of the firm as of Year 3 = 11.56 / (0.12 - 0.02) = 115.60. The value = 5.95 / (1.20) + 7.06 / (1.20)2 + (8.25 + 115.62) / (1.20)3 = 81.54.
作者: anshultongia    时间: 2012-3-31 14:19

An analyst has prepared the following scenarios for Schneider, Inc.:
Scenario 1 Assumptions:
Scenario 2 Assumptions:
Scenario 2 FCFF
Year 0
(last year)
Year 1
Year 2
Year 3
Year 4
EBIT$15.00$17.25$19.84$22.81$23.27
Capital Expenditures6.006.907.949.13
Depreciation4.004.605.296.08
Change in Working Capital2.002.102.202.402.40
FCFF5.957.068.2511.56
Given the assumptions contained in Scenario 1, what is the value of the firm?
A)
$333.33.
B)
$250.00.
C)
$343.33.


Under the stable growth FCFF model, the value of the firm = FCFF1 / (WACC − gn) = 30(1.03) / (0.12 − 0.03) = 343.33.

In Scenario 2, what is the year 0 free cash flow to the firm (FCFF)?
A)
$5.00.
B)
$2.00.
C)
$12.00.


FCFF = EBIT(1 − tax rate) + Depreciation − Capital Expenditures − Change in Working Capital = 15.0(1 − 0.4) + 4.0 − 6.0 − 2.0 = 5.00.
作者: anshultongia    时间: 2012-3-31 14:20

Starshah Industries competes in a high-growth, emerging technology sector that is facing increasing competitive pressures. So far, the firm has been performing well, earning $4.55 per share in 2004. Investment requirements were high, with capital expenditures of $1.75 per share, depreciation expense of $1.05, and a net investment in working capital that year of $1.00 per share. However, despite Starshah’s high growth rate and impressive profitability, Starshah’s Chairman, Lorenzo di Stefano, has become concerned about the impact that a slowdown in expected growth may have on the firm’s valuation.Di Stefano asked Starshah’s Director of Strategic Planning, Keisha Simmons, to make a presentation to Starshah’s board at the end of 2004 about the future growth of the firm. The news was sobering. Simmons told the board members that Starshah could expect two more years of rapid growth, during which time earnings per share could be expected to rise 45% per year with 30% annual increases in capital spending and depreciation. During this high-growth period, Simmons estimates that the required return on equity for Starshah will be 25%. Starshah consistently maintains a target debt ratio of 0.25.
After the near-term spurt of high growth, however, she and her group expect Starshah to move eventually to a stable growth period. During the stable growth period, free cash flow to equity (FCFE) will rise only 5% per year and the annual return to shareholders will decline to 10%.The strategy group expects the transitional period between high-growth and mature growth to last five years. During that time, capital expenditures will rise only 8% per year, with depreciation rising 13% per year. The growth in earnings should drop by eight percentage points per year, hitting 5% in the fifth year. During this transition, the expected return to shareholders will be 15% per year.
Throughout the high-growth and transitional growth periods, Simmons expects Starshah to be able to limit increases in the investment in working capital to 20 cents per year. In her analysis, the investment in working capital will peak in 2010, declining a dime to $2.10 per share in 2011.After Simmons’ presentation, the board debated what to do about the incipient slowdown in Starshah’s growth. A majority of the board argued in favor of moving to offset this slowdown in organic growth through a new emphasis on growth by acquisition.
One potential target is TPX. TPX's current and expected FCFE: $425,000 in 2004, $500,000 in 2005, $600,000 the following year, and $700,000 in 2007. After that, Starshah expects FCFE at TPX to grow 3% per year indefinitely. Starshah would require a return on its equity investment of 20% per year in the high-growth stage and 12% per year in the stable growth stage.Di Stefano and Simmons had a somber meeting the day after the board presentation. But despite the bleak news about future years, di Stefano had convinced himself it was worth staying around through the high-growth and transitional periods. He pointed out to Simmons that, if Simmons’ projections were correct, the value of Starshah’s stock would be in excess of $450 per share by the time the company hit the stable-growth phase. Di Stefano was very pleased with what that implied for the value of his stock options.
Simmons had done the same calculations herself, but she also realized that if required rates of return in 2012 rose from the very modest 10% she used in her board projections to only 15%, that would cut the terminal value of Starshah’s stock in 2011 to only half the level di Stefano was counting on. She considered that valuation too small to make the wait worthwhile. Simmons said nothing to di Stefano, but planned to look for another job. Which of the following FCFE models is best suited to analyzing TPX?
A)
Two-stage FCFE model.
B)
Stable growth FCFE model.
C)
Three-stage FCFE model.


