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LOS j: Explain the relationship of the residual income model to the dividend discount and free cash flow to equity models. ffice ffice" />
Q1. Which of the following statements least accurately explains the relationship between the residual income (RI) model, the dividend discount model (DDM), and free cash flow to equity (FCFE):
A) FCFE models use historical cash flows.
B) All the models discount future cash flows or income at the required rate of return.
C) RI models use an equity value from the balance sheet plus the present value of expected future residual income.
Correct answer is A)
In theory, the same value or total present value should be derived using expected dividends, expected FCFE, or book value plus expected residual income if the underlying assumptions are the same. However, the recognition of value is different because FCFE and DDM models forecast future cash flows, while residual income models start with a balance sheet measure of equity and add the present value of expected future residual income. A residual income model can be used along with other models to assess the consistency of results.
Q2. Which description of the relationship among residual income, dividend discount (DDM) and free cash flow to equity (FCFE) models is least accurate?
A) Residual income differs from DDM and FCFE in that residual income starts with book value.
B) Residual income differs from DDM and FCFE in that it discounts income rather than cash.
C) The different models should result in different intrinsic values because of the theoretical differences in the models.
Correct answer is C)
The three models should all produce the same intrinsic value as long as the underlying assumptions are the same. The differences in intrinsic values arise from difficulty in estimating the inputs, not from theoretical differences in the models. Since they should produce the same results, they can be used to assess consistency. Residual income differs from DDM and FCFE in the use of accounting assumptions, including book value and discounting income.
Q3. Which statement best describes the relationship between the residual income model and the free cash flow to equity model?
A) Intrinsic value calculated by both should be the same if the assumptions are the same.
B) They do not rely on accounting assumptions.
C) They both discount a future stream of cash flows.
Correct answer is A)
Theoretically the intrinsic value calculated by both should be the same, but since they use different approaches the values are often different in practice. Residual income relies on book value and discounts income, not cash flow.
Q4. A use of the residual income (RI) valuation approach is:
A) providing a check of consistency between competing approaches like free cash flow of equity (FCFE) and dividend discount model (DDM) .
B) deferring value more than in competing valuation approaches.
C) providing more reliable estimates of terminal value.
Correct answer is A)
A RI model can be used along with other models to assess the consistency of results. FCFE and DDM models forecast future cash flows while RI models start with a balance sheet measure of equity and add the present value of expected future RI.
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发表于 2009-3-10 09:29
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