HuskyGrad2010

The three-stage FCFE model might result in an extremely high value if:

A) the growth rate in the stable-period is equal to that of GNP.

B) the growth rate in the stable-period is too high.

C) the growth rate in the stable-period is too low.

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If the growth rate in the stable-period is too high or the high-growth and transition periods are too long, the three-stage FCFE model might result in an extremely high value.

HuskyGrad2010

Assuming that the investment in fixed capital and working capital offset each other, free cash flow to the firm (FCFF) may be proxied by net income if:

A) non-cash charges and interest charges are zero.

B) earnings before interest and taxes (EBIT) equals depreciation.

C) non-cash charges and interest charges are equal.

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The answer is shown by the relationship between FCFF and net income: FCFF = NI + NCC + Int (1 – tax rate) – FCInv – WCInv. Further: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv, which assumes that depreciation is the only non-cash charge.

HuskyGrad2010

If the investment in fixed capital and working capital offset each other, free cash flow to the firm (FCFF) may be proxied by:

A) after-tax EBIT plus non-cash charges.

B) earnings before interest and taxes (EBIT).

C) net income plus after-tax interest.

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The answer is indicated by the definition of FCFF: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv, which assumes that depreciation is the only non-cash charge. Further: FCFF = NI + NCC + Int (1 – tax rate) – FCInv – WCInv.

HuskyGrad2010

If the investment in fixed capital and working capital offset each other, free cash flow to the firm (FCFF) may be proxied by:

A) earnings before interest and taxes (EBIT).

B) net income plus non-cash charges plus after-tax interest.

C) net income plus after-tax interest.

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The answer is indicated by the definition of FCFF: FCFF = NI + NCC + Int (1 – tax rate) – FCInv – WCInv. The relationship between net income and FCFF is indicated by: NI = EBIT (1 – tax rate) – Int (1 – tax rate).

HuskyGrad2010

In what ways are dividends different from free cashflow to equity (FCFE)?

A) Dividends are often viewed as "sticky." Managers are reluctant to radically change the dividend payout policy while FCFE often has immense variability.

B) Companies often use FCFE as a signal of positive future growth prospects while dividends are not used for signaling.

C) There is no difference. Dividends must equal FCFE.

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Dividends and the FCFE are often different and dividends are used as a signal to the market not FCFE. Dividends viewed as sticky is the true statement.

HuskyGrad2010

Which of the following statements regarding dividends and free cash flow to equity (FCFE) is least accurate?

A) Required returns are higher in FCFE discount models than they are in dividend discount models, since FCFE is more difficult to estimate.

B) FCFE discount models usually result in higher equity values than do dividend discount models (DDMs).

C) FCFE can be negative but dividends cannot.

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Although FCFE may be more difficult to estimate than dividends, the required return is based on the risk faced by the shareholders, which would be the same under both models.

HuskyGrad2010

Dividends paid out to the shareholders:

A) may be higher than free cash flow to equity FCFE.

B) are always equal to free cash flow to equity (FCFE).

C) are always less than free cash flow to equity (FCFE).

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Dividends represent the cash that the firm chooses to pay to the shareholders and the amount of the dividend is subject to the discretion of the firm. Dividends can be equal to, lower or higher than FCFE. For example, sometimes firms may pay dividends in years when there is a net loss.

HuskyGrad2010

Which of the following is least likely to change as the firm changes leverage?

A) Free cash flows to firm (FCFF).

B) Free cash flows to equity (FCFE).

C) Weighted average cost of capital (WACC).

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The FCFFs are normally unaffected by the changes in leverage, as these are the cash flows before the debt payments.

HuskyGrad2010

Ignoring any costs related to financial distress, if a firm increases its financial leverage, the value of the firm should:

A) increase because the FCFF will increase.

B) decrease because the required rate of return on debt is lower than that of equity.

C) increase because the weighted average cost of capital will be lower due to interest tax shields.

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When a firm adds leverage, its value may increase due to the tax shields on interest expense and the generally lower cost of debt. In theory, there is an optimal capital structure. If the amount of debt employed is greater than the optimal, the costs associated with risk of bankruptcy or financial distress begin to outweigh the advantage of interest tax shields.

HuskyGrad2010

Optimal capital structure is the mix of debt and equity that will maximize the value of the firm and minimize:

A) interest expense.

B) weighted average cost of equity.

C) weighted average cost of capital (WACC).

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The optimal capital structure is the mix of debt and equity that will maximize the value of the firm and minimize the WACC.