LOS m: Discuss approaches for calculating the terminal value in a multistage valuation model.

Q1. 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 is $5.25 per share at the end of year 5. What is its projected terminal value at that time?

A)   $87.50.

B)   $51.93.

C)   $131.25.

Q2. 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)   FCFE divided by the total of required rate on equity minus growth.

C)   free cash flow divided by the growth rate.

Q3. 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.

Q4. 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)   equal to the average required rate of return for the industry.

C)   lower than the required rate of return used for the high-growth phase.

LOS m: Discuss approaches for calculating the terminal value in a multistage valuation model. fficeffice" />

Q1. 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 is $5.25 per share at the end of year 5. What is its projected terminal value at that time?

A)   $87.50.

B)   $51.93.

C)   $131.25.

Correct answer is A)

Terminal value = FCFE / (k ? g) = $5.25 / (0.11 ? 0.05) = $87.50

Q2. 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)   FCFE divided by the total of required rate on equity minus growth.

C)   free cash flow divided by the growth rate.

Correct answer is B)

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).

Q3. 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.

Correct answer is C)

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.

Q4. 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)   equal to the average required rate of return for the industry.

C)   lower than the required rate of return used for the high-growth phase.

Correct answer is C)

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.

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