Free Cash Flow Valuation Models
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Free Cash Flow Valuation Models

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Questions and Answers

What is free cash flow to equity (FCFE) specifically defined as?

  • The remaining cash flow after paying dividends to shareholders.
  • Cash flow available to shareholders after funding capital requirements and debt obligations. (correct)
  • Total earnings of the firm before any expenses are deducted.
  • Cash available to both shareholders and bondholders after operating expenses.

    • Why are free cash flow valuation models broadly applicable to firms?

  • They require detailed financial forecasts over a decade.
  • They depend on a clear earnings history.
  • They rely on the firm's current dividend level.
  • They can be applied regardless of dividend policy or capital structure. (correct)

    • What happens to free cash flows after the firm meets its obligations to bondholders?

  • It is reinvested into the firm's operational activities directly.
  • It is held in reserve for unexpected company expenses.
  • It is distributed to shareholders as dividends.
  • It becomes free cash flow to equity (FCFE) for shareholders. (correct)

    • What is a significant limitation of free cash flow valuation due to external business conditions?

    <p>It may result in negative free cash flow due to high capital investment needs.</p> Signup and view all the answers

    How is the value of the firm calculated using free cash flow?

    <p>By discounting the FCFF at the weighted average cost of capital (WACC).</p> Signup and view all the answers

    What characterizes the perspective of free cash flow valuation from a controlling shareholder's point of view?

    <p>The ability to influence the distribution of the firm's free cash flows.</p> Signup and view all the answers

    What is the expected dividend per share for the year 2010?

    <p>$2.40</p> Signup and view all the answers

    How much is the expected book value per share at the end of 2011?

    <p>$34.8</p> Signup and view all the answers

    Which of the following is the forecast for earnings per share in 2011?

    <p>$4.25</p> Signup and view all the answers

    What is the dividend payout ratio for the next three years?

    <p>60%</p> Signup and view all the answers

    What will be the intrinsic value of the firm if the residual income is assumed to be zero after 2011?

    <p>The value cannot be determined</p> Signup and view all the answers

    What is the equity charge per share for the year 2009?

    <p>$3.00</p> Signup and view all the answers

    What needs to be added to net income to calculate FCFF?

    <p>Depreciation and non-cash expenses</p> Signup and view all the answers

    What is the formula for calculating FCFF using EBIT?

    <p>FCFF = $EBIT imes (1 - Tax rate) + Depreciation - Fixed Capital Investment - Working Capital Investment$</p> Signup and view all the answers

    How do you derive the value of equity from firm value?

    <p>By subtracting the market value of debt from firm value</p> Signup and view all the answers

    Which of the following best describes fixed capital investment?

    <p>Expenditure on long-term assets</p> Signup and view all the answers

    What does FCFE stand for in equity valuation?

    <p>Free Cash Flow to Equity</p> Signup and view all the answers

    Which line item in ABC Corp's income statement shows non-cash expenses?

    <p>Depreciation</p> Signup and view all the answers

    What is indicated by the calculation of interest expenses in the FCFF formula?

    <p>Cost of debt financing adjusted for tax</p> Signup and view all the answers

    What is the effect of the tax rate on the EBIT when calculating FCFF?

    <p>It decreases the EBIT value</p> Signup and view all the answers

    In 2009, what was the total forecasted amount for Current Assets?

    <p>1,055</p> Signup and view all the answers

    How much did the actual Accounts Payables in 2008 amount to?

    <p>460</p> Signup and view all the answers

    What was the forecasted Fixed Assets in 2009?

    <p>1,600</p> Signup and view all the answers

    What is the actual amount for Short-term Debts in 2009?

    <p>460</p> Signup and view all the answers

    What was the actual Cash balance in 2008?

    <p>150</p> Signup and view all the answers

    In 2009, how much was forecasted for Accounts Receivable?

    <p>610</p> Signup and view all the answers

    What was the actual amount for Current Liabilities in 2009?

    <p>460</p> Signup and view all the answers

    What was the forecasted amount for Long-term Debt in 2008?

    <p>1,000</p> Signup and view all the answers

    How did the actual Inventory amount in 2009 compare to 2008?

    <p>Increased</p> Signup and view all the answers

    What was the total amount of Fixed Assets in 2008?

    <p>1,450</p> Signup and view all the answers

    Study Notes

    Free Cash Flow to Firm (FCFF)

    • FCFF is the cash available to the firm's investors (shareholders and bondholders) after the firm pays its operating expenses, makes working capital investments, and long-term investments.
    • FCFF is the cash flow available to the firm before payments to debt holders.

    Free Cash Flow to Equity (FCFE)

    • FCFE is the cash flow available to shareholders after the firm pays its bondholders and meets all other investor obligations.
    • FCFE is essentially the cash flow available to the firm's equity holders.

    Advantages of Using Free Cash Flow Valuation Models

    • Applicable to most firms, regardless of dividend policy or capital structure.
    • Suitable for firms with unclear or unrelated dividend policies.
    • More appropriate from the perspective of controlling shareholders who can influence dividend payouts.

    Limitations of Using Free Cash Flow Valuation Models

    • Firms might experience negative free cash flow for years if they need significant capital investments due to rapid technological advancements.

    Calculating FCFF from Net Income

    • FCFF can be calculated from net income by making adjustments for non-cash expenses, interest expenses, fixed capital investments, and working capital investments.
    • FCFF = Net Income + Depreciation + (Interest x (1- Tax Rate)) - Fixed Capital Investment - Working Capital Investment.
    • FCFF = (EBIT x (1- Tax Rate)) + Depreciation - Fixed Capital Investment - Working Capital Investment.

    Using Residual Income to Calculate Intrinsic Value

    • Residual Income is calculated by subtracting the equity charge (cost of equity x book value per share) from earnings per share.
    • Intrinsic value can be computed by summing the discounted forecast residual income for the forecast horizon and adding the present value of the terminal value to the current book value per share.

    NYSE Operations

    • A member of the NYSE owns a seat on the exchange.
    • Commission brokers execute customer orders to buy and sell stock on the exchange floor.
    • Specialists act as dealers in a small number of securities and are also known as market makers.
    • Specialists operate from a fixed place on the exchange floor, known as a specialist's post.
    • Floor brokers execute orders for commission brokers on a fee basis.
    • Floor traders trade for their own accounts, anticipating short-term price fluctuations.
    • SuperDOT system allows orders to be transmitted directly to the specialist electronically.
    • Order flow refers to the continuous flow of customer orders to buy and sell securities.

    NASDAQ Operations

    • NASDAQ is an electronic network without a physical exchange floor.
    • It is a system of multiple market makers.
    • Approximately 4,000 securities are listed on NASDAQ.
    • Trading happens electronically through dealers.

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    Related Documents

    BF Chapter 8 Lecture Notes on Stock Valuation

    Description

    Explore the concepts of Free Cash Flow to Firm (FCFF) and Free Cash Flow to Equity (FCFE) through this quiz. Learn about their advantages, limitations, and how they can be applied to assess a firm's financial health. Test your understanding of these critical valuation metrics now!

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