The two-stage FCFE model is most suited to analyzing TPX because we have specific forecasts for the first several years and then a stable growth pattern into the indefinite future. (Study Session 12, LOS 40.i)
The FCFE for Starshah at the end of the transition period in 2011 is closest to:
A)
$20.62.
B)
$23.42.
C)
$21.89.


In order to calculate FCFE for Starshah in 2011, we need to construct a table of the components of cash flow for Starshah.We are given the 2004 values for net income, capital expenditures, depreciation, and change in working capital. We are also given growth rates for each of the three stages of Starshah’s growth: high-growth for two years followed by transitional growth for five years, culminating in stable growth for the following years. Using the original values and their related growth rates, plus the formula for FCFE (see below), we can construct the following table:

20042005200620072008200920102011
EPS4.556.609.5713.1116.9120.4623.1224.27
Capital expenditures1.752.282.963.193.453.734.024.35
Depreciation1.051.371.772.012.272.562.893.27
Change in working capital1.001.201.401.601.802.002.202.10
FCFE3.285.027.6311.0114.6718.0820.6221.89


FCFE = Earnings per share − (Capital Expenditures − Depreciation) × (1 − Debt Ratio) − (Change in working capital × (1 − Debt Ratio)) = 24.27 − (4.35 − 3.27) × (1 − 0.25) − (2.10 × (1 − 0.25))
= 24.27 − 0.81 − 1.57 = 21.89
FCFE = $21.89 per share in 2011.
(Study Session 12, LOS 40.j)

Regarding di Stefano’s and Simmons’ statements about the terminal value of Starshah stock in 2011:
A)
both are correct.
B)
only di Stefano is correct.
C)
only Simmons is correct.


Starshah hits the stable growth phase in 2012. At that point,
Terminal Firm Value2011 = (FCFE in year 2012) / (required rate of return − growth rate)
= $21.89 (1.05) / (0.10 − 0.05) = $22.98 per share / 0.05
= $460 per share. Di Stefano’s statement is correct.
Terminal Firm Value2011 = (FCFE in year 2012) / (required rate of return − growth rate) = $21.89 (1.05) / (0.15 − 0.05)
= $22.98 per share / 0.10 = $230 per share. Simmons’ statement is also correct.
(Study Session 12, LOS 40.j)

Assuming Simmons is right that the required return on Starshah equity rises to 15% in 2012 and beyond, what is the value of Starshah stock at the end of 2004?
A)
$63.71.
B)
$117.49.
C)
$111.35.


In order to calculate the firm value, we need to know the discount rate that applies over each period. Since the discount rate changes, we can simplify the arithmetic by constructing a table of discount factors using 25% for each of the first two years and 15% for each of the following five years:

2005200620072008200920102011
Discount factor1.251.561.802.072.382.733.14


We can then calculate firm value in 2004 using the FCFE values we calculated in question 1 and the stock value in the year 2012 (that we calculated in question 3).
Starshah equity value in 2004 = (5.02 / 1.25) + (7.63 / 1.56) + (11.01 / 1.80) + (14.67 / 2.07) + (18.08 / 2.38) + (20.62 / 2.73) + (21.89 / 3.14) + (230 / 3.14)= 4.02 + 4.89 + 6.12 + 7.09 + 7.60 + 7.55 + 6.97 + 73.25
= 117.49The value of Starshah stock at the end of 2004 is $117.49 per share. (Study Session 12, LOS 40.j)
What is the maximum amount that Starshah would be willing to pay for TPX (in millions)?
A)
$6.941.
B)
$5.102.
C)
$5.874.


