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FreeCashFlowValuation

TestID:7441130

Question#1of145

QuestionID:463221

AnanalysthaspreparedthefollowingscenariosforSchneider,Inc.:
Scenario1Assumptions:
Taxrateis40%.
Weightedaveragecostofcapital(WACC)=12%.
Constantgrowthrateinfreecashflow=3%.
Lastyear,freecashflowtothefirm(FCFF)=$30.
Targetdebtratio=10%.
Scenario2Assumptions:
Taxrateis40%.
Expensesbeforeinterestandtaxes(EBIT),capitalexpenditures,anddepreciationwillgrowat15%forthenextthree
years.
Afterthreeyears,thegrowthinEBITwillbe2%,andcapitalexpenditureanddepreciationwilloffseteachother.
WACCduringhighgrowthstage=20%.
WACCduringstablegrowthstage=12%.
Targetdebtratio=10%.

Year0
Scenario2FCFF

(last

Year1

Year2

Year3

Year4

$15.00

$17.25

$19.84

$22.81

$23.27

CapitalExpenditures

6.00

6.90

7.94

9.13

Depreciation

4.00

4.60

5.29

6.08

ChangeinWorkingCapital

2.00

2.10

2.20

2.40

2.40

5.95

7.06

8.25

11.56

year)
EBIT

FCFF

AssumingthatSchneider,Inc.,slightlyincreasesitsfinancialleverage,whatshouldhappentoitsfirmvalue?Thefirmvalue
should:
A) increaseduetotheadditionalvalueofinteresttaxshields.
B) notchangebecausefinancialleveragehasnorelationshipwithfirmvalue.
C) declineduetotheincreaseinrisk.
Explanation
Forsmallchangesinleverage,theadditionalvalueaddedbytheinteresttaxshieldswillmorethanoffsettheadditionalriskofbankruptcy
/financialdistress.Giventhetaxadvantageofdebt,thefirm'sWACCshoulddecline,notincreasewithsmallchangesinleverage.

Questions#27of145
HarrisburgTireCompany(HTC)forecaststhefollowingfor2013:
Earnings(netincome)=$600M.
Dividends=$120M.
Interestexpense=$400M.
Taxrate=40.0%.
Depreciation=$500M.
Capitalspending=$800M.
Totalassets=$10B(bookvalueandmarketvalue).
Debt=$4B(bookvalueandmarketvalue).
Equity=$6B(bookvalueandmarketvalue).
Targetdebttoassetratio=0.40.
Sharesoutstanding=2.0billion
Thefirm'sworkingcapitalneedsarenegligible,andHTCplanstocontinuetooperatewiththecurrentcapitalstructure.Thetireindustry
demandishighlydependentondemandfornewautomobiles.Individualcompaniesintheindustrydon'thavemuchinfluenceonthe
designofautomobilesandhaveverylittleabilitytoaffecttheirbusinessenvironment.Thedemandfornewautomobilesishighlycyclical
butdemandforecasterrorstendtobelow.

Question#2of145

QuestionID:463279

Thefirm'searningsgrowthrateismostaccuratelyestimatedas:

A) 6.4%.
B) 4.8%.
C) 8.0%.
Explanation
Thefirm'sestimatedearningsgrowthrateistheproductofitsretentionratioandROE:
g=RR(ROE)=[(600120)/600](600/6000)=0.08(LOS35.o)

Question#3of145
The2013forecastedfreecashflowtoequityis:

A) $300M.
B) $420M.
C) $340M.
Explanation
Sinceworkingcapitalneedsarenegligible,thefreecashflowtoequityis:
FCFE=Netincome[1DR)][FCInvDepreciation][(1DR)WCInv]
FCFE=600M[10.4](800M500M)=420M
where:
DR=targetdebttoassetratio(LOS36.d)

QuestionID:463280

Question#4of145

QuestionID:463281

Ifthetotalmarketvalueofequityis$6.0billionandthegrowthrateis8.0%,thecostofequitybasedonthestablegrowthFCFEmodelis
closestto:

A) 15.0%.
B) 7.6%.
C) 15.6%.
Explanation
Valueofequity=FCFE1/(Costofequitygrowthrate)so$6,000=[$420(1.08)]/(Costofequity0.08)
(Costofequity0.08)$6,000=$453.6
Costofequity0.08=0.0756
Costofequity=0.1556=15.56%(LOS36.j)

Question#5of145

QuestionID:463282

ThebetaforHTCis1.056,theriskfreerateis5.0%andthemarketriskpremiumis10.0%.TheweightedaveragecostofcapitalforHTC
isclosestto:

A) 11.74%.
B) 13.34%.
C) 15.56%.
Explanation
Costofequity=rf+(rmrf)=0.05+1.056(0.10)=0.05+0.1056=0.1556
Thebestapproximationforcostofdebtistheinterestexpensedividedbythemarketvalueofthedebt.
Costofdebt=Interestexpense/marketvalueofdebt=$400million/$4.0billion=0.10
WACC=wdrd(1t)+were=0.400.10(10.40)+0.600.1556=0.1174(LOS36.j)

Question#6of145

QuestionID:463283

ThemostappropriatestrategyformulationstyleforHTCis:

A) Adaptive
B) Classical
C) Shaping
Explanation
Industrydemandiscyclicalbutforecasterrorstendtobelowindicatingpredictablebusinessenvironment.Wearealsogiventhat
malleabilityislow.HenceClassicalstylewouldbemostappropriate.(LOS33.c)

Question#7of145

QuestionID:463284

FCFEfor2013is$400.0millionandHTCtookonanadditionaldebtof$40.0millionwhilerepayingexistingdebtof$60.0
million.ThegrowthrateforFCFFis5.0%andtheWACCis11.5%.Thevalueofthefirmcalculatedusingthestablegrowth
modelismostaccuratelydescribedas:

A) lessthanthemarketvalueofthefirmby$3.3billion.
B) lessthanthemarketvalueofthefirmby$7.5billion.
C) greaterthanthemarketvalueofthefirmby$0.7billion.
Explanation
FCFF=FCFE+Interestexpense(1t)netborrowing=$400million+$400million(10.40)($40million$60million)
=$660million.
Valueofthefirm=[$660million(1.05)]/(0.1150.05)=$10.662billion.Thisisadifferenceof$0.662billioncomparedtothe
$10.0billioncurrentmarketvalue.(LOS36.j,m)

Question#8of145

QuestionID:463199

Afirmcurrentlyhassalespershareof$10.00,andexpectssalestogrowby25%nextyear.Thenetprofitmarginisexpectedtobe15%.
Fixedcapitalinvestmentnetofdepreciationisprojectedtobe65%ofthesalesincrease,andworkingcapitalrequirementsare15%ofthe
projectedsalesincrease.Debtwillfinance45%oftheinvestmentsinnetcapitalandworkingcapital.Thecompanyhasan11%required
rateofreturnonequity.Whatisthefirm'sexpectedfreecashflowtoequity(FCFE)persharenextyearundertheseassumptions?

A) $0.38.
B) $1.88.
C) $0.77.
Explanation
FCFE=netprofitNetFCInvWCInv+DebtFin=$1.88$1.630.38+0.90=0.77

Question#9of145

QuestionID:463244

InusingFCFEmodels,theassumptionofgrowthshouldbe:
A) independentfromtheassumptionsofothervariables.
B) onlyconsistentwiththeassumptionsofcapitalspendinganddepreciation.
C) consistentwithassumptionsofothervariables.
Explanation
Theassumptionofgrowthshouldbeconsistentwithassumptionsaboutothervariables.Netcapitalexpenditures(capital
expendituresminusdepreciation)andbeta(risk)usedtocalculaterequiredrateofreturnshouldbeconsistentwithassumed
growthrate.

Question#10of145
WhichofthefollowingstatementsaboutthethreestageFCFEmodelismostaccurate?
A) Thereisafinalphasewhengrowthratestartstodecline.

QuestionID:463232

B) Thereisatransitionperiodwherethegrowthratedeclines.
C) Thereisatransitionperiodwherethegrowthrateisstable.
Explanation
InthethreestageFCFEmodel,thereisaninitialphaseofhighgrowth,atransitionperiodwherethegrowthratedeclines,and
asteadystateperiodwheregrowthisstable.

Questions#1116of145
MichaelBallmerisanequityanalystwithNewHorizonResearch.Thefirmhashistoricallyreliedondividendandresidual
incomevaluationmodelstovalueequity,butthefirm'sdirectorofresearch,DougLeads,hasdecidedthatthefirmneedsto
incorporatefreecashflowvaluationsintoitspractices.Therefore,LeadsdecidestosendBallmertoaseminaronfreecash
flowvaluation.
Uponhisreturnfromtheconvention,Ballmerisexcitedtosharehisnewfoundknowledgewithhiscoworkers.Ballmerisasked
togiveadebriefingtoNewHorizon'steamofequityanalysts,wherehemakesthefollowingstatements:
Statement
1:

Freecashflowtothefirmistheamountofthefirm'scashflowthatis
freeforthefirmtouseinmakinginvestmentsaftercashoperating
expenseshavebeencovered.

Statement
2:

Freecashflowtoequity,then,istheamountofthefirm'scashflow
thatisfreeforequityholdersaftercoveringcashoperatingexpenses,
workingcapitalandfixedcapitalinvestments,interestprincipal
paymentstobondholders,andrequireddividedpayments.

Statement
3:

Oneofthebenefitsoffreecashflowvaluationisthatthevalueofthe
firmandthevalueofequitycanbefoundbydiscountingfreecash
flowtothefirmandfreecashflowtoequity,respectively,bythe
WACC.

Aspartofhispresentation,Ballmerincludesashortexampleofhowtocalculatefreecashflowtoequity.Thefiguresfromhis
exampleareincludedbelow.
Figure1:ExampleBalanceSheet
20X2

20X1

Cash

$632

$245

Accountsreceivable

$208

$105

Inventory

$8,249

$8,209

Currentassets

$9,089

$8,559

GrossPPE

$22,499 $22,722

Accumulateddepreciation

($3,251) ($2,875)

Totalassets

$28,337 $28,406

Accountspayable

$4,864

$4,543

Shorttermdebt

$2,491

$2,996

Currentliabilities

$7,355

$7,539

Longtermdebt

$4,528

$5,039

Commonstock

$729

$735

Retainedearnings

$15,725 $15,093

Totalliabilitiesandowner's
equity

$28,337 $28,406

Figure2:ExampleCashFlowFrom
Operations
20X2
Netincome

20X1

$1,783 $2,195

Depreciation

$376

$267

WCInv

($178)

$357

Cashflowfrom
operations

$2,337 $2,819

Afterdiscussingthecalculationoffreecashflowtothefirmandfreecashflowtoequityfromhistoricalinformation,Ballmer
proceedstoexplainthemajorapproachesforforecastingfreecashflow.Hefocuseshisdiscussiononforecastingthe
componentsoffreecashflowasthismethodismoreflexible.Duringhispresentation,severaloftheanalystsnoticethatthe
formulaforforecastingfreecashflowtoequitydoesnotincludenetborrowing.TheybringthistoBallmer'sattention,andhe
statesthathewilllookintotheformulaandsendoutanupdatedpresentationafterthemeeting.
Aweekafterthemeeting,JonathanHodgesapproachedBallmerregardingtwoissueshehadwhileapplyingfreecashflow
basedvaluations.ThefirstissuethatHodgeshadwasthathecalculatedtheequityvalueofafirmusingbothfreecashflowto
equitybasedanddividendbasedvaluationsandarrivedatdifferentvalues.ThesecondissuethatHodgescameacrosswas
theeffectofachangeinafirm'stargetleverageonFCFE.OneofthefirmsthatHodgeswasanalyzingmayreduceleverage,
andHodgesneedstoknowifthiswillaffecthisvaluation.

Question#11of145

QuestionID:463179

Regardingstatements1and2,areBallmer'sinterpretationsoffreecashflowtothefirm(FCFF)andfreecashflowtoequity
(FCFE)CORRECT?
A) No,neitherinterpretationiscorrect.
B) No,onlyoneinterpretationiscorrect.
C) Yes,bothinterpretationsarecorrect.
Explanation
Freecashflowtothefirm(FCFF)isthecashflowsthatarefreetoinvestorsaftercashoperatingexpenses(includingtaxes
butexcludinginterestexpense),workingcapitalinvestments,andfixedcapitalinvestmentshavebeenmade.Freecashflowto
equity(FCFE)isFCFFlessinterestpaymentstobondholdersandnetborrowingfrombondholders.(StudySession12,LOS
36.a)

Question#12of145
IsBallmer'sthirdstatementregardingthecomputationoffirmvalueandequityvalueCORRECT?
A) Yes.

QuestionID:463180

B) No,freecashflowtoequityshouldbediscountedattherequiredreturnonequity.
C) No,bothfreecashflowtothefirmandfreecashflowtoequityshouldbediscounted
attherequiredrateofreturnonequity.
Explanation
Thevalueofafirmistheexpectedfuturefreecashflowtothefirm(FCFF)discountedatthefirm'sweightedaveragecostof
capital(WACC).Thevalueofthefirm'sequityistheexpectedfuturefreecashflowtoequitydiscountedattherequiredreturn
onequity.(StudySession12,LOS36.d)

Question#13of145

QuestionID:463181

Basedonfigures1and2,the20X2freecashflowtoequity(FCFE)forBallmer'sexamplefirmis:
A) $1,010.
B) $1,693.
C) $1,544.
Explanation
Freecashflowtoequity(FCFE)canbecomputedas:
FCFE=CFOFCInv+netborrowing
Basedonthefiguresincludedintheexample,fixedcapitalinvestment(FCInv)is$223(=$22,499$22,722)andnet
borrowingis$1,016(=$2,491+$4,528$2,996$5,039).
FCFEistherefore:FCFE=$2,337+$223$1,016=$1,544.(StudySession12,LOS36.d)

Question#14of145

QuestionID:463182

WhichofthefollowingstatementsregardingforecastingFCFEusingthecomponentsoffreecashflowmethodandnet
borrowingismostaccurate?
A) Investmentinfixedcapitalandnetborrowingareassumedtooffseteachother.
B) Netincomealreadyaccountsforinterestexpensetherefore,netborrowingisnot
needed.
C) Thetargetdebttoassetratioaccountsforthefinancingofnewinvestmentinfixed
capitalandworkingcapital.
Explanation
WhenforecastingFCFE,itiscommontoassumethatafirmwillmaintainatargetdebttoassetratiofornewinvestmentsin
fixedcapitalandworkingcapital.Basedonthisassumption,theformulaforforecastingFCFEis:
FCFE=NI&8722[(1DR)(FCInvDep)][(1DR)WCInv]
Bymultiplyingthefixedcapitalandworkingcapitalinvestmentsbyoneminusthetargetdebttoassetratio,youareleftwith
theinvestmentamountlesstheamountfinancedbydebt,whichisthenetborrowingamount.Therefore,thisformulaaccounts
fornetborrowingthroughthetargetdebttoassetratio.(StudySession12,LOS36.e)

Question#15of145

QuestionID:463183

Shoulddividendbasedandfreecashflowfromequity(FCFE)basedvaluationsresultindifferentequityvaluesforafirm?
A) Yes,dividendbasedvaluationswouldbehigherforfirmswithlarge,consistent
dividends.
B) Yes,thefreecashflowfromequityvaluationwouldbehigheriftherewereapremium
associatedwithcontrolofthefirm.
C) No,bothmodelsshouldresultinthesamevalue.
Explanation
TheownershipperspectivesofdividendbasedandFCFEbasedvaluationsaredifferent.Dividendbasedvaluationstakethe
perspectiveofminorityshareholders,whileFCFEbasedvaluationstaketheperspectiveofanacquirerwhowillassumea
controllingpositioninthefirm.Ifinvestorswerewillingtopayapremiumforacontrollingpositioninthefirm,thentheequity
valuecomputedundertheFCFEapproachwouldbehigher.(StudySession12,LOS36.b)

Question#16of145

QuestionID:463184

Whichofthefollowingstatementsregardingtheeffectadecreaseinleveragehasonafirm'sfreecashflowfromequity
(FCFE)ismostaccurate?
A) FCFEisunaffectedbychangesinleverage.
B) CurrentyearFCFEincreases,butfutureFCFEwillbereduced.
C) CurrentyearFCFEdecreases,butfutureFCFEwillbeincreased.
Explanation
ChangesinleveragedohaveasmalleffectonFCFE.AdecreaseinleveragewillcausethecurrentyearFCFEtodecrease
throughtherepaymentofdebt.FutureFCFEwillbeincreasedbecauseinterestexpensewillbelower.(StudySession12,LOS
36.g)

Question#17of145

QuestionID:463243

Athreestagefreecashflowtothefirm(FCFF)istypicallyappropriatewhen:

A) growthiscurrentlylowandwillmovethroughatransitionalstagetoafinalstage
whereingrowthexceedstherequiredrateofreturn.

