Question #8

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

Part of Context Group: Q7-8
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
If Carson had estimated FCFE under the assumption that Overhaul Trucking maintains a target debt-to-asset ratio of 36 percent for new investments in fixed and working capital, what would be his forecast of 2006 FCFE?
Answer Choices:
A. $26.5 million
B. $9.6 million
C. $16.9 million
Explanation
FCFE = NI – [(1 − DR) × (FCInv − Dep)] − [(1 − DR) × WCInv] Where: DR = target debt to asset ratio FCFE = 16.9 − [(1 − 0.36) × (480 − 400 − 80)] − [(1 − 0.36) × ((55 − 70) − (50 − 50))] = 16.9 − (0.64 × 0) − (0.64 × (−15)) = 16.9 + 0 + 9.6 = 26.5
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