Firm Value = [500 / (1.20)1] + [600 / (1.20)2] + [700 / (1.20)3] + [(700)(1.03) / (0.12 − 0.03) / (1.20)3] = $5,874.The most that Starshah could pay for TPX and still meet its required return targets is $5.874 million. (Study Session 12, LOS 43.j)

Which of the following FCFE models is best suited to analyzing Starshah Industries?
A)
Three-stage FCFE model.
B)
Stable growth FCFE model.
C)
Two-stage FCFE model.


The three-stage FCFE model is most suited to analyze firms in high growth industries that will face increasing competitive pressures over time, since those competitive pressures will lead to a gradual decline in the firm’s growth rate (second stage) to a stable level (third stage). (Study Session 12, LOS 40.i)
作者: anshultongia    时间: 2012-3-31 14:21

Ashley Winters, CFA, has been hired to value Goliath Communications, a company that is currently undergoing rapid growth and expansion. Ashley is an expert in the communications industry and has had extensive experience in valuing similar firms. She is convinced that a value for the equity of Goliath can be reliably obtained through the use of a three-stage free cash flow to equity (FCFE) model with declining growth in the second stage. Based on up-to-date financial statements, she has determined that the current FCFE per share is $0.90. Ashley has prepared a forecast of expected growth rates in FCFE as follows:
Stage 1:10.5% for years 1 through 3
Stage 2:8.5% in year 4, 6.5% in year 5, 5% in year 6
Stage 3:3% in year 7 and thereafter
Moreover, she has determined that the company has a beta of 1.8, the current risk-free rate is 3%, and the equity risk premium is 5%. The required return and terminal value in year 6 are closest to:
Required returnTerminal value in year 6
A)
9%$16.867
B)
12%$16.867
C)
12%$12.650


Based on the CAPM we can estimate a required return on equity as:
Required return = 3% + 1.8(5%) = 12%
Estimates for the future FCFE based on supplied growth rates are:
Year1234567
Growth rate10.5%10.5%10.5%8.5%6.5%5%3%
FCFE/share$0.995$1.099$1.214$1.318$1.403$1.473$1.518

R$ = 1.518/(12% - 3%) = 16.867

The per-share value Winters should assign to Goliath’s equity is closest to:
A)
$13.55.
B)
$20.24.
C)
$16.87.


We find the value of the equity/share by discounting all future FCFE/share by the required rate of return on equity.
Using the calculator, enter CF0 = 0; C01 = 0.995; C02 = 1.099; C03 = 1.214; C04 = 1.318; C05 = 1.403; C06 = 1.473 + 16.867 = 18.34; I = 12; Compute →NPV = 13.55.
作者: anshultongia    时间: 2012-3-31 14:22

A firm has projected free cash flow to equity next year of $1.25 per share, $1.55 in two years, and a terminal value of $90.00 two years from now, as well. Given the firm’s cost of equity of 12%, a weighted average cost of capital of 14%, and total outstanding debt of $30.00 per share, what is the current value of equity?
A)
$41.54.
B)
$74.10.
C)
$71.74.


Value of equity = $1.25 / (1.12)1 + $1.55 / (1.12)2 + $90.00 / (1.12)2 = $74.10
作者: anshultongia    时间: 2012-3-31 14:22


Industrial Light currently has:
What is the value of equity?
A)
$80,000,000.
B)
$44,440,000.
C)
$50,000,000.


The overall value of the firm is $4,000,000 / (0.10 – 0.05) = $80,000,000. Thus, the value of equity is $80,000,000 – $30,000,000 = $50,000,000.
作者: anshultongia    时间: 2012-3-31 14:23

Burcar-Eckhardt, a firm specializing in value investments, has been approached by the management of Overhaul Trucking, Inc., to explore the possibility of taking the firm private via a management buyout. Overhaul’s stock has stumbled recently, in large part due to a sudden increase in oil prices. Management considers this an opportune time to take the company private. Burcar would be a minority investor in a group of friendly buyers.
Jaimie Carson, CFA, is a private equity portfolio manager with Burcar. He has been asked by Thelma Eckhardt, CFA, one of the firm’s founding partners, to take a look at Overhaul and come up with a strategy for valuing the firm. After analyzing Overhaul’s financial statements as of the most recent fiscal year-end (presented below), he determines that a valuation using Free Cash Flow to Equity (FCFE) is most appropriate. He also notes that there were no sales of PPE.