B) growthiscurrentlyhighandwillmovethroughatransitionalstagetoasteadystategrowth
rate.

C) therequiredrateofreturnislessthanthegrowthrateinthelaststage.
Explanation
ThethreestagemodelusingeitherFCFEorFCFFtypicallyassumesthatgrowthiscurrentlyhighandwillmovethroughatransitional
stagetoasteadystategrowthrate.Multistagemodelsassumethattherequiredrateofreturnexceedsthegrowthrateinthelaststage.

Question#18of145

QuestionID:463225

Whichofthefollowingstatementsregardingdividendsandfreecashflowtoequity(FCFE)isleastaccurate?

A) FCFEcanbenegativebutdividendscannot.
B) RequiredreturnsarehigherinFCFEdiscountmodelsthantheyareindividenddiscount
models,sinceFCFEismoredifficulttoestimate.

C) FCFEdiscountmodelsusuallyresultinhigherequityvaluesthandodividenddiscountmodels
(DDMs).

Explanation
AlthoughFCFEmaybemoredifficulttoestimatethandividends,therequiredreturnisbasedontheriskfacedbytheshareholders,which
wouldbethesameunderbothmodels.

Questions#1924of145
AnanalysthaspreparedthefollowingscenariosforSchneiderInc.:
Scenario1Assumptions:
TaxRateis40%.
Weightedaveragecostofcapital(WACC)=12.0%.
Constantgrowthrateinfreecashflow(FCF)=3.0%.
Year0,freecashflowtothefirm(FCFF)=$30.0million
Targetdebtratio=10.0%.
Scenario2Assumptions:
TaxRateis40.0%.
Expensesbeforeinterestandtaxes(EBIT),capitalexpenditures,anddepreciationwillgrowat20.0%forthenextthree
years.
Afterthreeyears,thegrowthinEBITwillbe2.0%,andcapitalexpenditureanddepreciationwilloffseteachother.
Weightedaveragecostofcapital(WACC)=12.0%
Targetdebtratio=10.0%.

Scenario2FCFF(in$millions)

Year0 Year1 Year2 Year3 Year4


Year0

EBIT

$45.00 $54.00 $64.80 $77.76 $79.70

CapitalExpenditures

18.00

21.60

25.92

31.10

Depreciation

12.00

14.40

17.28

20.74

ChangeinWorkingCapital

6.00

6.30

6.60

7.20

7.20

18.90

23.64

29.09

40.62

FCFF

OtherfinancialitemsforSchneiderInc.:
Estimatedmarketvalueofdebt=$35.0million
Costofdebt=5.0%
Sharesoutstanding=20million.

Question#19of145

QuestionID:463248

GiventheassumptionscontainedinScenario1,thevalueofthefirmismostaccuratelyestimatedas:

A) $343million.
B) $250million.
C) $333million
Explanation
UnderthestablegrowthFCFFmodel,thevalueofthefirm=FCFF 1/(WACCgn)=$30million(1.03)/(0.120.03)=
$343.33million.
(LOS36.j)

Question#20of145

QuestionID:463249

InScenario2,theyear0freecashflowtothefirm(FCFF)isclosestto

A) $15million.
B) $16million.
C) $27million.
Explanation
FCFF=EBIT(1taxrate)+DepreciationCapitalExpendituresChangeinWorkingCapital=45.0(10.4)+12.0
18.06.0=15.00.
(LOS36.d)

Question#21of145

QuestionID:463250

InScenario2,thepresentvalueoftheterminalvalueisclosestto:
A) $289million.
B) $347million.
C) $258million.
Explanation
Theterminalvalueis:FCFFforyear4/(WACCgrowthrate)=$40.62/(0.120.02)=$406.22millionintermsofyear3
dollars.Thecalculatorinputstosolveforthepresentvalueis:FV=$406.22,N=3,I/Y=12solveforPV.PVis$289.14
Million.(LOS36.e)
(LOS36.e)

Question#22of145
InScenario2,thevalueofthefirmisclosestto:
A) $315million.

QuestionID:463251

B) $346million.
C) $321million.
Explanation
ThevalueofthefirmisthepresentvalueofYear13plustheterminalvalue.Theterminalvalueis:FCFFforyear4/(WACC
growthrate)=$40.62/(0.120.02)=$406.22millionintermsofyear3dollars.ThecalculatorinputstosolveNPVforthe
valueofthefirmis:CF0=$0,CF1=$18.90,CF2=$23.64,CF3=$29.09+$406.22=$435.31,I=12.NPV=$345.57million.
(LOS36.d)

Question#23of145

QuestionID:463252

ThecostofequityforSchneiderInc.isclosestto:
A) 13.0%.
B) 5.8%.
C) 11.3%
Explanation
TheweightedaveragecostofcapitalformulaisWACC=wdrd(1t)+were.Theweightofdebtis10.0%theweightof
equitymustbe90.0%.
0.12=0.100.05(10.40)+0.90re
0.1200.003=0.90re
0.117/0.9=re
re=13.0%
(LOS36.j)

Question#24of145

QuestionID:463253

ThemarketvalueofScheiderInc.'sstockis:
A) $17.50pershare.
B) $15.75pershare
C) $31.50pershare.
Explanation
Theestimatedmarketvalueofdebtis$35million,whichrepresents10.0%ofthevalueofthefirm.Theother90.0%isthe
valueofequityor$315million.$315million/20millionshares=$15.75pershare.
(LOS36.j)

Question#25of145

QuestionID:463185

Ananalystisperforminganequityvaluationforaminorityequitypositioninadividendpayingmultinational.Theappropriate
modelforthisanalysisismostlikely:

A) FCFEapproach.
B) TheDividendDiscountapproach.
C) FCFFapproach.
Explanation
Thedividenddiscountmodelismostappropriateforvaluingaminorityequitypositioninadividendpayingcompany.Thefree
cashflowapproachlookstothesourceofdividendsfromtheperspectiveofanownerthathascontrolratherthandirectlyat
dividends.

Question#26of145

QuestionID:463217

Anincreaseinfinancialleveragewillcausefreecashflowtoequity(FCFE)to:

A) increaseintheyeartheborrowingoccurred.
B) decreaseintheyeartheborrowingoccurred.
C) decreaseorincrease,dependingonitscircumstances.
Explanation
Anincreaseinfinancialleveragewillincreasenetborrowingand,hence,increaseFCFEintheyeartheborrowingoccurredbecause:
FCFE=FCFF[interestexpense](1taxrate)+netborrowing.

Questions#2732of145
BurcarEckhardt,afirmspecializinginvalueinvestments,hasbeenapproachedbythemanagementofOverhaulTrucking,
Inc.,toexplorethepossibilityoftakingthefirmprivateviaamanagementbuyout.Overhaul'sstockhasstumbledrecently,in
largepartduetoasuddenincreaseinoilprices.Managementconsidersthisanopportunetimetotakethecompanyprivate.
Burcarwouldbeaminorityinvestorinagroupoffriendlybuyers.
JaimieCarson,CFA,isaprivateequityportfoliomanagerwithBurcar.HehasbeenaskedbyThelmaEckhardt,CFA,oneof
thefirm'sfoundingpartners,totakealookatOverhaulandcomeupwithastrategyforvaluingthefirm.Afteranalyzing
Overhaul'sfinancialstatementsasofthemostrecentfiscalyearend(presentedbelow),hedeterminesthatavaluationusing
FreeCashFlowtoEquity(FCFE)ismostappropriate.HealsonotesthattherewerenosalesofPPE.

OverhaulTrucking,Inc.
IncomeStatement
April30,2005
(Millionsofdollars)
2005 2006E
Sales

300.0

320.0

GrossProfit

200.0

190.0

SG&A

50.0

50.0

Depreciation

70.0

80.0

EBIT

80.0

60.0

InterestExpense

30.0

34.0

Taxes(at35percent)

17.5

9.1

NetIncome

32.5

16.9

OverhaulTrucking,Inc.
BalanceSheet
April30,2005
(Millionsofdollars)
2005

2006E

Cash

10.0

15.0

AccountsReceivable

50.0

55.0

GrossProperty,Plant&Equip.

400.0

480.0

AccumulatedDepreciation

(160.0) (240.0)

TotalAssets

300.0

310.0

AccountsPayable

50.0

70.0

LongTermDebt

140.0

113.1

CommonStock

80.0

80.0

RetainedEarnings

30.0

46.9

TotalLiabilities&Equity

300.0

310.0

EckhardtagreeswithCarson'schoiceofvaluationmethod,butherconcernisOverhaul'sdebtratio.Considerablyhigherthan
theindustryaverage,Eckhardtworriesthatthefirm'sheavyleverageposesarisktoequityinvestors.OverhaulTruckinguses
aweightedaveragecostofcapitalof12%forcapitalbudgeting,andEckhardtwondersifthat'srealistic.
EckhardtasksCarsontodoavaluationofOverhaulinahighgrowthscenariotoseeifoptimisticestimatesofthefirm'snear
termgrowthratecanjustifytherequiredreturntoequity.Forthehighgrowthscenario,sheaskshimtostartwithhis2006
estimateofFCFE,growitat30%peryearforthreeyearsandthendecreasethegrowthrateinFCFEinequalincrementsfor
anotherthreeyearsuntilithitsthelongrungrowthrateof3%in2012.EckhardttellsCarsonthatthereturnstoequityBurcar
Eckhardtwouldrequireare20%untilthecompletionofthehighgrowthphase,15%duringthethreeyearsofdeclininggrowth,
and10percentthereafter.EckhardtwantstoknowwhatBurcarcouldaffordtopayfora15%stakeinOverhaulinthishigh
growthscenario.
CarsonassemblesafewspreadsheetsandtellsEckhardt,"Wecouldmakeabidofjustunder$16millionforthestakein
Overhaulifthehighgrowthscenarioplaysout."Eckhardtworries,though,thatthevalueoftheirbidisextremelysensitiveto
theassumptionforterminalgrowth,sinceinthatscenario,theterminalvalueofthefirmaccountsforslightlymorethantwo
thirdsofthetotalvalue.
Carsonagrees,andproposesdoingavaluationundera"sustainedgrowth"scenario.HisestimatesshowOverhaulgrowing
FCFEbythefollowingamounts:

2007

2008

2009

2010

2011

GrowthinFCFE 40.0% 15.7% 8.6%

9.1%

8.3%

Inthisscenario,hewouldprojectsustainedgrowthof6%peryearin2012andbeyond.Withthemorestablegrowthpatternin
cashflow,EckhardtandCarsonagreethattherequiredreturntoequitycouldbecuttoamoremoderate12%.
CarsonalsodecidestotryvaluingthefirmonFreeCashFlowtotheFirm(FCFF)usingthissame12%requiredreturn.Using
asinglestagemodelontheestimated2006figurespresentedinthefinancialstatementsabove,hecomesupwithavaluation
of$1.08billion.

Question#27of145

QuestionID:463300

WhichofthefollowingisoneofthedifferencesbetweenFCFEandFCFF?FCFFdoesnotdeduct:
A) workingcapitalinvestment.
B) operatingexpenses.
C) interestpaymentstobondholders.
Explanation
FCFFincludesthecashavailabletoallofthefirm'sinvestors,includingbondholders.Therefore,interestpaymentsto
bondholdersarenotremovedfromrevenuestoderiveFCFF.FCFEisFCFFminusinterestpaymentstobondholdersplusnet
borrowingsfrombondholders.(StudySession10,LOS30.a)

Question#28of145

QuestionID:463301

WhichofthefollowingistheleastlikelyreasonforCarson'sdecisiontouseFCFEinvaluingOverhaulratherthanFCFF?
A) Overhaul'scapitalstructureisstable.
B) FCFEisaneasierandmorestraightforwardcalculationthanFCFF.
C) Overhaul'sdebtratioissignificantlyhigherthantheindustryaverage.
Explanation
ThedifferencebetweenFCFFandFCFEisrelatedtocapitalstructureandresultinginterestexpense.Whenthecompany's
capitalstructureisrelativelystable,FCFEiseasierandmorestraightforwardtouse.FCFFisgenerallythebestchoicewhen
FCFEisnegativeorthefirmishighlyleveraged.ThefactthatOverhaul'sdebtratioissignificantlyhigherthantheindustry
averagewouldargueagainsttheuseofFCFE.Hence,thisistheleastlikelyreasontofavorFCFE.(StudySession10,LOS
30.a)

Question#29of145

QuestionID:463302

AssumingthatCarsonisusingMay1,2005ashisdateofvaluation,whatistheestimatedvalueofthefirm'sequityunderthe
scenariomostsuitedtousingthetwostageFCFEmethod?
A) $129.5million.
B) $173.3million.
C) $125.2million.
Explanation
The"sustainedgrowth"scenarioistheonlyscenariosuitableforusingthetwostagemethod,inpartbecausethe"high
growth"scenariousesthreedifferentrequiredratesofreturn.

