LOS g: Contrast the recognition of value in the FCFE model with the recognition of value in dividend discount models.

Q1. The primary difference between the three-stage DDM and the FCFE model is:

A)   growth rate assumptions.

B)   cost of equity.

C)   the definition of cash flows.

Q2. The estimate of value from FCFE models will always be different than the value obtained using DDM, if:

A)   FCFE is higher than dividends, and the excess is invested in zero NPV projects.

B)   FCFE is greater than dividends, and the excess is not invested in zero NPV projects.

C)   FCFE is higher than dividends.

Q3. 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)   Different sales forecast.

B)   Different estimates of model risk.

C)   The value in controlling the firm's dividend policy.

Q4. When FCFE is greater than dividends, the value obtained using FCFE will equal the value obtained using DDM if the:

A)   values will never be equal if FCFE is greater than dividends.

B)   excess cash is invested in projects with positive NPV.

C)   excess cash is invested in projects with net present value (NPV) of zero.

Q5. When are the free cashflow to equity (FCFE) model and the dividend discount model (DDM) valuations different? When FCFE:

A)   is greater than dividends and excess cash is invested in projects with a net present value of 0.

B)   equals dividends.

C)   is greater than dividends and excess cash is invested in projects with a positive net present value.

LOS g: Contrast the recognition of value in the FCFE model with the recognition of value in dividend discount models. fficeffice" />

Q1. The primary difference between the three-stage DDM and the FCFE model is:

A)   growth rate assumptions.

B)   cost of equity.

C)   the definition of cash flows.

Correct answer is C)

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.

Q2. The estimate of value from FCFE models will always be different than the value obtained using DDM, if:

A)   FCFE is higher than dividends, and the excess is invested in zero NPV projects.

B)   FCFE is greater than dividends, and the excess is not invested in zero NPV projects.

C)   FCFE is higher than dividends.

Correct answer is B)

The estimate of value from FCFE models will always be different from the value obtained using DDM, if the FCFE is greater than dividends, and the excess cash is not invested in zero NPV projects.

Q3. 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)   Different sales forecast.

B)   Different estimates of model risk.

C)   The value in controlling the firm's dividend policy.

Correct answer is C)

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.

Q4. When FCFE is greater than dividends, the value obtained using FCFE will equal the value obtained using DDM if the:

A)   values will never be equal if FCFE is greater than dividends.

B)   excess cash is invested in projects with positive NPV.

C)   excess cash is invested in projects with net present value (NPV) of zero.

Correct answer is C)

When FCFE is greater than dividends, but the excess cash is invested in projects with zero NPV, the FCFE model and DDM will give same estimates of firm value.

Q5. When are the free cashflow to equity (FCFE) model and the dividend discount model (DDM) valuations different? When FCFE:

A)   is greater than dividends and excess cash is invested in projects with a net present value of 0.

B)   equals dividends.

C)   is greater than dividends and excess cash is invested in projects with a positive net present value.

Correct answer is C)

There are two conditions when the valuation derived from the FCFE valuation model will be the same as the value from the Dividend Discount Model Valuation. First, if dividends are identical to FCFE. Second, if FCFE is larger than the dividends yet the excess cash (FCFE minus dividends) is invested in projects with a NPV equal to 0. When the FCFE is greater than the dividends and excess cash (FCFE minus dividends) are invested in projects with a positive NPV, the FCFE model will obtain a greater value than the dividend discount model. Typically, the value produced by the FCFE model exceeds the value produced by the dividend discount model with the difference considered to be the value in controlling the firm’s dividend policy.

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