Overhaul Trucking, Inc.
Income Statement
April 30, 2005
(Millions of dollars)


2005

2006E


Sales

300.0

320.0


Gross Profit

200.0

190.0


SG&A

50.0

50.0


Depreciation

70.0

80.0


EBIT

80.0

60.0


Interest Expense

30.0

34.0


Taxes (at 35 percent)

17.5

9.1


Net Income

32.5

16.9



Overhaul Trucking, Inc.
Balance Sheet
April 30, 2005
(Millions of dollars)


2005

2006E


Cash

10.0

15.0


Accounts Receivable

50.0

55.0


Gross Property, Plant & Equip.

400.0

480.0


Accumulated Depreciation

(160.0)

(240.0)


Total Assets

300.0

310.0





Accounts Payable

50.0

70.0


Long-Term Debt

140.0

113.1


Common Stock

80.0

80.0


Retained Earnings

30.0

46.9


Total Liabilities & Equity

300.0

310.0



Eckhardt agrees with Carson’s choice of valuation method, but her concern is Overhaul’s debt ratio. Considerably higher than the industry average, Eckhardt worries that the firm’s heavy leverage poses a risk to equity investors. Overhaul Trucking uses a weighted average cost of capital of 12% for capital budgeting, and Eckhardt wonders if that’s realistic.
Eckhardt asks Carson to do a valuation of Overhaul in a high-growth scenario to see if optimistic estimates of the firm’s near-term growth rate can justify the required return to equity. For the high-growth scenario, she asks him to start with his 2006 estimate of FCFE, grow it at 30% per year for three years and then decrease the growth rate in FCFE in equal increments for another three years until it hits the long-run growth rate of 3% in 2012. Eckhardt tells Carson that the returns to equity Burcar-Eckhardt would require are 20% until the completion of the high-growth phase, 15% during the three years of declining growth, and 10 percent thereafter. Eckhardt wants to know what Burcar could afford to pay for a 15% stake in Overhaul in this high-growth scenario.Carson assembles a few spreadsheets and tells Eckhardt, “We could make a bid of just under $16 million for the stake in Overhaul if the high-growth scenario plays out.” Eckhardt worries, though, that the value of their bid is extremely sensitive to the assumption for terminal growth, since in that scenario, the terminal value of the firm accounts for slightly more than two-thirds of the total value.
Carson agrees, and proposes doing a valuation under a “sustained growth” scenario. His estimates show Overhaul growing FCFE by the following amounts:

2007

2008

2009

2010

2011

Growth in FCFE

40.0%

15.7%

8.6%

9.1%

8.3%


In this scenario, he would project sustained growth of 6% per year in 2012 and beyond. With the more stable growth pattern in cash flow, Eckhardt and Carson agree that the required return to equity could be cut to a more moderate 12%.Carson also decides to try valuing the firm on Free Cash Flow to the Firm (FCFF) using this same 12% required return. Using a single-stage model on the estimated 2006 figures presented in the financial statements above, he comes up with a valuation of $1.08 billion.
Which of the following is least likely one of the differences between FCFE and FCFF? FCFF does not deduct:
A)
working capital investment.
B)
operating expenses.
C)
interest payments to bondholders.


FCFF includes the cash available to all of the firm’s investors, including bondholders. Therefore, interest payments to bondholders are not removed from revenues to derive FCFF. FCFE is FCFF minus interest payments to bondholders plus net borrowings from bondholders. (Study Session 12, LOS 40.a)
Which of the following is the least likely reason for Carson’s decision to use FCFE in valuing Overhaul rather than FCFF?
A)
Overhaul’s capital structure is stable.
B)
FCFE is an easier and more straightforward calculation than FCFF.
C)
Overhaul’s debt ratio is significantly higher than the industry average.