First,weneedtocalculateestimatedFCFEin2006.SincetherewerenosalesofPPE,wecancalculateFCInvasthechange
inGrossPPE.
FCFE=NI+NCCFCInvWCInv+NetBorrowing
=16.9+80(480400)[(5570)(5050)]+(113.1140)
=16.9+8080+1526.9
=$5millionin2006
HavingcalculatedFCFEin2006,wecancalculateFCFEfor2007through2011usingthegrowthratesprovided:

2007
GrowthinFCFE

2008

2009 2010

2011

40.0% 15.7% 8.6% 9.1%

8.3%

Impliedlevelof
FCFE

$7.0

$8.1

$8.8

$9.6

$10.4

(inmillions)

NowthatweknowFCFE,wecandiscountfutureFCFEbacktothepresentatthecostofequity.
Inthefirststageofthetwostagemodel,wedeterminetheterminalvalueatthestartoftheconstantgrowthperiodasfollows:
TerminalValue=(10.41.06)/(0.120.06)=$183.733million.
Inthesecondstage,wediscountFCFEforthefirstsixyearsandtheterminalvaluetothepresent.
EquityValue=[5.0/(1.12)1]+[7.0/(1.12)2]+[8.1/(1.12)3]+[8.8/(1.12)4]+[9.6/(1.12)5]+[(10.4+183.7333)/(1.12)6]
EquityValue=4.46+5.58+5.77+5.59+5.45+98.35
EquityValue=$125.20million
(StudySession12,LOS36.j)

Question#30of145

QuestionID:463303

WhatistheexpectedgrowthrateinFCFFthatCarsonmusthaveusedtogeneratehisvaluationof$1.08billion?
A) 5%.
B) 7%.
C) 12%.
Explanation
SinceFirmValue=FCFF 1/(WACCg),wefirstneedtodetermineFCFF 1,whichisFCFFin2006:FCFF=NI+NCC+[Int
(1taxrate)]FCInvWCInv
=16.9+80+[34(10.35)](480400)[(5570)(5050)]
=16.9+80+22.180(15)=54
FirmValue=FCFF 1/(WACCg)
1080=54/(0.12x)
[(1080)(0.12)]1080x=54
129.61080x=54
75.6=1080x
0.07=x

TheexpectedgrowthrateinFCFFthatCarsonmusthaveusedis7%.(StudySession12,LOS36.j)

Question#31of145

QuestionID:463304

IfCarsonhadestimatedFCFEundertheassumptionthatOverhaulTruckingmaintainsatargetdebttoassetratioof36
percentfornewinvestmentsinfixedandworkingcapital,whatwouldbehisforecastof2006FCFE?
A) $9.6million.
B) $26.5million.
C) $16.9million.
Explanation
FCFE=NI[(1DR)(FCInvDep)][(1DR)WCInv]
Where:DR=targetdebttoassetratio
FCFE=16.9[(10.36)(48040080)][(10.36)((5570)(5050))]
=16.9(0.640)(0.64(15))
=16.9+0+9.6=26.5
(StudySession12,LOS36.j)

Question#32of145

QuestionID:463305

RegardingthestatementsmadebyCarsonandEckhardtaboutthevalueofOverhaulinthehighgrowthscenario:
A) botharecorrect.
B) onlyoneiscorrect.
C) bothareincorrect.
Explanation
Thisisacomplexproblem.Itwouldhelptocreateatable:
2006
2007
(year1) (year2)

2008
2009
(year3) (year4)

2010
(year5)

2011
(year6)

2012
(year7)

GrowthinFCFE(given)
ForecastFCFE(calculated)
Requiredreturntoequity
(given)
Totaldiscountfactor
(calculated)

n/a
5.0

30%
6.50

30%
8.45

30%
10.99

21%
13.29

12%
14.89

3%
15.33

20%

20%

20%

20%

15%

15%

15%

1.20

(1.20)2

(1.20)3

(1.20)4

(1.20)4(1.15)

(1.20)4(1.15)2

(1.20)4(1.15)3

PVofFCFE

4.17

4.51

4.89

5.30

5.57

5.43

4.86

WebeginwiththeforecastgrowthratesinFCFEinline1.SincewehavepreviouslycalculatedthatFCFEis$5millionin2006,
wecanusethegrowthratesfromline1toforecastFCFEineachyearonline2.
Line3,requiredreturntoequity,isgiven.Usingthat,wecancalculatediscountfactorsinline4.
Noticethatthetotaldiscountfactorissimplyeachyear'sfactormultipliedtogether.Forexample,thetotaldiscountfactorfor
year4is(1.20)4sothetotaldiscountfactorforyear5,whentheyear5requiredrateofreturndropsfrom20%to15%,
becomes(1.20)4(1.15).
Usingthetotaldiscountfactorsfromline4,wecancalculatethepresentvalueofeachyear'scashflowinline5.Forexample,
thepresentvalueofyear2010FCFEof$13.29millionwillbe$13.29/[(1.20)4(1.15)]or$5.57million.

Oncewehavethediscountedcashflowsforeachyear,weneedtocalculatetheterminalvalue.Terminalvaluewillbe:
TV=(15.33)(1.03)/(0.100.03)
TV=15.7899/0.07
TV=$225.57million
Notethattherequiredrateofreturnusedfortheterminalvalueistherateforthesteadygrowthperiod,whichislowerthan
thatusedinthehighgrowthphase(stage)orthedeclininggrowthphase(stagetwo).
Wenowneedtodiscountterminalvaluebackusingthetotaldiscountfactorfor2012:
PVofterminalvalue=$225.57million/[(1.20)4(1.15)3]
PVofterminalvalue=$71.53million
Addingtogetherthediscountedcashflowsforeachyearwiththediscountedterminalvalue,wehave:
Equityvalue=4.17+4.51+4.89+5.30+5.57+5.43+4.86+71.53=$106.26million
Sincetheequityvalueofthefirmis$106.26million,Burcarshouldbewillingtopayupto$106.260.15=$15.94millionfora
15%stakeinthefirm.Sincethisisslightlylessthan$16million,Carson'sstatementiscorrect.Theterminalvaluerepresents
($71.53/$106.26)=67.3%ofthefirm'spresentvalue,soEckhardt'sstatementisalsocorrect.(StudySession12,LOS36.j)

Question#33of145

QuestionID:463190

Incomputingfreecashflow,themostsignificantnoncashexpenseisusually:

A) depreciation.
B) capitalexpenditures.
C) deferredtaxes.
Explanation
Depreciationisusuallythelargestnoncashexpense.

Question#34of145
Afirmhas:
Freecashflowtothefirm=$4.0million.
Weightedaveragecostofcapital=10%.
Totaldebt=$30.0million.
Longtermexpectedgrowthrate=5%.
Valueofthefirm=$50.00pershare.
Whatwillhappentothevalueofthefirmiftheweightedaveragecostofcapitalincreasesto12%?

A) Thevaluewillremainthesame.
B) Thevaluewillincrease.

QuestionID:463307

C) Thevaluewilldecrease.
Explanation
Everythingelsebeingconstant,anincreaseintherelevantrequiredrateofreturnshoulddecreasethevalueofthefirm.

Question#35of145

QuestionID:463310

Infiveyears,afirmisexpectedtobeoperatinginastageofitslifecyclewhereinitsexpectedgrowthrateis5%,indefinitelyitsrequired
rateofreturnonequityis11%itsweightedaveragecostofcapitalis9%andthefreecashflowtoequityinyear6willbe$5.25per
share.Whatisitsprojectedterminalvalueattheendofyear5?

A) $131.25.
B) $51.93.
C) $87.50.
Explanation
Terminalvalue=FCFE/(kg)=$5.25/(0.110.05)=$87.50

Question#36of145

QuestionID:463202

Inforecastingfreecashflowsitiscommontoassumethatinvestmentinworkingcapital:

A) isgreaterthanfixedcapitalinvestmentduringagrowthphase.
B) willbefinancedusingthetargetdebtratio.
C) willequalfixedcapitalinvestment.
Explanation
Itisusuallyassumedthattheinvestmentinworkingcapitalwillbefinancedconsistentwiththetargetdebtratio.

Question#37of145

QuestionID:463311

Terminalvalueinmultistagefreecashflowvaluationmodelsisoftencalculatedasthepresentvalueof:

A) atwostagevaluationmodel'sprice.
B) freecashflowdividedbythegrowthrate.
C) aconstantgrowthmodel'spriceasofthebeginningofthelaststage.
Explanation
Terminalvaluesareusuallycalculatedasthepresentvalueofthepriceproducedbyaconstantgrowthmodelasofthebeginningofthe
laststage.

Questions#3843of145
ThefollowinginformationwascollectedfromthefinancialstatementsofBankersIndustrialCorp(BIC)fortheyearendedDecember31,
2013.
Earningsbeforeinterestandtaxes(EBIT)=$6.00million.
Capitalexpenditures=$1.25million.
Depreciationexpense=$0.63million.
Workingcapitaladditions=$0.59million.
Costofdebt=10.50%.
Costofequity=16.00%.
StablegrowthrateforFCFF=7.00%.
StablegrowthrateforFCFE=10.00%.
Marketvalueofdebt=$20.00million.
Bookvalueofdebt=$22.50million.
Outstandingshares=500,000.
Interestexpense=$2.00million.
NewDebtborrowing=$3.30million.
Debtrepayment=$2.85million.
GrowthratesfortwostagegrowthmodelforFCFE:
25.0%forYears13.
6.0%forYears4andthereafter.

BICiscurrentlyoperatingattheirtargetdebtratioof40.00%.Thefirm'staxrateis40.00%.

Question#38of145

QuestionID:463260

Thefreecashflowtothefirm(FCFF)forthecurrentyearisclosestto:

A) $3.57million.
B) $2.39million.
C) $2.31million.
Explanation
TheFCFFforthecurrentyearis[$6.00m(10.40)]+$0.63m$1.25m$0.59m=$2.39m.

(LOS36.d)

Question#39of145
TheappropriatediscountratetoapplyinvaluingBICusingFCFFisclosestto:

QuestionID:463261

A) 12.1%.
B) 16.0%.
C) 13.8%.
Explanation
Theappropriatediscountratetouseistheweightedaveragecostofcapital(WACC),andthisisWACC=(0.600.16)+[0.400.105
(10.40)]=12.12%.

(LOS36.j)

Question#40of145

QuestionID:463262

Theestimatedvalueofthefirmisclosestto:

A) $38million.
B) $47million.
C) $50million.
Explanation
ThevalueofBICusingastablegrowthFCFFmodelis$49.95million,calculatedas:
FCFF=[$6.00m(10.40)]+$0.63m$1.25m$0.59m.=$2.39m
WACC=(0.600.16)+[0.400.105(10.40)]=12.12%.
Estimatedvalue=($2.39m1.07)/(0.12120.07)=$49.95million.
(LOS36.j)

Question#41of145

QuestionID:463263

Iftheestimatedvalueofthefirmis$50.0million,thevaluepershareofBICstockshouldbeclosestto:
A) $60.
B) $28.
C) $30.
Explanation
Equityvalue=Firmvaluemarketvalueofdebt$50million$20million=$30million:
$30,000,000/500,000=$60.00pershare.
(LOS36.j)

Question#42of145

QuestionID:463264

Iftheestimatedvalueofthefreecashtothefirm(FCFF)foryear0is$2.4million,thevaluepershareofBICstock,basedon
thestablegrowthmodel,isclosestto:

A) $61
B) $55
C) $39
Explanation
FCFE=FCFFInterestexpense(1taxrate)+Netborrowing=$2.40million[$2.00million(10.40)]+$3.30million
$2.85million=$1.65million.
Thevalueofequityis:[$1.65million(1+0.10)]/(0.160.10)=$30.25million.
Onapersharebasis:$30.25million/500,000=$60.50
(LOS36.j)

Question#43of145

QuestionID:463265

ThecurrentmarketpriceofBICis$62.50pershare,andthecurrentyear'sFCFEis$1.75million.Usingatwostagegrowth
modeltofindtheestimatedthefirm'svalue,thecurrentmarketpriceBICismostaccuratelydescribedas:
A) overvalued.
B) fairlyvalued.
C) undervalued.
Explanation
FCFE=FCFFInterestexpense(1T)+Newborrowing.
Year

Growthrate

FCFEin
mil$

25.0% 25.0% 25.0% 6.0%

$1.750 $2.188 $2.734 $3.418 $3.623

Theterminalvalueis$3,623/(0.160.06)=$36,230million.Thecalculatorinputs:CF0=0,CF1=$2,188,CF2=$2,734,CF3
=$3,418+$36,230=$39,648,I=16,NPV=$29.319million.
Persharepriceis$29,319,000/500,000=$58.64.Thestockappearstobeovervaluedatthecurrentmarketpriceof$62.50
pershare,asourestimatedvalueof$58.64suggeststhatthemarketpriceistoohigh.
(LOS36.m)

Question#44of145
Thedifferencebetweenfreecashflowtoequity(FCFE)andfreecashflowtothefirm(FCFF)is:

A) beforetaxinterestandnetborrowing.
B) earningsbeforeinterestandtaxes(EBIT)lesstaxes.
C) aftertaxinterestandnetborrowing.
Explanation

QuestionID:463174

FCFE=FCFF[interestexpense](1taxrate)+netborrowing.

Question#45of145

QuestionID:463222

Therepurchaseof20%ofafirm'soutstandingcommonshareswillcausefreecashflowtothefirm(FCFF)to:

A) decrease.
B) remainthesame.
C) increase.
Explanation
Sharerepurchasesareauseoffreecashflows,notasource.FCFFiscashflowthatisavailabletoallcapitalsuppliers.Noticethe
conspicuousabsenceofrepurchasesinthefollowing:FCFF=CFO+Int(1taxrate)FCInv.

Question#46of145

QuestionID:463230

Whichofthefollowingfreecashflowtothefirm(FCFF)modelsismostsuitedtoanalyzefirmsthataregrowingatafasterratethanthe
overalleconomy?

A) HighgrowthFCFFmodel.
B) NogrowthFCFFmodel.
C) TwostageFCFFmodel.
Explanation
ThetwostageFCFFmodelismostsuitedforanalyzingfirmsgrowingataratefasterthantheoveralleconomy.Thetwostagemodel
assumesahighrateofgrowthforaninitialperiod,followedbyanimmediatejumptoaconstant,stablegrowthrate.

Question#47of145

QuestionID:463258

ThevalueofstockunderthetwostageFCFEmodelwillbeequalto:
A) presentvalue(PV)ofFCFEduringtheextraordinarygrowthandtransitional
periodsplusthePVofterminalvalue.
B) presentvalue(PV)ofFCFEduringtheextraordinarygrowthperiodplustheterminal
value.
C) presentvalue(PV)ofFCFEduringtheextraordinarygrowthperiodplusthePVof
terminalvalue.
Explanation
ThevalueofstockunderthetwostageFCFEmodelwillbeequaltothepresentvalueofFCFEduringtheextraordinary
growthperiodplusthepresentvalueoftheterminalvalueattheendofthisperiod.

Question#48of145

QuestionID:463308

Afirmhas:
Freecashflowtoequity=$4.0million.
Costofequity=12%.
Longtermexpectedgrowthrate=5%.
Valueofequitypershare=$57.14pershare.
Whatwillhappentothevalueofthefirmiffreecashflowtoequitydecreasesto$3.2million?

A) Thereisinsufficientinformationtotell.
B) Thevaluewilldecrease.
C) Thevaluewillincrease.
Explanation
Everythingelsebeingconstant,adecreaseinfreecashflowtoequityshoulddecreasethevalueofthefirm.

Question#49of145

QuestionID:463236

Whichofthefollowingfreecashflowtoequity(FCFE)modelsismostsuitedtoanalyzefirmsinanindustrywithsignificantbarriersto
entry?

A) StableGrowthFCFEModel.
B) TwostageFCFEModel.
C) FCFEPerpetuityModel.
Explanation
ThetwostageFCFEmodelismostsuitedforanalyzingfirmsinhighgrowththatwillmaintainthatgrowthforaspecificperiod,suchas
firmswithpatentsorfirmsinanindustrywithsignificantbarrierstoentry.

Question#50of145

QuestionID:463193

WhichofthefollowingitemsisNOTsubtractedfromthenetincometocalculatefreecashflowtoequity(FCFE)?
A) increaseinaccountsreceivable.
B) Interestpaymentstobondholders.
C) Increaseinfixedassets.
Explanation
Interestpaymentstobondholdersareincludedintheincomestatementandarealreadysubtractedtocalculatenetincome.

Question#51of145

QuestionID:463200

Onapersharebasisforafirm:
Salesare$10.00.
Earningspershare(EPS)is$4.00.
Depreciationis$3.00.
Aftertaxinterestis$2.40.
Investmentinworkingcapitalis$1.50.
Investmentinfixedcapitalis$2.00.
Whatisthefirm'sexpectedfreecashflowtothefirm(FCFF)pershare?

