Question #7 - Reading 21 Free Cash Flow Valuation

Reading: Reading 21 Free Cash Flow Valuation

PDF File: Reading 21 Free Cash Flow Valuation.pdf

Page: 4

Status: Incorrect

Correct Answer: A

Your Answer: B

Shared Context

- Which of the following is the least likely reason for Carson's decision to use FCFE in valuing Overhaul rather than FCFF? A) Overhaul’s capital structure is stable. B) FCFE is an easier and more straightforward calculation than FCFF. C) Overhaul’s debt ratio is significantly higher than the industry average.

Question

What is the expected growth rate in FCFF that Carson must have used to generate his valuation of $1.08 billion?

Answer Choices:

A. 5%

B. 7%

C. 12%

Explanation

Since Firm Value = FCFF1 / (WACC − g), we first need to determine FCFF1, which is FCFF in 2006: FCFF = NI + NCC + [Int × (1 − tax rate)] – FCInv − WCInv = 16.9 + 80 + [34 × (1 − 0.35)] − (480 − 400) − [(55 − 70) − (50 − 50)] = 16.9 + 80 + 22.1 − 80 − (−15) = 54 Firm Value = FCFF1 / (WACC − g) 1080 = 54 / (0.12 − x) [(1080)(0.12)] − 1080x = 54 129.6 − 1080x = 54 75.6 = 1080x 0.07 = x The expected growth rate in FCFF that Carson must have used is 7%.

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