The difference between FCFF and FCFE is related to capital structure and resulting interest expense. When the company’s capital structure is relatively stable, FCFE is easier and more straightforward to use. FCFF is generally the best choice when FCFE is negative or the firm is highly leveraged. The fact that Overhaul’s debt ratio is significantly higher than the industry average would argue against the use of FCFE. Hence, this is the least likely reason to favor FCFE. (Study Session 12, LOS 40.a)
Assuming that Carson is using May 1, 2005 as his date of valuation, what is the estimated value of the firm’s equity under the scenario most suited to using the two-stage FCFE method?
A)
$173.3 million.
B)
$129.5 million.
C)
$125.2 million.


The “sustained-growth” scenario is the only scenario suitable for using the two-stage method, in part because the “high-growth” scenario uses three different required rates of return.

First, we need to calculate estimated FCFE in 2006. Since there were no sales of PPE, we can calculate FCInv as the change in Gross PPE.FCFE = NI + NCC − FCInv − WCInv + Net Borrowing
= 16.9 + 80 – (480 – 400) – [(55 – 70) – (50 – 50)] + (113.1 – 140)
= 16.9 + 80 – 80 + 15 – 26.9
= $5 million in 2006

Having calculated FCFE in 2006, we can calculate FCFE for 2007 through 2011 using the growth rates provided:


2007

2008

2009

2010

2011


Growth in FCFE

40.0%

15.7%

8.6%

9.1%

8.3%


Implied level of FCFE
(in millions)

$7.0

$8.1

$8.8

$9.6

$10.4




Now that we know FCFE, we can discount future FCFE back to the present at the cost of equity.

In the first stage of the two-stage model, we determine the terminal value at the start of the constant growth period as follows:

Terminal Value = (10.4 × 1.06)/(0.12 - 0.06) = $183.733 million.

In the second stage, we discount FCFE for the first six years and the terminal value to the present.
Equity Value = [5.0 / (1.12)1] + [7.0 / (1.12)2] + [8.1 / (1.12)3] + [8.8 / (1.12)4] + [9.6 / (1.12)5] + [(10.4 + 183.7333) / (1.12)6]
Equity Value = 4.46 + 5.58 + 5.77 + 5.59 + 5.45 + 98.35
Equity Value = $125.20 million

(Study Session 12, LOS 40.j)

What is the expected growth rate in FCFF that Carson must have used to generate his valuation of $1.08 billion?
A)
7%.
B)
12%.
C)
5%.

Since Firm Value = FCFF1 / (WACC − g), we first need to determine FCFF1, which is FCFF in 2006: FCFF = NI + NCC + [Int × (1 - tax rate)] – FCInv – WCInv
= 16.9 + 80 + [34 × (1 – 0.35)] – (480 – 400) – [(55 – 70) – (50 – 50)]
= 16.9 + 80 + 22.1 – 80 – (–15) = 54  

Firm Value = FCFF1 / (WACC - g)

1080 = 54 / (0.12 − x)

[(1080)(0.12)] – 1080x = 54
129.6 – 1080x = 54
75.6 = 1080x
0.07 = x
The expected growth rate in FCFF that Carson must have used is 7%. (Study Session 12, LOS 40.j)



If Carson had estimated FCFE under the assumption that Overhaul Trucking maintains a target debt-to-asset ratio of 36 percent for new investments in fixed and working capital, what would be his forecast of 2006 FCFE?
A)
$26.5 million.
B)
$9.6 million.
C)
$16.9 million.


FCFE = NI – [(1 - DR) × (FCInv - Dep)] – [(1 - DR) × WCInv]Where: DR = target debt to asset ratio
FCFE = 16.9 – [(1 – 0.36) × (480 – 400 – 80)] – [(1 – 0.36) × ((55 – 70) – (50 – 50))]
= 16.9 – (0.64 × 0) – (0.64 × (–15))
= 16.9 + 0 + 9.6 = 26.5
(Study Session 12, LOS 40.j)

Regarding the statements made by Carson and Eckhardt about the value of Overhaul in the high-growth scenario:
A)
only one is correct.
B)
both are correct.
C)
both are incorrect.