A) $5.90.
B) $7.50.
C) $2.90.
Explanation
FCFF=EPS+netnoncashcharges+aftertaxinterestFCInvWCInv
FCFF=$4.00+3.00+$2.40$2.001.50=$5.90

Question#52of145

QuestionID:463277

Afirm'sfreecashflowtoequity(FCFE)inthemostrecentyearis$50Mandisexpectedtogrowat5%peryearforever.Ifits
shareholdersrequireareturnof12%,thevalueofthefirm'sequityusingthesinglestageFCFEmodelis:

A) $714M.
B) $417M.
C) $750M.
Explanation
Thevalueofthefirm'sequityis:$50M1.05/(0.120.05)=$750M

Question#53of145

QuestionID:463309

InthetwostageFCFEmodel,therequiredrateofreturnforcalculatingterminalvalueshouldbe:
A) lowerthantherequiredrateofreturnusedforthehighgrowthphase.
B) higherthantherequiredrateofreturnusedforthehighgrowthphase.
C) equaltotheaveragerequiredrateofreturnfortheindustry.
Explanation
Inmostcases,therequiredrateofreturnusedtocalculatetheterminalvalueshouldbelowerthantherequiredrateofreturn
usedforinitialhighgrowthphase.Duringthestableperiodthefirmislessriskyandtherequiredrateofreturnistherefore
lower.

Questions#5459of145
BeachwoodBuildersmergedwithCountryPointHomesinDecember31,1992.Bothcompanieswerebuildersofmidscale
andluxuryhomesintheirrespectivemarkets.In2004,becauseoftaxconsiderationsandtheneedtosegmentthebusinesses
betweenmidscaleandluxuryhomes,BeachwooddecidedtospinoffCountryPoint,itsluxuryhomesubsidiary,toitscommon
shareholders.BeachwoodretainedBernheimSecuritiestovaluethespinoffofCountryPointasofDecember31,2004.
Whenthebooksclosedon2004,Beachwoodhad$140millionindebtoutstandingduein2012atacouponrateof8%,a
spreadof2%abovethecurrentriskfreerate.Beachwoodalsohad5millioncommonsharesoutstanding.Itpaysno
dividends,hasnopreferredshareholders,andfacesataxrateof30%.Whenvaluingcommonstock,Bernhiem'svaluation
modelsutilizeamarketriskpremiumof11%.
ThecommonequityallocatedtoCountryPointforthespinoffwas$55.6millionasofDecember31,2004.Therewasnolong
termdebtallocatedfromBeachwood.
TheManagingDirectorinchargeofBernheim'sconstructiongroup,DenzelJohnson,ispreppingforthevaluationpresentation
forBeachwood'sboardwithCaraNguyen,oneofthefirm'sassociates.NguyentellsJohnsonthatBernheimestimated
CountryPoint'snetincomeat$10millionin2004,growing$5millionperyearthrough2008.BasedonNguyen'scalculations,
CountryPointwillbeworth$223.7millionin2008.NguyendecidedtouseacostofequityforCountryPointinthevaluation
equaltoitsreturnonequityattheendof2004(roundedtothenearestpercentagepoint).
NguyenalsogivesJohnsonthetablesheobtainedfromBeachwoodprojectingdepreciation(theonlynoncashcharge)and
capitalexpenditures:

$(inmillions)

2004 2005 2006 2007 2008

Depreciation

CapitalExpenditures

10

12

Lookingatthenumbers,JohnsontellsNguyen,"CountryPoint'sfreecashflow(FCF)willbe$25millionin2006."Nguyen
adds,"That'sFCFtotheFirm(FCFF).FCFtoEquity(FCFE)willbelower."

Question#54of145

QuestionID:463286

RegardingthestatementsbyJohnsonandNguyenaboutFCFin2006:
A) onlyNguyenisincorrect.
B) bothareincorrect.
C) onlyJohnsonisincorrect.
Explanation
ToestimateFCF,wecanconstructthefollowingtableusingthetablegivenandtheinformationaboutgrowthinnetincome:

$(inmillions)

2004 2005 2006 2007 2008

NetIncome

10

15

20

25

30

Plus:Depreciation

Less:CapitalExpenditures

10

12

FreeCashFlow

13

16

21

23

Theestimatedfreecashflowfor2006is$16million.Johnson'sstatementisincorrect.SincenoneofBeachwood'sdebtis
allocatedtoCountryPoint,allthefinancingisintheformofequity,soFCFFandFCFEareequal.Nguyen'sstatementisalso
incorrect.(StudySession12,LOS36.j)

Question#55of145

QuestionID:463287

IfFCInvequalsFixedCapitalInvestmentandWCInvequalsWorkingCapitalInvestment,whichstatementaboutFCFandits
componentsisleastaccurate?
A) WCInvisthechangeintheworkingcapitalaccounts,excludingcashand
shorttermborrowings.
B) FCFF=(EBITDA(1taxrate))+(Depreciationtaxrate)FCInvWCInv.
C) FCFE=(EBIT(1taxrate))+DepreciationFCInvWCInv.
Explanation
Thecorrectversionofthisequationis:
FCFF=(EBIT(1taxrate))+DepreciationFCInvWCInv(StudySession12,LOS36.j)

Question#56of145

QuestionID:463288

WhatisthecostofcapitalthatNguyenusedforhervaluationofCountryPoint?
A) 17%.
B) 15%.
C) 18%.
Explanation
SincethereisnodebtallocatedtoCountryPoint,thecostofcapitalwillequalthecostofequity.Nguyensaidthatsheuseda
costofequityequaltoCountryPoint'sReturnonEquity(ROE)atyearend,roundedtothenearestpercentagepoint.Since
thenetincomeattheendof2004was$10millionandtheallocatedcommonequitywas$55.6million,thereturnofequityis
(10million/55.6million)=18%.(StudySession18,LOS62.c)

Question#57of145

QuestionID:463289

GivenNguyen'sestimateofCountryPoint'sterminalvaluein2008,whatisthegrowthassumptionshemusthaveusedforfree
cashflowafter2008?
A) 3%.
B) 7%.
C) 9%.
Explanation
Weknowtheterminalvaluein2008is$223.7million.Wecancalculatethefreecashflowin2008tobe$23million(=$30
millionnetincome+$5milliondepreciation$12millioncapitalexpenditures).(Seethetableinquestion1).Thus,wecan
solvefortheestimatedgrowthrate:

Terminalvalue=[CF@2008(growthrate+1)]/(discountrategrowthrate)
223.7million=($23million(growthrate+1))/(0.18growthrate)
223.7million(0.18growthrate)=23million(growthrate+1)
40.266(223.7growthrate)=23million+(23growthrate)
17.266=246.7(growthrate)
growthrate=0.07
Nguyen'sgrowthrateassumptionis7%peryear.(StudySession12,LOS36.c)

Question#58of145

QuestionID:463290

ThevalueofbetaforCountryPointis:
A) 1.09.
B) 1.00.
C) 1.27.
Explanation
Theriskfreerateis(8%2%)=6%.Wearetoldthatthemarketriskpremiumis11%,andwecalculatedthecostofequity
(requiredreturn)tobe(10million/55.6million=)18%.Sinceweknowtheriskfreerate,themarketriskpremium,andthe
discountrate,wecanusethecapitalassetpricingmodeltosolveforbeta:

Requiredrateofreturn=0.18=0.06+(b0.11)
0.180.06=b0.11
0.12=b0.11
b=1.09
(StudySession12,LOS36.c)

Question#59of145

QuestionID:463291

WhatistheestimatedvalueofCountryPointinaproposedspinoff?
A) $162.6million.
B) $178.3million.
C) $144.5million.
Explanation
Usingthediscountedcashflowapproachonthelevelsofcashflowwecalculated(seethetableinquestion1):

Firmvalue=($13/1.181)+($16/1.182)+($21/1.183)+($23/1.184)+($223.7/1.184)
=$11.0+$11.5+$12.8+$11.9+$115.4
=$162.6million
(StudySession12,LOS36.c)

Question#60of145

QuestionID:463212

Thedifferencebetweenthevalueestimateproducedbythedividenddiscountmodel(DDM)andtheoneproducedbythefreecashflowto
equity(FCFE)modelcanbeaccountedforbywhichofthefollowing?

A) Differentsalesforecast.
B) Thevalueincontrollingthefirm'sdividendpolicy.
C) Differentestimatesofmodelrisk.
Explanation
ThedifferencebetweenthevalueestimateproducedbytheDDMandtheoneproducedbytheFCFEmodelcanbeinterpretedasthe
valueofcontrollingthefirm'sdividendpolicy.

Question#61of145

QuestionID:463256

Afirm'sfreecashflowtothefirm(FCFF)inthemostrecentyearis$80Mandisexpectedtogrowat3%peryearforever.Ifthefirmhas
$100Mindebtfinancinganditsweightedaveragecostofcapitalis10%.Thevalueofthefirm'sequityusingthesinglestageFCFFmodel
is:

A) $1,177M.
B) $1,043M.
C) $1,077M.
Explanation
Thevalueofthefirm'sequityisequaltothevalueofthefirmminusthevalueofthedebt.Firmvalue=$80M1.03/(0.100.03)=
$1,177M,soequityvalueis$1,177M$100M=$1,077M.

Question#62of145

QuestionID:463267

AnanalysthaspreparedthefollowingscenariosforSchneider,Inc.:
Scenario1Assumptions
TaxRateis40%.
Weightedaveragecostofcapital(WACC)=12%.
Constantgrowthrateinfreecashflow=3%.
Lastyear,freecashflowtothefirm(FCFF)=$30.
Targetdebtratio=10%.
Scenario2Assumptions
TaxRateis40%.
Expensesbeforeinterestandtaxes(EBIT),capitalexpenditures,anddepreciationwillgrowat15%forthenextthreeyears.
Afterthreeyears,thegrowthinEBITwillbe2%,andcapitalexpenditureanddepreciationwilloffseteachother.
Weightedaveragecostofcapital(WACC)duringhighgrowthstage=20%.

Weightedaveragecostofcapital(WACC)duringstablegrowthstage=12%.
Targetdebtratio=10%.
Year0
Scenario2FCFF

Year1

Year2

Year3

Year4

$15.00

$17.25

$19.84

$22.81

$23.27

CapitalExpenditures

6.00

6.90

7.94

9.13

Depreciation

4.00

4.60

5.29

6.08

ChangeinWorkingCapital

2.00

2.10

2.20

2.40

2.40

5.95

7.06

8.25

11.56

(lastyear)
EBIT

FCFF

GiventheassumptionscontainedinScenario2,whatisthevalueofthefirm?

A) $81.54.
B) $96.92.
C) $70.39.
Explanation
UsethetwostageFCFFmodeltovaluethefirm.TheTerminalValueofthefirmasofYear3=11.56/(0.120.02)=115.60.Thevalue=
5.95/(1.20)+7.06/(1.20)2+(8.25+115.62)/(1.20)3=81.54.

Question#63of145

QuestionID:463237

WhichofthefollowingstatementsregardingtheFCFFmodelsismostaccurate?ThetwostageFCFFmodelismoreusefulthanthe
stablegrowthFCFFmodelwhenthefirmisgrowingatarate:
A) significantlyhigherthanthatoftheoveralleconomy.
B) notsignificantlyhigherthanthatoftheoveralleconomy.
C) significantlylowerthanthatoftheoveralleconomy.
Explanation
ThetwostageFCFFmodelismoreusefulinvaluingafirmthatisgrowingataratesignificantlyhigherthantheoveralleconomy.Since
thiscannotpersistindefinitely,growthwilleventuallyslowtoastablegrowthrateconsistentwiththatoftheeconomy.

Questions#6469of145
ThefollowinginformationwascollectedfromthefinancialstatementsofHillerGmbH,aGermanconsultingcompany,fortheyearending
December31,2013:
Earningspershare=
4.50.
CapitalExpenditurespershare=
3.00.
Depreciationpershare=
2.75.
Increaseinworkingcapitalpershare=
0.75.

Debtfinancingratio=30.0%.
Costofequity=12.0%.
Costofdebt=6.0%.
Taxrate=30.0%.
Outstandingshares=100million.
Newdebtborrowing=
15.0million.
Debtrepayment=
30.0million.
Interestexpense=
7.1million.
Thefinancialleverageforthefirmisexpectedtobestable.HillerusesIFRSaccountingstandardsandrecordsinterestexpenseascash
flowfromfinancing(CFF).
TwoanalystsarevaluingHillerstockbotharebasingtheiranalysisonFCFEapproaches.
Analyst#1remarks:"Hillerisarelativelymaturecompanyaconstantgrowthmodelisthebetterapproach."
Analyst#1estimatesFCFEbasedontheinformationaboveandagrowthrateof5.0%.
Analyst#2states:"Hillerjustacquiredarivalthatshouldchangetheirgrowthpattern.Ithinkathreestagegrowthmodelbasedon
industrygrowthpatternsshouldbeused."
Analyst#2estimatesFCFEpershareas
3.85.Growthrateestimatesarelistedbelow,andfromyear7andthereaftertheestimated
growthrateis3.0%.

Year1

Year2

Year3

Year4

Year5

Year6

Year7+

Growthrates

12.5%

12.5%

12.5%

8.0%

6.5%

5.0%

3.0%

Question#64of145

QuestionID:463206

TheFCFEbasedonAnalyst#1'sestimatesforthebaseyearisclosestto:
A)
3.80.
B)
3.00.
C)
4.85.
Explanation
BaseyearFCFE=EPS(capitalexpendituresdepreciation)(1debtratio)increaseinworkingcapital(1debtratio)=
4.50
(
3.00
2.75)(10.30)
0.75(10.30)=
3.80.(LOS36.d)

Question#65of145

QuestionID:463207

UsingthestablegrowthFCFEmodelassuggestedbyAnalyst#1,thevalueofHillerstockisclosestto:
A) 51.58.
B) 54.29.
C) 57.00.
Explanation
Valuepershare=(3.801.05)/(0.120.05)=57.00.(LOS36.j)

Question#66of145

QuestionID:463208

BasedonAnalyst#2'sestimates,thesumoftheterminalvalueplustheFCFEforyear6isclosestto:
A)
82.40.
B)
60.70.
C)
75.80.
Explanation
EstimatesforthefutureFCFEbasedonsuppliedgrowthratesare:
Year

Growthrate

12.5%

12.5%

12.5%

8.0%

6.5%

5.0%

3.0%

FCFE/share

3.850

4.331

4.873

5.482

5.893

6.335

6.620

6.818

Terminalvalueyear6=6.818/(12.0%3.0%)=
75.76
Thenominalcashflowforyear6is
75.76+
6.62=
82.38,whichistheterminalcashflowplustheFCFEvaluefortheyear.(LOS36.e)

Question#67of145

QuestionID:463209

BasedonAnalyst#2'sestimates,thevalueofHillerstockisclosestto:
A)
59.70.
B)
57.00.
C)
60.70.
Explanation
Year

Growthrate
FCFE/share

3.850

12.5%

12.5%

12.5%

8.0%

6.5%

5.0%

3.0%

4.331

4.873

5.482

5.893

6.335

6.620

6.818

Terminalvalueyear6=6.818/(12.0%3.0%)=
75.76
ForthecalculatorfindNPV:CF0=0,CF1=
4.33,CF2=
4.87,CF3=
5.48,CF4=
5.89,CF5=
6.34,CF6=
82.38,I/Y=12.Theresultis
60.73.(LOS36.e)

Question#68of145

QuestionID:463210

TheappropriatediscountrateforvaluingHilleronafreecashflowbasisisclosestto:
A) 12.00%.
B) 6.54%.
C) 9.66%.
Explanation
Theappropriatediscountrateistheweightedaveragecostofcapital.Theformulais:WACC=wdrd(1taxrate)+were=(0.30)
(0.06)(10.30)+(0.70)(0.12)=0.0966or9.66%.(LOS36.j)

Question#69of145

QuestionID:463211

IfHiller'stotalfreecashflowtoequityis
380millionandthegrowthrateofthefirmis3.5%,thevalueofHiller(Firm)usingthestable

growthmodelisclosestto:
A)
6.7billion.
B)
8.9billion.
C)
4.8billion.
Explanation
FCFF=FCFENetborrowing+interestexpense(1taxrate).
FCFF=
380million+(7.1million(10.3))(
15million)=
399.7million.
Theweightedaveragecostofcapitalis:(0.30)(0.06)(10.30)+(0.70)(0.12)=0.0966or9.66%.
Thevalueofthefirmisthen:[
399.7million(1+0.035)]/(0.09660.035)=
6,720million.(LOS36.d)

Question#70of145

QuestionID:463266

Usingthestablegrowthfreecashflowtothefirm(FCFF)model,whatisthevalueofQualityBuildersundertheassumptionscontainedin
thetablebelow?
QualityBuilders
FreeCashFlowtotheFirm
Year0
EBIT

$500

Depreciation

$200

CapitalSpending

$300

WorkingCapitalAdditions
TaxRate
AssumedConstantGrowthRatein
FreeCashFlow
WeightedaverageCostofCapital

$30
40%
5%
11%

A) $2,975.00.
B) $2,833.33.
C) $6,475.00.
Explanation
ThestablegrowthFCFFmodelassumesthatFCFFgrowsataconstantrateforever.FCFFinYear0isequaltoEBIT(1taxrate)+
DepreciationCapitalSpendingWorkingCapitalAdditions=500(10.4)+20030030=170.TheFirmValue=FCFF1/(rgn)=
170(1.05)/(0.110.05)=$2,975.

