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Question 4

Using Chan's alternative valuation assumptions and the FCFE valuation approach, the year-end 2007 value per share of McLaughlin common stock should be closest to:

A. $18.00.

B. $22.80.

C. $24.17.

D. $25.20.

 
Correct answer = B

"Free Cash Flow Estimation," John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey
2008 Modular Level II, Vol. 4, pp. 353, 363-364
Study Session 12-47-f, k
discuss approaches for forecasting FCFF and FCFE;
calculate the value of a company using the single-stage, two-stage, and three-stage FCFF and FCFE models
FCFE = Net income - (1 - DR)(FCInv - Depreciation) - (1 - DR)(WCInv)
FCFE₁ = 1.80 - (1 - 0.40)(0.30 x 1.80) - (1 - 0.40)(0.10 x 1.80)
FCFE₁ = 1.80 - 0.324 - 0.108 = 1.368
FCFE will grow at the same rate as Net income, 6% annually.

The value per share is $22.80 

Question 5

The combined effect of the three possible financial actions is most likely to result in a decrease in McLaughlin's 2008 FCFE of:

A. $100 million.

B. $160 million.

C. $170 million.

D. $270 million.

 
Correct answer = A

"Free Cash Flow Estimation," John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey
2008 Modular Level II, Vol. 4, pp. 363-364
Study Session 12-47-h
explain how dividends, share repurchases, share issues, and changes in leverage may affect FCFF and FCFE
The three possible actions are: dividend increase = 110; share repurchase = 60; and the debt repayment = 100. Reducing debt by $100 million reduces FCFE (the amount of cash available to equity holders) by that amount. The cash dividend and the share repurchase are uses of FCFE and do not change the amount of cash available to equity holders. 

Question 6

Are Nicosia's explanations correct with respect to the:

	free cash flow valuation approach being superior to the discounted dividend valuation approach?	FCFE valuation approach being superior to the FCFF valuation approach?
A.	No	No
B.	No	Yes
C.	Yes	No
D.	Yes	Yes

A. Answer A.

B. Answer B.

C. Answer C.

D. Answer D.

 
Correct answer = C

"Free Cash Flow Estimation," John D. Stowe, Thomas R. Robinson, Jerald E. Pinto, and Dennis W. McLeavey
2008 Modular Level II, Vol. 4, pp. 375-380
Study Session 12-47-c, n
contrast the ownership perspective implicit in the FCFE approach to the ownership perspective implicit in the dividend discount approach;
describe the characteristics of companies for which the FCFF model is preferred to the FCFE model
Analysts should use free cash flow valuation whenever dividends differ significantly from the company's capacity to pay dividends. FCFF valuation is preferred over FCFE valuation whenever the capital structure is unstable or ever-changing. So Chan's first statement is correct, and her second statement is incorrect.