This is a complex problem. It would help to create a table:

2006

(year 1)

2007
(year 2)

2008
(year 3)

2009
(year 4)

2010
(year 5)

2011
(year 6)

2012
(year 7)

Growth in FCFE (given)

n/a

30%

30%

30%

21%

12%

3%

Forecast FCFE (calculated)

5.0

6.50

8.45

10.99

13.29

14.89

15.33

Required return to equity (given)

20%

20%

20%

20%

15%

15%

15%

Total discount factor (calculated)

1.20

(1.20)2

(1.20)3

(1.20)4

(1.20)4(1.15)

(1.20)4(1.15)2

(1.20)4(1.15)3

PV of FCFE

4.17

4.51

4.89

5.30

5.57

5.43

4.86



We begin with the forecast growth rates in FCFE in line 1. Since we have previously calculated that FCFE is $5 million in 2006, we can use the growth rates from line 1 to forecast FCFE in each year on line 2.

Line 3, required return to equity, is given. Using that, we can calculate discount factors in line 4.

Notice that the total discount factor is simply each year’s factor multiplied together. For example, the total discount factor for year 4 is (1.20)4 so the total discount factor for year 5, when the year 5 required rate of return drops from 20% to 15%, becomes (1.20)4(1.15).

Using the total discount factors from line 4, we can calculate the present value of each year’s cash flow in line 5. For example, the present value of year 2010 FCFE of $13.29 million will be $13.29 / [(1.20)4(1.15)] or $5.57 million.

Once we have the discounted cash flows for each year, we need to calculate the terminal value. Terminal value will be:

TV = (15.33)(1.03) / (0.10 - 0.03)
TV = 15.7899 / 0.07
TV = $225.57 million

Note that the required rate of return used for the terminal value is the rate for the steady-growth period, which is lower than that used in the high-growth phase (stage) or the declining growth phase (stage two).

We now need to discount terminal value back using the total discount factor for 2012:

PV of terminal value = $225.57 million / [(1.20)4(1.15)3]
PV of terminal value = $71.53 million

Adding together the discounted cash flows for each year with the discounted terminal value, we have:

Equity value = 4.17 + 4.51 + 4.89 + 5.30 + 5.57 + 5.43 + 4.86 + 71.53 = $106.26 million

Since the equity value of the firm is $106.26 million, Burcar should be willing to pay up to $106.26 × 0.15 = $15.94 million for a 15% stake in the firm. Since this is slightly less than $16 million, Carson’s statement is correct. The terminal value represents ($71.53 / $106.26) = 67.3% of the firm’s present value, so Eckhardt’s statement is also correct. (Study Session 12, LOS 40.j
作者: anshultongia    时间: 2012-3-31 14:24

The following information was collected from the financial statements of the Hiller Corp. for the year ending December 31, 2000:

The financial leverage for the firm is expected to be stable.

The FCFE for the base-year will be:
A)
$3.00.
B)
$3.80.
C)
$4.85.


Base-year FCFE = EPS − (capital expenditures − depreciation) × (1 − debt ratio) − increase in working capital × (1 − debt ratio) = $ 4.50 − ($3.00 − $2.75)(1 − 0.30) − $0.75(1 − 0.30) = $3.80.
If earnings, capital expenditures, depreciation and working capital are all expected to grow constantly at 5%, the value per share using stable-growth FCFE model will be:
A)
$72.75.
B)
$57.00.
C)
$54.29.


Value per share = $57.00 = ($3.80 × 1.05) / (0.12 − 0.05).
作者: anshultongia    时间: 2012-3-31 14:24

The following table provides background information on a per share basis for TOY, Inc., in the year 0:
Current InformationYear 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% and has a required rate of return of 12%. Earnings, capital expenditures, depreciation, and working capital are all expected to grow by 5% a year in the future.In year 1, what is the forecasted free cash flow to equity (FCFE) for TOY, Inc.?
A)
$3.56.
B)
$4.53.
C)
$4.31.