Question#71of145

QuestionID:463257

IndustrialLightcurrentlyhas:
Freecashflowtoequity=$4.0million.
Costofequity=12%.
Weightedaveragecostofcapital=10%.
Totaldebt=$30.0million.
Longtermexpectedgrowthrate=5%.
Whatisthevalueofequity?

A) $57,142,857.
B) $60,000,000.
C) $27,142,857.
Explanation
Thevalueofequityis[($4,000,000)(1.05)/(0.120.05)]=$60,000,000.

Question#72of145

QuestionID:463173

WhenusingthetwostageFCFEmodel,ifincreasesinworkingcapitalappeartoohightheanalystshould:
A) switchtoathreestagemodel.
B) normalizethemtobeequaltozero.
C) usechangesthatarebaseduponaworkingcapitalratiothatisclosertotheindustryaverage.
Explanation
Thebestsolutionistousechangesthatarebaseduponaworkingcapitalratiothatapproximatestheindustryaverage.Theproblemwill
notbeeliminatedbyswitchingtoathreestageFCFEmodel.

Question#73of145

QuestionID:463204

Acommonapproachtoforecastingfreecashflowsisto:
A) calculatehistoricalfreecashflowandapplyanexpectedgrowthrate.
B) projectearningsbeforeinterestandtaxes(EBIT)andexpectedcapitalexpenditures.
C) projectnetincomeandexpectedcapitalexpenditures.
Explanation
Historicalfreecashflowsareoftenusedforforecasting.

Questions#7479of145
StarshahIndustriescompetesinahighgrowth,emergingtechnologysectorthatisfacingincreasingcompetitivepressures.Sofar,the

firmhasbeenperformingwell,earning$4.55persharein2004.Investmentrequirementswerehigh,withcapitalexpendituresof$1.75per
share,depreciationexpenseof$1.05,andanetinvestmentinworkingcapitalthatyearof$1.00pershare.However,despiteStarshah's
highgrowthrateandimpressiveprofitability,Starshah'sChairman,LorenzodiStefano,hasbecomeconcernedabouttheimpactthata
slowdowninexpectedgrowthmayhaveonthefirm'svaluation.
DiStefanoaskedStarshah'sDirectorofStrategicPlanning,KeishaSimmons,tomakeapresentationtoStarshah'sboardattheendof
2004aboutthefuturegrowthofthefirm.Thenewswassobering.SimmonstoldtheboardmembersthatStarshahcouldexpecttwomore
yearsofrapidgrowth,duringwhichtimeearningspersharecouldbeexpectedtorise45%peryearwith30%annualincreasesincapital
spendinganddepreciation.Duringthishighgrowthperiod,SimmonsestimatesthattherequiredreturnonequityforStarshahwillbe25%.
Starshahconsistentlymaintainsatargetdebtratioof0.25.
Aftertheneartermspurtofhighgrowth,however,sheandhergroupexpectStarshahtomoveeventuallytoastablegrowthperiod.During
thestablegrowthperiod,freecashflowtoequity(FCFE)willriseonly5%peryearandtheannualreturntoshareholderswilldeclineto
10%.
Thestrategygroupexpectsthetransitionalperiodbetweenhighgrowthandmaturegrowthtolastfiveyears.Duringthattime,capital
expenditureswillriseonly8%peryear,withdepreciationrising13%peryear.Thegrowthinearningsshoulddropbyeightpercentage
pointsperyear,hitting5%inthefifthyear.Duringthistransition,theexpectedreturntoshareholderswillbe15%peryear.
Throughoutthehighgrowthandtransitionalgrowthperiods,SimmonsexpectsStarshahtobeabletolimitincreasesintheinvestmentin
workingcapitalto20centsperyear.Inheranalysis,theinvestmentinworkingcapitalwillpeakin2010,decliningadimeto$2.10per
sharein2011.
AfterSimmons'presentation,theboarddebatedwhattodoabouttheincipientslowdowninStarshah'sgrowth.Amajorityoftheboard
arguedinfavorofmovingtooffsetthisslowdowninorganicgrowththroughanewemphasisongrowthbyacquisition.
OnepotentialtargetisTPX.TPX'scurrentandexpectedFCFE:$425,000in2004,$500,000in2005,$600,000thefollowingyear,and
$700,000in2007.Afterthat,StarshahexpectsFCFEatTPXtogrow3%peryearindefinitely.Starshahwouldrequireareturnonits
equityinvestmentof20%peryearinthehighgrowthstageand12%peryearinthestablegrowthstage.
DiStefanoandSimmonshadasombermeetingthedayaftertheboardpresentation.Butdespitethebleaknewsaboutfutureyears,di
Stefanohadconvincedhimselfitwasworthstayingaroundthroughthehighgrowthandtransitionalperiods.HepointedouttoSimmons
that,ifSimmons'projectionswerecorrect,thevalueofStarshah'sstockwouldbeinexcessof$450persharebythetimethecompany
hitthestablegrowthphase.DiStefanowasverypleasedwithwhatthatimpliedforthevalueofhisstockoptions.
Simmonshaddonethesamecalculationsherself,butshealsorealizedthatifrequiredratesofreturnin2012rosefromtheverymodest
10%sheusedinherboardprojectionstoonly15%,thatwouldcuttheterminalvalueofStarshah'sstockin2011toonlyhalftheleveldi
Stefanowascountingon.Sheconsideredthatvaluationtoosmalltomakethewaitworthwhile.SimmonssaidnothingtodiStefano,but
plannedtolookforanotherjob.

Question#74of145

QuestionID:463269

WhichofthefollowingFCFEmodelsisbestsuitedtoanalyzingTPX?
A) TwostageFCFEmodel.
B) StablegrowthFCFEmodel.
C) ThreestageFCFEmodel.
Explanation
ThetwostageFCFEmodelismostsuitedtoanalyzingTPXbecausewehavespecificforecastsforthefirstseveralyearsandthena
stablegrowthpatternintotheindefinitefuture.(StudySession12,LOS36.i)

Question#75of145

QuestionID:463270

TheFCFEforStarshahattheendofthetransitionperiodin2011isclosestto:
A) $21.89.
B) $20.62.
C) $23.42.
Explanation
InordertocalculateFCFEforStarshahin2011,weneedtoconstructatableofthecomponentsofcashflowforStarshah.
Wearegiventhe2004valuesfornetincome,capitalexpenditures,depreciation,andchangeinworkingcapital.Wearealsogivengrowth
ratesforeachofthethreestagesofStarshah'sgrowth:highgrowthfortwoyearsfollowedbytransitionalgrowthforfiveyears,culminating
instablegrowthforthefollowingyears.Usingtheoriginalvaluesandtheirrelatedgrowthrates,plustheformulaforFCFE(seebelow),we
canconstructthefollowingtable:
2004

2005

2006

2007

2008

2009

2010

2011

EPS

4.55

6.60

9.57

13.11

16.91

20.46

23.12

24.27

Capitalexpenditures

1.75

2.28

2.96

3.19

3.45

3.73

4.02

4.35

Depreciation

1.05

1.37

1.77

2.01

2.27

2.56

2.89

3.27

Changeinworkingcapital

1.00

1.20

1.40

1.60

1.80

2.00

2.20

2.10

FCFE

3.28

5.02

7.63

11.01

14.67

18.08

20.62

21.89

FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)(Changeinworkingcapital(1DebtRatio))=
24.27(4.353.27)(10.25)(2.10(10.25))
=24.270.811.57=21.89
FCFE=$21.89persharein2011.
(StudySession12,LOS36.j)

Question#76of145

QuestionID:463271

RegardingdiStefano'sandSimmons'statementsabouttheterminalvalueofStarshahstockin2011:
A) botharecorrect.
B) onlySimmonsiscorrect.
C) onlydiStefanoiscorrect.
Explanation
Starshahhitsthestablegrowthphasein2012.Atthatpoint,
TerminalFirmValue2011=(FCFEinyear2012)/(requiredrateofreturn&8722growthrate)
=$21.89(1.05)/(0.100.05)=$22.98pershare/0.05
=$460pershare.DiStefano'sstatementiscorrect.
TerminalFirmValue2011=(FCFEinyear2012)/(requiredrateofreturn&8722growthrate)=$21.89(1.05)/(0.150.05)
=$22.98pershare/0.10=$230pershare.Simmons'statementisalsocorrect.
(StudySession12,LOS36.j)

Question#77of145

QuestionID:463272

AssumingSimmonsisrightthattherequiredreturnonStarshahequityrisesto15%in2012andbeyond,whatisthevalueofStarshah

stockattheendof2004?
A) $63.71.
B) $117.49.
C) $111.35.
Explanation
Inordertocalculatethefirmvalue,weneedtoknowthediscountratethatappliesovereachperiod.Sincethediscountratechanges,we
cansimplifythearithmeticbyconstructingatableofdiscountfactorsusing25%foreachofthefirsttwoyearsand15%foreachofthe
followingfiveyears:

Discountfactor

2005

2006

2007

2008

2009

2010

2011

1.25

1.56

1.80

2.07

2.38

2.73

3.14

Wecanthencalculatefirmvaluein2004usingtheFCFEvalueswecalculatedinquestion1andthestockvalueintheyear2012(thatwe
calculatedinquestion3).
Starshahequityvaluein2004=(5.02/1.25)+(7.63/1.56)+(11.01/1.80)+(14.67/2.07)+(18.08/2.38)+(20.62/2.73)+(21.89/
3.14)+(230/3.14)
=4.02+4.89+6.12+7.09+7.60+7.55+6.97+73.25
=117.49
ThevalueofStarshahstockattheendof2004is$117.49pershare.(StudySession12,LOS36.j)

Question#78of145

QuestionID:463273

WhatisthemaximumamountthatStarshahwouldbewillingtopayforTPX(inmillions)?
A) $5.102.
B) $5.874.
C) $6.941.
Explanation
FirmValue=[500/(1.20)1]+[600/(1.20)2]+[700/(1.20)3]+[(700)(1.03)/(0.12&87220.03)/(1.20)3]=$5,874.
ThemostthatStarshahcouldpayforTPXandstillmeetitsrequiredreturntargetsis$5.874million.(StudySession12,LOS39.j)

Question#79of145

QuestionID:463274

WhichofthefollowingFCFEmodelsisbestsuitedtoanalyzingStarshahIndustries?
A) ThreestageFCFEmodel.
B) TwostageFCFEmodel.
C) StablegrowthFCFEmodel.
Explanation
ThethreestageFCFEmodelismostsuitedtoanalyzefirmsinhighgrowthindustriesthatwillfaceincreasingcompetitivepressuresover
time,sincethosecompetitivepressureswillleadtoagradualdeclineinthefirm'sgrowthrate(secondstage)toastablelevel(third

stage).(StudySession12,LOS36.i)

Question#80of145

QuestionID:463219

Currently,afirmhasnooutstandingdebt.Ifthefirmwouldaddasmallamountofleveragetoitsbalancesheet,whatshouldbethe
impactonthefirm'svalue?Therewouldbe:
A) nochangeinfirmvalue.
B) adecreaseinvalueduetohigherinterestexpense.
C) anincreaseinvalueduetointeresttaxshields.
Explanation
Theamountoffinancialleverageusedbyafirmwillaffectitsvalue.Forsmallamountsofleverage,theadditionalbankruptcyriskwillbe
low,andwillbemorethanoffsetbytheadditionalvalueofinteresttaxshields.

Question#81of145

QuestionID:463201

Inforecastingfreecashflowsitiscommontoassumethat:
A) thefirmhasnononcashexpenses.
B) historicalandfuturefreecashflowwillbethesame.
C) thefirmadherestoatargetcapitalstructure.
Explanation
Atargetdebtratioisusuallyassumedtoremainconstant.Historicalcashflowsareoftenprojectedforwardwithagrowthrate.

Question#82of145

QuestionID:463312

Terminalvalueinamultistagefreecashflowtoequity(FCFE)valuationmodelisoftencalculatedasthepresentvalueof:
A) FCFEdividedbythetotalofrequiredrateonequityminusgrowth.
B) freecashflowdividedbythegrowthrate.
C) atwostagevaluationmodel'sprice.
Explanation
Terminalvaluesareusuallycalculatedasthepresentvalueofthepriceproducedbyaconstantgrowthmodelasofthebeginningofthe
laststage,whichisFCFE/(requiredrateonequitygrowth).

Question#83of145

QuestionID:463231

Whichofthefollowingtypesofcompaniesisthetwostagefreecashflowtoequity(FCFE)modelbestsuitedfor?Companies:

A) inhighgrowthindustriesthatwillfaceincreasingcompetitivepressuresovertime,
leadingtoagradualdeclineingrowthtoastablelevel.
B) growingataratesimilartoorlessthanthenominalgrowthrateoftheeconomy.
C) withpatentsorfirmsinanindustrywithsignificantbarrierstoentry.
Explanation
Thetwostagemodelisbestsuitedtoanalyzingfirmsinahighgrowthphasethatwillmaintainthatgrowthforaspecificperiod,suchas
firmswithpatentsorfirmsinanindustrywithsignificantbarrierstoentry.Companiesgrowingataratesimilartoorlessthanthenominal
growthrateoftheeconomyarebestsuitedforthesinglestageFCFEModel.Companiesinhighgrowthindustriescorrespondtothethree
StageFCFEModel.

Question#84of145

QuestionID:463187

Theownershipperspectiveimplicitinthedividendvaluationapproachisof:
A) apreferredstockholder.
B) acommonstockholder.
C) control.
Explanation
Dividendsaremostrelevanttothestockholderswhoreceivethemandwhohavelittlecontrolovertheiramount.

Question#85of145

QuestionID:463176

WhatisthemostlikelyreasonthatyougetanextremelylowvaluefromthethreestageFCFEmodel?Capitalexpendituresare
significantly:
A) higherthandepreciationduringthehighgrowthphase.
B) higherthandepreciationinthestablegrowthphase.
C) lessthandepreciationduringthehighgrowthphase.
Explanation
Ifcapitalexpendituresestimatesaresignificantlyhigherthandepreciationforthestablegrowthperiod,thenthethreestageFCFEmodel
mightresultinanextremelylowvalue.Onepossiblesolutionfortheproblemistogrowthecapitalexpendituresmoreslowlythan
deprecationinthetransitionperiodtonarrowthedifference.Anotheristoassumethatcapitalexpendituresanddepreciationwilloffset
whengrowthnormalizes.

