RobertA

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.

RobertA

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.

RobertA

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.

RobertA

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.