Reading 41: Free Cash Flow Valuation-LOS b习题精选 2010, contrast, div, discount, valuation

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Session 12: Equity Investments: Valuation Models
Reading 41: Free Cash Flow Valuation

LOS b: Compare and contrast the FCFF and FCFE approaches to valuation.

 

 

 

Free cash flow to the firm valuation uses which discount rate?

A) Weighted average cost of capital.

B) After-tax cost of debt.

C) Cost of equity.

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Free cash flow to the firm valuation uses the opportunity cost relevant to the overall firm, which is the weighted average cost of capital.

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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.

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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.

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Free cash flow to equity valuation uses which discount rate?

A) Weighted average cost of capital.

B) After-tax cost of debt.

C) Cost of equity.

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Free cash flow to equity valuation uses the opportunity cost relevant to stockholders, which is the cost of equity.

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The difference between free cash flow to equity (FCFE) and free cash flow to the firm (FCFF) is:

A) earnings before interest and taxes (EBIT) less taxes.

B) before-tax interest and net borrowing.

C) after-tax interest and net borrowing.

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FCFE = FCFF – [interest expense] (1 – tax rate) + net borrowing.

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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.

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FCF approaches are best when those flows are a good indication of a firm’s profitability over the analyst’s forecast horizon.

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What is the most likely reason that you get an extremely low value from the three-stage FCFE model? Capital expenditures are significantly:

A) less than depreciation during the high-growth phase.

B) higher than depreciation in the stable-growth phase.

C) higher than depreciation during the high-growth phase.

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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.

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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.

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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.

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Free cash flow approaches are the best source of value when:

A) a firm has significant minority interest.

B) dividends are not paid.

C) return on assets is falling.

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Free cash flow approaches are best when dividends are not paid. Both remaining responses have nothing to do with the decision.

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Valuation with free cash flow to equity and free cash flow to the firm:

A) both use the cost of equity.

B) use different discount rates.

C) both use the after-tax cost of debt.

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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.

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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.

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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.