Question#86of145
Freecashflowtothefirmisequaltocashflowfromoperationsminusfixedcapitalinvestment:
A) minusaftertaxinterestexpense.
B) minuspretaxinterestexpense.

QuestionID:463192

C) plusaftertaxinterestexpense.
Explanation
Freecashflowtothefirmisequaltocashflowfromoperationsminusfixedcapitalinvestmentplusaftertaxinterestexpense.

Question#87of145

QuestionID:463242

WhichofthefollowingtypesofcompanyistheEModel,athreestagefreecashflowtoequity(FCFE)Model,bestsuitedfor?
Companies:

A) growingataratesimilartoorlessthanthenominalgrowthrateoftheeconomy.
B) inhighgrowthindustriesthatwillfaceincreasingcompetitivepressuresovertime,leadingtoa
gradualdeclineingrowthtoastablelevel.
C) withpatentsorfirmsinanindustrywithsignificantbarrierstoentry.
Explanation
ThethreestageFCFEmodel,orEModel,ismostsuitedtoanalyzingfirmscurrentlyexperiencinghighgrowththatwillfaceincreasing
competitivepressuresovertime,leadingtoagradualdeclineingrowthtoastablelevel.Thetwostagemodelisbestsuitedtoanalyzing
firmsinahighgrowthphasethatwillmaintainthatgrowthforaspecificperiod,suchasfirmswithpatentsorfirmsinanindustrywith
significantbarrierstoentry.Companiesgrowingataratesimilartoorlessthanthenominalgrowthrateoftheeconomyarebestsuitedfor
theStableGrowthFCFEModel.Afirmthatpaysoutallofitsearningsasdividendswillhaveagrowthrateofzero(rememberg=RR
ROE)andwouldnotbevaluedusingthethreestageFCFEmodel.

Question#88of145

QuestionID:463167

Freecashflowtothefirmvaluationuseswhichdiscountrate?
A) Aftertaxcostofdebt.
B) Costofequity.
C) Weightedaveragecostofcapital.
Explanation
Freecashflowtothefirmvaluationusestheopportunitycostrelevanttotheoverallfirm,whichistheweightedaveragecostofcapital.

Question#89of145

QuestionID:463203

ThefollowingtableprovidesbackgroundinformationonapersharebasisforTOYInc.intheyear0:
CurrentInformation:

Year0

Earnings

$5.00

CapitalExpenditures

$2.40

Depreciation

$1.80

ChangeinWorkingCapital

$1.70

TOYInc.'stargetdebtratiois30%andhasarequiredrateofreturnof12%.Earnings,capitalexpenditures,depreciation,andworking
capitalareallexpectedtogrowby5%ayearinthefuture.Assumethatcapitalexpendituresandworkingcapitalarefinancedatthetarget
debtratio.
Inyear0,whatisthefreecashflowtoequity(FCFE)forTOYInc.?

A) $4.31.
B) $3.39.
C) $2.70.
Explanation
Year0FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)Changeinworkingcapital(1DebtRatio)=
5.00(2.401.80)(10.3)(1.7)(10.3)=3.39.

Question#90of145

QuestionID:463235

Thestablegrowthfreecashflowtoequity(FCFE)modelisbestsuitedforwhichofthefollowingtypesofcompanies?Companies:

A) growingataratesimilarorlessthanthenominalgrowthrateoftheeconomy.
B) withsignificantbarrierstoentry.
C) withpatentsthatwillnotexpirefor20ormoreyears.
Explanation
CompaniesgrowingataratesimilartoorlessthanthenominalgrowthrateoftheeconomyarebestsuitedfortheStableGrowthFCFE
Model.ThethreestageFCFEmodelismostsuitedtoanalyzingfirmscurrentlyexperiencinghighgrowththatwillfaceincreasing
competitivepressuresovertime,leadingtoagradualdeclineingrowthtoastablelevel.Thetwostagemodelisbestsuitedtoanalyzing
firmsinahighgrowthphasethatwillmaintainthatgrowthforaspecificperiod,suchasfirmswithpatentsorfirmsinanindustrywith
significantbarrierstoentry.

Question#91of145

QuestionID:463218

Optimalcapitalstructureisthemixofdebtandequitythatwillmaximizethevalueofthefirmandminimize:
A) weightedaveragecostofcapital(WACC).
B) weightedaveragecostofequity.
C) interestexpense.
Explanation
TheoptimalcapitalstructureisthemixofdebtandequitythatwillmaximizethevalueofthefirmandminimizetheWACC.

Question#92of145

QuestionID:463166

InthestablegrowthFCFEmodel,anextremelylowvaluecanresultfromallofthefollowingEXCEPT:
A) therequiredrateofreturnistoohighforastablefirm.
B) theexpectedgrowthrateistoohighforastablefirm.
C) capitalexpendituresaretoohighrelativetodepreciation.
Explanation
Iftheexpectedgrowthrateistoohighforastablefirm,thevalueobtainedusingthestablegrowthFCFEmodelwillbeextremelyhigh.

Question#93of145

QuestionID:463195

ThefollowinginformationpertainstotheHarrisburgTireCompany(HTC)in2000.
Earnings(netincome)=$600M.
Dividends=$120M.
Interestexpense=$400M.
Taxrate=40%.
Depreciation=$500M.
Capitalspending=$800M.
Totalassets=$10B(bookvalueandmarketvalue).
Debt=$4B(bookvalueandmarketvalue).
Equity=$6B(bookvalueandmarketvalue).
Thefirm'sworkingcapitalneedsarenegligible,andtheyplantocontinuetooperateattheircurrentcapitalstructure.
Thefreecashflowtothefirmis:

A) $540M.
B) $300M.
C) $420M.
Explanation
Thefreecashflowtothefirmis:
FCFF=Netincome+(Interestexpense)(1T)Capitalexpenditures+Depreciation
600M+400M(10.40)800M+500M=540M

Question#94of145

QuestionID:463168

MarkWashington,CFA,usesatwostagefreecashflowtoequity(FCFE)discountmodeltovalueTexasVanLines.Hisanalysisyields
anextremelylowvalue,whichhebelievesisincorrect.Whichofthefollowingisleastlikelytobeacauseofthissuspectvaluation
estimate?
A) Thecostofequityestimateinthestablegrowthperiodistoohighforastablefirm.

B) Earningsaretemporarilydepressedbecauseofaonetimeextraordinaryaccountingchargein
themostrecentfiscalyear.
C) Theforecastofworkingcapitalasapercentageofrevenuesinthestablegrowthperiodisnot
largeenoughtomaintainthelongtermsustainablegrowthrate.
Explanation
Thelargertheestimateofworkingcapitalasapercentageofrevenues,thelargertheinvestmentinnetworkingcapital,andthelowerthe
FCFEinthestableperiod.AlowstableperiodFCFEestimatewillresultinalowestimateofvaluetoday.Thesolutionistouseaworking
capitalratioclosertothelongrunindustryaverage.
Ifthecostofequityestimateinthestablegrowthperiodistoohigh,theterminalvaluewillbetoolow.Becausetheterminalvalue
typicallymakesupalargeportionofthecurrentvalue,thiswillcausethecurrentvalueestimatetobetoolow.Thesolutionistousea
costofequityestimatebasedonabetaofone.
Ifearningsaretemporarilydepressed,alltheFCFEestimateswillbelow,andthecurrentvalueestimatewillbelow.Thesolutionistouse
anestimateoflongrunnormalizedearnings.

Question#95of145

QuestionID:463194

Afirmcurrentlyhasthefollowingpersharevalues:
Cashflowfromoperations(CFO)is$49.50.
Investmentinfixedcapitalis$40.00.
Netborrowingis$7.50.
Whatisthecurrentpersharefreecashflowtoequity(FCFE)?

A) $97.00.
B) $16.50.
C) $17.00.
Explanation
FCFE=CFOFCInv+netborrowing=$49.50$40.00+$7.50=$17.00

Question#96of145

QuestionID:463213

TheprimarydifferencebetweenthethreestageDDMandtheFCFEmodelis:
A) growthrateassumptions.
B) costofequity.
C) thedefinitionofcashflows.
Explanation
Theprimarydifferencebetweenthedividenddiscountmodelsandthefreecashflowfromequitymodelsliesinthedefinitionofcash
flows.TheFCFEmodelusesresidualcashflowsaftermeetingallfinancialobligationsandinvestmentneeds.TheDDMusesastrict
definitionofcashflowstoequity,thatis,theexpecteddividendsonthestock.

Question#97of145

QuestionID:463171

Freecashflow(FCF)approachesarethebestsourceofvaluewhen:
A) afirmhaspreferredstock.
B) afirmispayingadividendthatishigherthantheindustryaverage.
C) FCFstrackprofitabilitycloselyovertheanalyst'sforecasthorizon.
Explanation
FCFapproachesarebestwhenthoseflowsareagoodindicationofafirm'sprofitabilityovertheanalyst'sforecasthorizon.

Question#98of145

QuestionID:463172

Freecashflowapproachesarethebestsourceofvaluewhen:
A) dividendsarenotpaid.
B) afirmhassignificantminorityinterest.
C) returnonassetsisfalling.
Explanation
Freecashflowapproachesarebestwhendividendsarenotpaid.Bothremainingresponseshavenothingtodowiththedecision.

Question#99of145

QuestionID:463169

IfafirmisvaluedusingFCFF,therelevantdiscountrateisthe:
A) aftertaxweightedaveragecostofcapital.
B) beforetaxweightedaveragecostofcapital.
C) beforetaxcostofequity.
Explanation
SincetheFCFFisthecashavailabletoalltheinvestors,theaftertaxweightedaveragecostofcapitalshouldbeusedasthediscount
rateinFCFFmodels.

Question#100of145

QuestionID:463196

Usingtheinformationbelow,valuethestockofSymphonyPublishing,Inc.usingthefreecashflowfromequity(FCFE)valuationmethod.
Requiredreturnof13.0%.
Valueattheendofyear3of13timesFCFE3.
Sharesoutstanding:10.0million.

Netincomeinyear1of$10.0million,projectedtogrowat10%forthenexttwoyears.
Depreciationperyearof$3.0million.
CapitalExpendituresperyearof$2.5million.
Increaseinworkingcapitalperyearof$1.0million.
Principalrepaymentsondebtperyearof$1.5million.
ThevaluepershareofSymphonyPublishingisapproximately:

A) $11.21.
B) $112.10.
C) $14.10.
Explanation
Step1:Calculateeachyear'sFCFEanddiscountattherequiredreturn.
FCFE=netincome+depreciationcapitalexpendituresincreaseinworkingcapitalprincipalrepayments+newdebtissues
Year1:10.0+3.02.51.01.5=8.0,
PV=7.08=8.0/(1.13)1,orFV=8.0,I=13,PMT=0,N=1,ComputePV
Year2:10.01.10+3.02.51.01.5=9.0,
PV=7.05=9.0/(1.13)2,orFV=9.0,I=13,PMT=0,N=2,ComputePV
Year3:10.0(1.10)2+3.02.51.01.5=10.10
PV=7.00=10.10/(1.13)3,orFV=10.10,I=13,PMT=0,N=3,ComputePV
Step2:CalculatePresentValueoffinalcashflowtimesFCFEmultiple.
Valueatendofyear3=FCFE3multiple=10.1013=131.30
PV=91.00=131.30/(1.13)3,orusingcalculator,N=3,FV=131.30,I=13,PMT=0,ComputePV
Step3:Calculatepersharevalue.
AddupPVofFCFEandendvalueanddividebynumberofsharesoutstanding
=(7.08+7.05+7.00+91.0)/10.0=11.21

Question#101of145

QuestionID:463233

Abiotechfirmiscurrentlyexperiencinghighgrowthandpaysnodividends.Oneoftheirproductpatentsisscheduledtoexpirein5years.
Thisfirmwouldbeagoodcandidateforwhichofthefollowingvaluationmodels?
A) Twostagedividenddiscountmodel(DDM).
B) Twostagefreecashflowtoequity(FCFE).
C) Singlestagefreecashflowtoequity(FCFE).
Explanation

ThetwostageFCFEmodeliswellsuitedtovalueafirmthatiscurrentlyexperiencinghighgrowthandwilllikelyseethisgrowthdroptoa
lower,morestablerateinthefuture.

Question#102of145

QuestionID:463254

BOX,Inc.,earned$4.55persharelastyear.Thefirmhadcapitalexpendituresof$1.75pershareanddepreciationexpenseof$1.05.
BOX,Inc.,hasatargetdebtratioof0.25.
HighGrowth

Period

Duration

TransitionalPeriod

StableGrowthPeriod

5Years

2Years

Willdecline8%peryear
to
Earningsgrowthrate

45%

5%

5%inthestablegrowth
period

GrowthinCapital

30%

Expenditures

GrowthinDepreciation

ChangeinWorking
Capital

Increasesby8%per

Same$amountas

year

Depreciation

Increasesby13%per

30%

year

GivenBelow

GivenBelow

25%

15%

ShareholderRequired
Return

Capital
Expenditures
$2.25pershareinYear
8
10%

Yr0

Yr1

Yr2

Earningspershare(EPS)

4.55

6.60

9.57

13.11 16.91 20.46 23.12 24.27

CapitalExpenditures

1.75

2.28

2.96

3.19

3.45

3.73

4.02

4.35

Depreciation

1.05

1.37

1.77

2.01

2.27

2.56

2.89

3.27

0.90

1.10

1.40

1.60

1.80

2.00

2.20

2.10

7.63

11.01 14.67 18.08 20.62 21.89

Changeinworkingcapital
(WC)
Freecashflowtoequity
(FCFE)

Yr3

Same$amountas

Yr4

Yr5

Yr6

Yr7

WhatisthepresentvalueofBOX,Inc.?

A) $195.71.
B) $212.91.
C) $223.65.
Explanation
Year1FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)(Changeinworkingcapital)(1DebtRatio)
=6.60(2.281.37)(10.25)(1.1)(10.25)=5.09.

Year8FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)(Changeinworkingcapital)(1DebtRatio)
=24.271.050(2.25)(10.25)=23.79.
TheTerminalValue(asofYear7)=23.79/(0.100.05)=475.80.
ThevalueofBOX,Inc.,stockwouldbeequalto:5.09/1.25+7.63/1.252+11.01/[(1.25)2(1.15)1]+14.67/[(1.25)2(1.15)2]+18.08/
[(1.25)2(1.15)3]+20.62/[(1.25)2(1.15)4]+21.89/[(1.25)2(1.15)5]+475.80/[(1.25)2(1.15)5]=
4.07+4.88+6.13+7.10+7.61+7.55+6.97+151.40=195.71

Question#103of145

QuestionID:463216

Dividendspaidouttotheshareholders:
A) arealwayslessthanfreecashflowtoequity(FCFE).
B) maybehigherthanfreecashflowtoequityFCFE.
C) arealwaysequaltofreecashflowtoequity(FCFE).
Explanation
Dividendsrepresentthecashthatthefirmchoosestopaytotheshareholdersandtheamountofthedividendissubjecttothediscretion
ofthefirm.Dividendscanbeequalto,lowerorhigherthanFCFE.Forexample,sometimesfirmsmaypaydividendsinyearswhenthere
isanetloss.

