RobertA

Using the information below, value the stock of Symphony Publishing, Inc. using the free cash flow from equity (FCFE) valuation method.

• Required return of 13.0%.

• Value at the end of year 3 of 13 times FCFE3.

• Shares outstanding: 10.0 million.

• Net income in year 1 of $10.0 million, projected to grow at 10% for the next two years.
  

• Depreciation per year of $3.0 million.

• Capital Expenditures per year of $2.5 million.

• Increase in working capital per year of $1.0 million.

• Principal repayments on debt per year of $1.5 million.

The value per share of Symphony Publishing is approximately:

A) $112.10.

B) $11.21.

C) $14.10.

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Step 1: Calculate each year’s FCFE and discount at the required return.

• 
  FCFE = net income + depreciation − capital expenditures − increase in working capital − principal repayments + new debt issues
• 
  Year 1: 10.0 + 3.0 − 2.5 − 1.0 − 1.5 = 8.0,
• 
  PV = 7.08 = 8.0 / (1.13)1, or FV = −8.0, I = 13, PMT = 0, N = 1, Compute PV
• 
  Year 2: 10.0 × 1.10 + 3.0 − 2.5 − 1.0 − 1.5 = 9.0,
• 
  PV = 7.05 = 9.0 / (1.13)2, or FV = −9.0, I = 13, PMT = 0, N = 2, Compute PV
• 
  Year 3: 10.0 × (1.10)2 + 3.0 − 2.5 − 1.0 − 1.5 = 10.10
• 
  PV = 7.00 = 10.10 / (1.13)3, or FV = −10.10, I = 13, PMT = 0, N = 3, Compute PV

Step 2: Calculate Present Value of final cash flow times FCFE multiple.

• 
  Value at end of year 3 = FCFE3 × multiple = 10.10 × 13 = 131.30
• 
  PV = 91.00 = 131.30 / (1.13)3 , or using calculator, N = 3, FV = −131.30, I = 13, PMT = 0, Compute PV

Step 3: Calculate per share value.

• 
  Add up PV of FCFE and end value and divide by number of shares outstanding
• 
  = (7.08 + 7.05 + 7.00 + 91.0) / 10.0 = 11.21

RobertA

The following information pertains to the Harrisburg Tire Company (HTC) in 2000.

• Earnings (net income) = $600M.
• Dividends = $120M.
• Interest expense = $400M.
• Tax rate = 40%.
• Depreciation = $500M.
• Capital spending = $800M.
• Total assets = $10B (book value and market value).
• Debt = $4B (book value and market value).
• Equity = $6B (book value and market value).

The firm's working capital needs are negligible, and they plan to continue to operate at their current capital structure.
The free cash flow to the firm is:

A) $540M.

B) $420M.

C) $300M.

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The free cash flow to the firm is:

FCFF = Net income + (Interest expense)(1 − T) − Capital expenditures + Depreciation

RobertA

A firm currently has the following per share values:

• Cash flow from operations (CFO) is $49.50.
• Investment in fixed capital is $40.00.
• Net borrowing is $7.50.
  

What is the current per share free cash flow to equity (FCFE)?

A) $97.00.

B) $16.50.

C) $17.00.

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FCFE = CFO − FCInv + net borrowing = $49.50 − $40.00 + $7.50 = $17.00

RobertA

Which of the following items is NOT subtracted from the net income to calculate free cash flow to equity (FCFE)?

A) Subtractions to notes payable.

B) Additions to cash.

C) Interest payments to bondholders.

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Interest payments to bondholders are included in the income statement and are already subtracted to calculate net income.

RobertA

Free cash flow to the firm is equal to cash flow from operations minus fixed capital investment:

A) minus pre-tax interest expense.

B) minus after-tax interest expense.

C) plus after-tax interest expense.

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Free cash flow to the firm is equal to cash flow from operations minus fixed capital investment plus after-tax interest expense.

RobertA

Free cash flow to the firm (FCFF) adjusts earnings before interest and taxes (EBIT) by:

A) subtracting investments in fixed capital and working capital.

B) deducting taxes, adding back depreciation, and deducting the investments in fixed capital and working capital.

C) adding taxes, deducting depreciation, and adding back the investments in fixed capital and working capital.

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As presented in the reading: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv.

RobertA

Free cash flow to the firm (FCFF) adjusts earnings before interest and taxes (EBIT) by:

A) subtracting investments in fixed capital and working capital.

B) deducting taxes, adding back depreciation, and deducting the investments in fixed capital and working capital.

C) adding taxes, deducting depreciation, and adding back the investments in fixed capital and working capital.

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As presented in the reading: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv.

RobertA

In computing free cash flow, the most significant non-cash expense is usually:

A) deferred taxes.

B) depreciation.

C) capital expenditures.

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Depreciation is usually the largest non-cash expense.

RobertA

The ownership perspective implicit in the dividend valuation approach is of:

A) control.

B) a common stockholder.

C) a preferred stockholder.

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Dividends are most relevant to the stockholders who receive them and who have little control over their amount.

RobertA

The ownership perspective implicit in the free cash flow to equity valuation approach is of:

A) control.

B) a preferred stockholder.

C) a minority position.

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Dividend policy can be changed by the buyer of a firm. Thus, the free cash flow perspective looks to the source of dividends in a position of control rather than directly at dividends.