Question #22 - Reading 21 Free Cash Flow Valuation

Reading: Reading 21 Free Cash Flow Valuation

PDF File: Reading 21 Free Cash Flow Valuation.pdf

Page: 10

Status: Correct

Correct Answer: A

Shared Context

of 137 Which of the following statements is least accurate? A firm's free cash flows to equity (FCFE) is the cash available to stockholders after funding: A) capital expenditure requirements. B) debt principal repayments. C) dividend payments. TOY, Inc. is a company that manufactures dolls, games, and other items to entertain children. The following table provides background information for TOY, Inc. on a per share basis in the year 0: Current Information Year 0 Earnings $5.00 Capital Expenditures $2.40 Depreciation $1.80 Change in Working Capital $1.70 Cost of equity 12.0% Target debt ratio 30.0% Market value of stock $56.00 Shares outstanding 5.0 million Interest expense $7.2 million Cash & short-term investments $40.0 million Tax rate 37.5% Earnings, capital expenditures, depreciation, and working capital are all expected to grow by 5.0% per year in the future.

Question

In year 1, the forecasted free cash flow to equity (FCFE) for TOY, Inc. is closest to:

Answer Choices:

A. $3.56

B. $4.31

C. $4.53

Explanation

FCFE year 0 = Earnings per share − [(Capital Expenditures − Depreciation) × (1 − Debt Ratio)] − [(Change in working capital) × (1 − Debt Ratio)] = 5.00 − [(2.40 − 1.80) × (1 − 0.30)] − [(1.70) × (1 − 0.30)] = 3.39. FCFE for year 1 = FCFE year 0 × (1 + growth rate) = 3.39 × (1.05) = $3.56.

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