Question#104of145

QuestionID:463177

Freecashflow(FCF)approachesarethebestsourceofvaluewhen:
A) afirmhasnopreferredstock.
B) dividendsarepaidbutdonotreflectthecompany'scapacitytopaydividends.
C) afirmhassignificantminorityinterest.
Explanation
FCFapproachesarebestwhendividendsarepaidbutdonotappeartoberepresentativeofthefirm'scapacitytopaythem.Both
remainingresponseshavenothingtodowiththedecision.

Questions#105110of145
TOY,Inc.isacompanythatmanufacturesdolls,games,andotheritemstoentertainchildren.
ThefollowingtableprovidesbackgroundinformationforTOY,Inc.onapersharebasisintheyear0:
CurrentInformation

Year0

Earnings

$5.00

CapitalExpenditures

$2.40

Depreciation

$1.80

ChangeinWorkingCapital

$1.70

Costofequity

12.0%

Targetdebtratio

30.0%

Marketvalueofstock

$56.00

Sharesoutstanding

5.0million

Interestexpense

$7.2million

Cash&shortterm
investments
Taxrate

$40.0million
37.5%

Earnings,capitalexpenditures,depreciation,andworkingcapitalareallexpectedtogrowby5.0%peryearinthefuture.

Question#105of145

QuestionID:463314

Inyear1,theforecastedfreecashflowtoequity(FCFE)forTOY,Inc.isclosestto:
A) $3.56.
B) $4.53.
C) $4.31.
Explanation
FCFEyear0=Earningspershare[(CapitalExpendituresDepreciation)(1DebtRatio)][(Changeinworkingcapital)(1Debt
Ratio)]=5.00[(2.401.80)(10.30)][(1.70)(10.30)]=3.39.
FCFEforyear1=FCFEyear0(1+growthrate)=3.39(1.05)=$3.56.
(LOS36.d)

Question#106of145

QuestionID:463315

ThevalueofTOY,Inc.'sstockgiventheaboveassumptions,isclosestto:
A) $50.86.
B) $64.71.
C) $61.57.
Explanation
Thevalueofthestock=FCFE1/(rgn)=3.56/(0.120.05)=50.86.
(LOS36.j)

Question#107of145

QuestionID:463316

ComparingthecurrentmarketvalueofTOYtoourestimateofthestock'scurrentmarketvalue,itismostlikelythatatthecurrentmarket
priceof$56.00,TOYInc.stockis:

A) fairlyvalued.
B) undervalued.
C) overvalued.

Explanation
Ourcalculatedvalueofthestock=FCFE1/(rgn)=3.56/(0.120.05)=$50.86.Thecurrentmarketpriceis$56.00,becausethe
marketpriceisgreaterthantheestimatedprice,thestockisovervaluedinthemarket.
(LOS36.m)

Question#108of145

QuestionID:463317

SeniormanagementofTOYInc.isconsideringsellingthecompanytoarivalfirmthathasoffered$450million.Ifthecurrentmarketprice
representsthefairvalueofequityandTOYInc.maintainsitstargetcapitalstructure,thebidrepresentsapricethatis:

A) greaterthanthetotalvalueofthefirm.
B) lessthanthetotalvalueofthefirm.
C) aboutthesametotalvalueofthefirm.
Explanation
Thetotalvalueofafirmisthetotalmarketvalueofequityplusthetotalmarketvalueofdebt.Thetotalvalueofequityis$56.00per
share5,000,000shares=$280million.Equityrepresents70.0%ofthecapitalstructure.Thetotalvalueofthefirmisthus$280
million/0.70=$400million.Anofferof$450millionisapremiumof$50millionapricegreaterthanthecurrentvalueofthefirm.
(LOS36.m)

Question#109of145

QuestionID:463318

TheEV/EBITDAratioforTOYInc.isclosestto:

A) 6.4x.
B) 4.3x
C) 7.1x
Explanation
Thetotalvalueofthefirmisthetotalmarketvalueofequityplusthetotalmarketvalueofdebt.Thetotalvalueofequityis$56.00per
share5,000,000shares=$280.0million.Equityrepresents70.0%ofthecapitalstructure.Thetotalvalueofthefirmis$280.0
million/0.70=$400.0million.Theenterprisevalueisthetotalvalueofthefirmminusthecashandshortterminvestments
$400.0million$40.0million=$360.0million.
Earningsbeforetaxes=$25.0million/(10.375)=$40.0million
EBITDA=$40.0million+$7.2million+$1.805.0millionshares=$56.2million.
EV/EBITDA=$360.0/$56.2=6.4x
(LOS37.n)

Question#110of145

QuestionID:463319

Oneyearlatertheenterprisevalueincreasedby5.0%whiletheEBITDAis$59.0million.IftheEV/EBITDAfortheindustryis7.0,
relativetoitspeers,TOYismostlikely:

A) undervalued.
B) overvalued.

C) fairlyvalued.
Explanation
Thetotalvalueofthefirmisthetotalmarketvalueofequityplusthetotalmarketvalueofdebt.Thetotalvalueofequityis$56.00per
share5,000,000shares=$280.0million.Equityrepresents70.0%ofthecapitalstructure.Thetotalvalueofthefirmis$280.0
million/0.70=$400.0million.Theenterprisevalueforyear0isthetotalvalueofthefirmminusthecashandshortterminvestments
$400.0million$40.0million=$360.0million.Enterprisevalueoneyearlateris$360million(1.05)=$378.0million.
EV/EBITDA=$378.0/$59.0=6.4x.TheEV/EBITDAratioofTOYislessthantheindustryratio.TOYisundervaluedinthemarket.
(LOS37.r)

Question#111of145

QuestionID:463224

Ignoringanycostsrelatedtofinancialdistress,ifafirmincreasesitsfinancialleverage,thevalueofthefirmshould:
A) decreasebecausetherequiredrateofreturnondebtislowerthanthatofequity.
B) increasebecausetheweightedaveragecostofcapitalwillbelowerduetointeresttax
shields.
C) increasebecausetheFCFFwillincrease.
Explanation
Whenafirmaddsleverage,itsvaluemayincreaseduetothetaxshieldsoninterestexpenseandthegenerallylowercostofdebt.In
theory,thereisanoptimalcapitalstructure.Iftheamountofdebtemployedisgreaterthantheoptimal,thecostsassociatedwithriskof
bankruptcyorfinancialdistressbegintooutweightheadvantageofinteresttaxshields.

Question#112of145

QuestionID:463170

Valuationwithfreecashflowtoequityandfreecashflowtothefirm:
A) usedifferentdiscountrates.
B) bothusethecostofequity.
C) bothusetheaftertaxcostofdebt.
Explanation
Freecashflowtothefirmusestheweightedaveragecostofcapitalandfreecashflowtoequityusesthecostofequity.Thekeyisto
useadiscountratethatreflectstheopportunitycostoftheindicatedinvestorgroup.

Question#113of145

QuestionID:463189

ThefollowinginformationisderivedfromthefinancialrecordsofBrownCompanyfortheyearendedDecember31,2004:

Sales

$3,400,000

CostofGoodsSold

(2,100,000)

(COGS)
Depreciation

(300,000)

InterestPaid

(200,000)

GainonSaleofOld

400,000

Equipment
IncomeTaxesPaid

(300,000)

NetIncome

$900,000

BrownissuedbondsonJune30,2004andreceivedproceedsof$4,000,000.
Oldequipmentwithabookvalueof$2,000,000wassoldonAugust15,2004for$2,400,000cash.
BrownpurchasedlandforanewfactoryonSeptember30,2004for$3,000,000,issuinga$2,000,000noteandpayingthebalancein
cash.
Cashflowfromoperationslesscapitalexpendituresis:

A) $6,200,000.
B) $200,000.
C) $2,200,000.
Explanation
Brown'scashflowfromoperations(CFO)was$800,000=($900,000NetIncome+$300,000depreciation$400,000gain).
Capitalexpenditurecashflowswere$3,000,000forthefactoryand$2,400,000cashreceivedfromsaleoftheoldequipmentforanet
outflowofcashof$600,000.
$200,000=($800,000$600,000).

Question#114of145

QuestionID:463320

SudburyIndustriesexpectsFCFFinthecomingyearof400millionCanadiandollars($),andexpectsFCFFtogrowforeveratarateof3
percent.Thecompanymaintainsanallequitycapitalstructure,andSudbury'srequiredrateofreturnonequityis8percent.
SudburyIndustrieshas100millionoutstandingcommonshares.Sudbury'scommonsharesarecurrentlytradinginthemarketfor$80per
share.
UsingtheConstantGrowthFCFFValuationModel,Sudbury'sstockis:

A) undervalued.
B) overvalued.
C) fairlyvalued.
Explanation
Basedonafreecashflowvaluationmodel,SudburyIndustriessharesappeartobefairlyvalued.
SinceSudburyisanallequityfirm,WACCisthesameastherequiredreturnonequityof8%.
ThefirmvalueofSudburyIndustriesisthepresentvalueofFCFFdiscountedbyusingWACC.SinceFCFFshouldgrowataconstant3

percentrate,theresultis:
Firmvalue=FCFF1/WACCg=400million/0.080.03=400million/0.05=$8,000million
Sincethefirmhasnodebt,equityvalueisequaltothevalueofthefirm.Dividingthe$8,000millionequityvaluebythenumberof
outstandingsharesgivestheestimatedvaluepershare:
V0=$8,000million/100millionshares=$80.00pershare

Question#115of145

QuestionID:463220

Whichofthefollowingisleastlikelytochangeasthefirmchangesleverage?
A) Freecashflowstofirm(FCFF).
B) Freecashflowstoequity(FCFE).
C) Weightedaveragecostofcapital(WACC).
Explanation
TheFCFFsarenormallyunaffectedbythechangesinleverage,asthesearethecashflowsbeforethedebtpayments.

Question#116of145

QuestionID:463241

Theonestage(stablegrowth)freecashflowmodelsassume:
A) aconstantgrowthratefornyearsandahighgrowthrateforeverthereafter.
B) therequiredrateofreturnexceedsthegrowthrate.
C) therequiredrateofreturnislessthanthegrowthrate.
Explanation
Theonestagemodelusingeitherfreecashflowtoequity(FCFE)orfreecashflowtothefirm(FCFF)assumesthattherequiredrateof
returnexceedsthegrowthrate.Ifthiswasnotthecase,themodelwouldproduceanunrealisticnegativeprice.

Question#117of145

QuestionID:463198

BOXInc.earned$4.55persharelastyear.Thefirmhadcapitalexpendituresof$1.75pershareanddepreciationexpenseof$1.05.BOX
Inc.hasatargetdebtratioof0.25.

Duration
Earningsgrowthrate
GrowthinCapital
Expenditures
GrowthinDepreciation

HighGrowthPeriod

TransitionalPeriod

2Years

5Years

45%

Willdecline8%peryearto5%
inthestablegrowthperiod

30%

Increasesby8%peryear

30%

Increasesby13%peryear

StableGrowthPeriod

5%

SameasDepreciation
SameasCapital

Expenditures
ChangeinWorkingCapital
ShareholderRequiredReturn

GivenBelow

GivenBelow

$2.25pershareinYear8

25%

15%

10%

Yr0

Yr1

Yr2

Yr3

Yr4

Yr5

Yr6

Yr7

4.55

6.60

9.57

13.11

16.91

20.46

23.12

24.27

1.75

2.28

2.96

3.19

3.45

3.73

4.02

4.35

Depreciation

1.05

1.37

1.77

2.01

2.27

2.56

2.89

3.27

ChangeinWC

0.90

1.10

1.40

1.60

1.80

2.00

2.20

2.10

7.63

11.01

14.67

18.08

20.62

21.89

EPS
Capital
Expenditures

FCFE

Inyear1,whatisthefreecashflowtoequity(FCFE)forBOXInc.?

A) $6.10.
B) $3.35.
C) $5.09.
Explanation
Year1FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)Changeinworkingcapital(1DebtRatio)
Year1FCFE=6.60(2.281.37)(10.25)(1.1)(10.25)=5.09

Question#118of145

QuestionID:463226

Inwhatwaysaredividendsdifferentfromfreecashflowtoequity(FCFE)?

A) CompaniesoftenuseFCFEasasignalofpositivefuturegrowthprospectswhile
dividendsarenotusedforsignaling.
B) Dividendsareoftenviewedas"sticky."Managersarereluctanttoradicallychangethe
dividendpayoutpolicywhileFCFEoftenhasimmensevariability.
C) Thereisnodifference.DividendsmustequalFCFE.
Explanation
DividendsandtheFCFEareoftendifferentanddividendsareusedasasignaltothemarketnotFCFE.Dividendsviewedasstickyisthe
truestatement.

Question#119of145
Therepaymentofasignificantamountofoutstandingdebtwillcausefreecashflowtoequity(FCFE)to:
A) decrease.
B) remainthesame.

QuestionID:463223

C) increase.
Explanation
Debtrepaymentwilldecreasenetborrowingand,hence,decreaseFCFEbecause:FCFE=FCFF[interestexpense](1taxrate)+net
borrowing.

Question#120of145

QuestionID:463214

TheestimateofvaluefromFCFEmodelswillalwaysbedifferentthanthevalueobtainedusingDDM,if:
A) FCFEishigherthandividends,andtheexcessisinvestedinzeroNPVprojects.
B) FCFEishigherthandividends.
C) FCFEisgreaterthandividends,andtheexcessisnotinvestedinzeroNPVprojects.
Explanation
TheestimateofvaluefromFCFEmodelswillalwaysbedifferentfromthevalueobtainedusingDDM,iftheFCFEisgreaterthan
dividends,andtheexcesscashisnotinvestedinzeroNPVprojects.

Question#121of145

QuestionID:463186

Acontrolperspectiveismostconsistentwithwhichofthefollowingvaluationapproaches?
A) Freecashflow(FCF).
B) Dividends.
C) Pricetoenterprisevalue.
Explanation
Dividendpolicycanbechangedbythebuyerofafirm.Thus,theFCFperspectivelookstothesourceofdividendsinapositionofcontrol
ratherthandirectlyatdividends.Thepricetoenterprisevalueapproachdoesnotfocusoncashflows.

Question#122of145

QuestionID:463240

Afirminstablegrowthphaseshouldhave:
A) capitalexpendituresthatarelessthanthedepreciationexpense.
B) agrowthratehigherthanthatoftheeconomyandarequiredrateofreturnthatisgreaterthan
themarketrateofreturn.
C) arequiredrateofreturnclosetothemarketrateofreturnandcapitalexpendituresthatarenot
toolargerelativetodepreciationexpense.
Explanation
Afirmthatisinastablegrowthphaseshouldhavegrowthrateclosetothatoftheeconomy,andthecostofequityshouldapproximate
therequiredrateofreturnonthemarket.Inaddition,thecapitalexpendituresshouldnotbedisproportionatelylargerelativetothe

depreciationexpense.

Questions#123128of145
AshleyWinters,CFA,hasbeenhiredtovalueGoliathCommunications,acompanythatiscurrentlyexperiencingrapidgrowthand
expansion.Wintersisanexpertinthecommunicationsindustryandhashadextensiveexperienceinvaluingsimilarfirms.Sheis
convincedthatavaluefortheequityofGoliathcanbereliablyobtainedthroughtheuseofathreestagefreecashflowtoequity(FCFE)
modelwithdeclininggrowthinthesecondstage.Basedonuptodatefinancialstatements,shehasdeterminedthatthecurrentFCFEper
shareis$0.90.WintershaspreparedaforecastofexpectedgrowthratesinFCFEasfollows:
Stage1: 10.5%foryears1through3
Stage2: 8.5%inyear4,6.5%inyear5,5.0%inyear6
Stage3: 3.0%inyear7andthereafter

Moreover,shehasdeterminedthatthecompanyhasabetaof1.8.Thecurrentriskfreerateis3.0%,andtheequityriskpremiumis
5.0%.
Otherfinancialinformation:
Outstandingshares

10million

Taxrate

40.0%

Interestexpense

$750,000

Netborrowing

$100,000

Costofdebt

7.5%

Debttoequityratio

25.0%

Estimatedgrowthrateforthefirm

4.0%

Question#123of145

QuestionID:463293

Therequiredreturnisclosestto:

A) 9.0%.
B) 6.6%.
C) 12.0%
Explanation
BasedontheCAPMwecanestimatearequiredreturnonequityas:
Requiredreturn=3.0%+1.8(5.0%)=12%
(LOS31.c)

Question#124of145
Theterminalvalueinyear6isclosestto:

A) $16.86.
B) $25.29.
C) $21.68.