Earnings = 5 × 1.05 = 5.25, capital expenditures = 2.4 × 1.05 = 2.52, deprecation = 1.8 × 1.05 = 1.89, change in working capital = 1.7 × 1.05 = 1.785, FCFE = Earnings per share − (Capital Expenditures − Depreciation)(1 − Debt Ratio) − (Change in working capital)(1 − Debt Ratio) = 5.25 − (2.52 − 1.89)(1 − 0.3) − (1.785)(1 − 0.3) = 3.56.
What is the value of TOY, Inc.'s, stock given the above assumptions?
A)
$61.57.
B)
$64.71.
C)
$50.86.


The value of the stock = FCFE1 / (r − gn) = 3.56 / (0.12 − 0.05) = 50.86.
作者: anshultongia    时间: 2012-3-31 14:26


Industrial Light currently has:
What is the value of equity?
A)
$60,000,000.
B)
$57,142,857.
C)
$27,142,857.



The value of equity is [($4,000,000)(1.05) / (0.12 – 0.05)] = $60,000,000.
作者: anshultongia    时间: 2012-3-31 14:27


A firm has:
What will happen to the value of equity if the cost of equity decreases to 10%?
A)
There is insufficient information to tell.
B)
The value will increase.
C)
The value will decrease.


Everything else being constant, a decrease in the relevant required rate of return should increase the value of the equity per share.
作者: anshultongia    时间: 2012-3-31 14:29


A firm has:
What will happen to the value of the firm if the weighted average cost of capital increases to 12%?
A)
The value will remain the same.
B)
The value will increase.
C)
The value will decrease.


Everything else being constant, an increase in the relevant required rate of return should decrease the value of the firm.
作者: anshultongia    时间: 2012-3-31 14:29


A firm has:
What will happen to the value of the firm if free cash flow to equity decreases to $3.2 million?
A)
There is insufficient information to tell.
B)
The value will increase.
C)
The value will decrease.


Everything else being constant, a decrease in free cash flow to equity should decrease the value of the firm.
作者: anshultongia    时间: 2012-3-31 14:30

In five years, a firm is expected to be operating in a stage of its life cycle wherein its expected growth rate is 5%, indefinitely; its required rate of return on equity is 11%; its weighted average cost of capital is 9%; and the free cash flow to equity in year 6 will be $5.25 per share. What is its projected terminal value at the end of year 5?
A)
$51.93.
B)
$131.25.
C)
$87.50.


Terminal value = FCFE / (k − g) = $5.25 / (0.11 − 0.05) = $87.50
作者: anshultongia    时间: 2012-3-31 14:30

In the two-stage FCFE model, the required rate of return for calculating terminal value should be:
A)
higher than the required rate of return used for the high-growth phase.
B)
lower than the required rate of return used for the high-growth phase.
C)
equal to the average required rate of return for the industry.


In most cases, the required rate of return used to calculate the terminal value should be lower than the required rate of return used for initial high-growth phase. During the stable period the firm is less risky and the required rate of return is therefore lower.
作者: anshultongia    时间: 2012-3-31 14:32

Terminal value in multi-stage free cash flow valuation models is often calculated as the present value of:
A)
a two-stage valuation model's price.
B)
free cash flow divided by the growth rate.
C)
a constant growth model's price as of the beginning of the last stage.


Terminal values are usually calculated as the present value of the price produced by a constant-growth model as of the beginning of the last stage.
作者: anshultongia    时间: 2012-3-31 14:34

Terminal value in a multi-stage free cash flow to equity (FCFE) valuation model is often calculated as the present value of:
A)
a two-stage valuation model's price.
B)
free cash flow divided by the growth rate.
C)
FCFE divided by the total of required rate on equity minus growth.


Terminal values are usually calculated as the present value of the price produced by a constant-growth model as of the beginning of the last stage, which is FCFE / (required rate on equity – growth).



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