QuestionID:463294

Explanation
EstimatesforthefutureFCFEbasedonsuppliedgrowthratesare:
Year

8.5%

6.5%

5.0%

3.0%

Growthrate

10.5% 10.5% 10.5%

FCFE/share

$0.995 $1.099 $1.214 $1.318 $1.403 $1.473 $1.518

R$=1.518/(12.0%3.0%)=16.861
(LOS36.e)

Question#125of145

QuestionID:463295

ThepersharevalueWintersshouldassigntoGoliath'sequityisclosestto:
A) $13.55.
B) $16.87.
C) $20.24.
Explanation
Wefindthevalueoftheequity/sharebydiscountingallfutureFCFE/sharebytherequiredrateofreturnonequity.

Usingourcalculator,enterCF0=0C01=0.995C02=1.099C03=1.214C04=1.318C05=1.403C06=1.473+16.867=18.34I
=12ComputeNPV=13.55.
(LOS36.j)

Question#126of145

QuestionID:463296

Thefreecashflowtothefirm(FCFF)isclosestto:

A) $9.45million.
B) $9.35million.
C) $9.55million.
Explanation
FCFEof$0.90pershareisgiven.Thereare10millionsharesoutstanding.ThetotalFCFEis$0.9010,000,000=$9,000,000.
TheformulaforFCFEisFCFE=CFO+FCInv+Netborrowing,andtheformulaforFCFFisFCFF=CFO+FCInv+interestexpense
(1taxrate)
FCFF=FCFENetborrowing+interestexpense(1taxrate)=$9million($100,000)+$750,000(10.40)=$9.55million
(LOS36.d)

Question#127of145
Theweightedaveragecostofcapital(WACC)isclosestto:

QuestionID:463297

A) 10.5%.
B) 11.1%.
C) 10.9%.
Explanation
Thedebttoequityratioof25.0%meansthatthedebttototalvalueis25.0%/125.0%or20.0%.Theweightofdebtisthus20.0%andthe
weightofequityis80.0%.
TheWACC=[0.20(0.075)(10.40)]+(0.800.12)=10.5%
(LOS36.j)

Question#128of145

QuestionID:463298

Thevalueofthefirm,basedontheconstantgrowthmodel,isclosestto:

A) $124million
B) $140million.
C) $153million.
Explanation
TheestimatedFCFFforyear0is$9.55millionandtheWACCis10.5%ascalculated.Ifthegrowthrateforthefirmisestimatedas4.0%,
thevalueofthefirmis:
$9.55million(1.04)/(0.1050.04)=$152,800,000.
(LOS36.j)

Question#129of145

QuestionID:463191

Freecashflowtothefirm(FCFF)adjustsearningsbeforeinterestandtaxes(EBIT)by:
A) subtractinginvestmentsinfixedcapitalandworkingcapital.
B) addingtaxes,deductingdepreciation,andaddingbacktheinvestmentsinfixedcapitaland
workingcapital.
C) deductingtaxes,addingbackdepreciation,anddeductingtheinvestmentsinfixedcapitaland
workingcapital.
Explanation
Aspresentedinthereading:FCFF=EBIT(1taxrate)+DepFCInvWCInv.

Question#130of145

QuestionID:463227

Iftheinvestmentinfixedcapitalandworkingcapitaloffseteachother,freecashflowtothefirm(FCFF)maybeproxiedby:
A) earningsbeforeinterestandtaxes(EBIT).

B) netincomeplusnoncashchargesplusaftertaxinterest.
C) netincomeplusaftertaxinterest.
Explanation
TheanswerisindicatedbythedefinitionofFCFF:FCFF=NI+NCC+Int(1taxrate)FCInvWCInv.Therelationshipbetweennet
incomeandFCFFisindicatedby:NI=EBIT(1taxrate)Int(1taxrate).

Question#131of145

QuestionID:463234

ThethreestageFCFEmodelmightresultinanextremelyhighvalueif:
A) thegrowthrateinthestableperiodistoohigh.
B) thegrowthrateinthestableperiodisequaltothatofGNP.
C) thegrowthrateinthestableperiodistoolow.
Explanation
Ifthegrowthrateinthestableperiodistoohighorthehighgrowthandtransitionperiodsaretoolong,thethreestageFCFEmodelmight
resultinanextremelyhighvalue.

Question#132of145

QuestionID:463238

Thestablegrowthfreecashflowtothefirm(FCFF)modelismostusefulinvaluingfirmsthat:
A) havecapitalexpendituresthatarenotsignificantlyhigherthandepreciation.
B) havecapitalexpendituresthataresignificantlyhigherthandepreciation.
C) aregrowingataratesignificantlylowerthanthatoftheoveralleconomy.
Explanation
ThestablegrowthFCFFmodelisusefulforvaluingfirmsthatareexpectedtohavegrowthratesclosetothatoftheoveralleconomy.
Sincetherateofgrowthapproximatesthatfortheoveralleconomy,thesefirmsshouldhavecapitalexpendituresthatarenotsignificantly
differentthandepreciation.

Question#133of145

QuestionID:463229

Assumingthattheinvestmentinfixedcapitalandworkingcapitaloffseteachother,freecashflowtothefirm(FCFF)maybeproxiedby
netincomeif:
A) earningsbeforeinterestandtaxes(EBIT)equalsdepreciation.
B) noncashchargesandinterestchargesareequal.
C) noncashchargesandinterestchargesarezero.
Explanation

TheanswerisshownbytherelationshipbetweenFCFFandnetincome:FCFF=NI+NCC+Int(1taxrate)FCInvWCInv.Further:
FCFF=EBIT(1taxrate)+DepFCInvWCInv,whichassumesthatdepreciationistheonlynoncashcharge.

Question#134of145

QuestionID:463245

ThetwostageFCFEmodelissuitableforvaluingfirmsthat:
A) havemoderategrowthintheinitialphasethatdeclinesgraduallytoastablerate.
B) haveveryhighbutdeclininggrowthrateintheinitialstage.
C) areinanindustrywithsignificantbarrierstoentry.
Explanation
ThetwostageFCFEmodelissuitableforvaluingfirmsinindustrieswithsignificantbarrierstoentry.Wherethesearepresentitis
possibleforthefirmtomaintainahighgrowthrateduringaninitialphaseoflowcompetition,andthattheratewilldropsharplytoa
normalizedratewhencompetitionultimatelyappears.

Question#135of145

QuestionID:463276

IndustrialLightcurrentlyhas:
Expectedfreecashflowtothefirminoneyear=$4.0million.
Costofequity=12%.
Weightedaveragecostofcapital=10%.
Totaldebt=$30.0million.
Longtermexpectedgrowthrate=5%.
Whatisthevalueofequity?

A) $44,440,000.
B) $80,000,000.
C) $50,000,000.
Explanation
Theoverallvalueofthefirmis$4,000,000/(0.100.05)=$80,000,000.Thus,thevalueofequityis$80,000,000$30,000,000=
$50,000,000.

Question#136of145

QuestionID:463197

SOXInc.expectshighgrowthinthenext4yearsbeforeslowingtoastablefuturegrowthof3%.Thefirmisassumedtopaynodividends
inthenearfutureandhasthefollowingforecastedfreecashflowtoequity(FCFE)informationonapersharebasisinthehighgrowth
period:

FCFE

Year1

Year2

Year3

Year4

$3.05

$4.10

$5.24

$6.71

Highgrowthperiodassumptions:
SOXInc.'stargetdebtratiois40%andabetaof1.3.
ThelongtermTreasuryBondRateis4.0%,andtheexpectedequityriskpremiumis6%.
Stablegrowthperiodassumptions:
SOXInc.'stargetdebtratiois40%andabetaof1.0.
ThelongtermTreasuryBondRateis4.0%andtheexpectedequityriskpremiumis6%.
Capitalexpendituresareassumedtoequaldepreciation.
Inyear5,earningsare$8.10persharewhilethechangeinworkingcapitalis$2.00pershare.
Earningsandworkingcapitalareexpectedtogrowby3%ayearinthefuture.
Inyear5,whatisthefreecashflowtoequity(FCFE)forSOXInc.?

A) $6.10.
B) $7.30.
C) $6.90.
Explanation
Inyear5,FCFE=Earningspershare(CapitalExpendituresDepreciation)(1DebtRatio)(Changeinworkingcapital)(1Debt
Ratio)=8.100(10.4)2.00(10.4)=6.90.

Question#137of145

QuestionID:463228

Iftheinvestmentinfixedcapitalandworkingcapitaloffseteachother,freecashflowtothefirm(FCFF)maybeproxiedby:
A) netincomeplusaftertaxinterest.
B) earningsbeforeinterestandtaxes(EBIT).
C) aftertaxEBITplusnoncashcharges.
Explanation
TheanswerisindicatedbythedefinitionofFCFF:FCFF=EBIT(1taxrate)+DepFCInvWCInv,whichassumesthatdepreciationis
theonlynoncashcharge.Further:FCFF=NI+NCC+Int(1taxrate)FCInvWCInv.

Question#138of145
Whichofthefollowingismostusefulinanalyzingfirmsthathavehighleverageandhighgrowth?
A) Twostagefreecashflowtothefirm(FCFF)model.
B) Stablegrowthfreecashflowtothefirm(FCFF)model.
C) Twostagefreecashflowtoequity(FCFE)model.
Explanation

QuestionID:463239

Ofthecashflowvaluationmodelsmentionedabove,thetwostageFCFFmodelismostusefulinanalyzingthefirmsthathavehigh
leverageandhighgrowth.Thehighgrowthwillmakethestablegrowthmodelsinapplicable,whilethehighleveragemakestheFCFF
modelmoreattractive.

Question#139of145

QuestionID:463188

Theownershipperspectiveimplicitinthefreecashflowtoequityvaluationapproachisof:
A) control.
B) apreferredstockholder.
C) aminorityposition.
Explanation
Dividendpolicycanbechangedbythebuyerofafirm.Thus,thefreecashflowperspectivelookstothesourceofdividendsinaposition
ofcontrolratherthandirectlyatdividends.

Question#140of145

QuestionID:463275

Afirmhasprojectedfreecashflowtoequitynextyearof$1.25pershare,$1.55intwoyears,andaterminalvalueof$90.00twoyears
fromnow,aswell.Giventhefirm'scostofequityof12%,aweightedaveragecostofcapitalof14%,andtotaloutstandingdebtof$30.00
pershare,whatisthecurrentvalueofequity?
A) $74.10.
B) $71.74.
C) $41.54.
Explanation
Valueofequity=$1.25/(1.12)1+$1.55/(1.12)2+$90.00/(1.12)2=$74.10

Question#141of145

QuestionID:463255

SOX,Inc.,expectshighgrowthinthenext4yearsbeforeslowingtoastablefuturegrowthof3%.Thefirmisassumedtopayno
dividendsinthenearfutureandhasthefollowingforecastedfreecashflowtoequity(FCFE)informationonapersharebasisinthehigh
growthperiod:
Year1 Year2 Year3 Year4
FCFE $3.05 $4.10 $5.24 $6.71

Highgrowthperiodassumptions:
SOX,Inc.'s,targetdebtratiois40%andabetaof1.3.
ThelongtermTreasuryBondRateis4.0%,andtheexpectedequityriskpremiumis6%.
Stablegrowthperiodassumptions:

SOX,Inc.'s,targetdebtratiois40%andabetaof1.0.
ThelongtermTreasuryBondRateis4.0%andtheexpectedequityriskpremiumis6%.
Capitalexpendituresareassumedtoequaldepreciation.
Inyear5,earningsare$8.10persharewhilethechangeinworkingcapitalis$2.00pershare.
Earningsandworkingcapitalareexpectedtogrowby3%ayearinthefuture.
WhatisthepresentvalueonapersharebasisforSOX,Inc.?

A) $64.24.
B) $70.49.
C) $77.15.
Explanation
Therequiredrateofreturninthehighgrowthperiodis(r)=0.04+1.3(0.06)=0.118.
Therequiredrateofreturninthestablegrowthperiodis(r)=0.04+1.0(0.06)=0.10.
ThePresentValue(PV)oftheFCFEinthehighgrowthperiodis(3.05/1.118)+(4.10/1.1182)+(5.24/1.1183)+(6.71/1.1184)=14.06.

TheTerminalPrice=ExpectedFCFEn+1 /(rgn )withFCFEn+1=FCFEinyear5=Earningspershare(CapitalExpenditures


Depreciation)(1DebtRatio)(Changeinworkingcapital)(1DebtRatio)=8.100(10.4)2.00(10.4)=6.90.
TheTerminalPrice=6.90/(0.100.03)=98.57.
ThePVoftheTerminalPrice=(98.57/1.1184)=63.09.
ThevalueofasharetodayisthePVoftheFCFEinthehighgrowthperiodplusthePVoftheTerminalPrice=14.06+63.09=77.15.

Question#142of145

QuestionID:463246

Thetwostage(stablegrowth)freecashflowtoequity(FCFE)andfreecashflowtothefirm(FCFF)modelstypicallyassume:
A) therequiredrateofreturnequalsthegrowthrateinthelaststage.
B) ahighgrowthratefornyearsandthenaconstantgrowthrateforeverthereafter.
C) therequiredrateofreturnislessthanthegrowthrateinthelaststage.
Explanation
ThetwostagemodelusingeitherFCFEorFCFFtypicallyassumesahighgrowthratefornyearsandthenaconstantgrowthrateforever
thereafter.Multistagemodelsassumethattherequiredrateofreturnexceedsthegrowthrateinthelaststage.

Question#143of145

QuestionID:463215

Whichofthefollowingstatementsisleastaccurate?Afirm'sfreecashflowstoequity(FCFE)isthecashavailabletostockholdersafter
funding:
A) dividendpayments.

B) debtprincipalrepayments.
C) capitalexpenditurerequirements.
Explanation
Afirm'sFCFEisthecashavailabletostockholdersafterfundingcapitalexpendituresanddebtprincipalrepayments.

Question#144of145

QuestionID:463306

Afirmhas:
Freecashflowtoequity=$4.0million.
Costofequity=12%.
Longtermexpectedgrowthrate=5%.
Valueofequitypershare=$57.14pershare.
Whatwillhappentothevalueofequityifthecostofequitydecreasesto10%?

A) Thevaluewilldecrease.
B) Thereisinsufficientinformationtotell.
C) Thevaluewillincrease.
Explanation
Everythingelsebeingconstant,adecreaseintherelevantrequiredrateofreturnshouldincreasethevalueoftheequitypershare.

Question#145of145
Freecashflowtoequityvaluationuseswhichdiscountrate?
A) Weightedaveragecostofcapital.
B) Costofequity.
C) Aftertaxcostofdebt.
Explanation
Freecashflowtoequityvaluationusestheopportunitycostrelevanttostockholders,whichisthecostofequity.

QuestionID:463175

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