Question #82
Reading: Reading 21 Free Cash Flow Valuation
PDF File: Reading 21 Free Cash Flow Valuation.pdf
Page: 39
Status: Unattempted
Correct Answer: A
Question
If a firm is valued using FCFF, the relevant discount rate is the:
Answer Choices:
A. after-tax weighted average cost of capital
B. before-tax weighted average cost of capital
C. before-tax cost of equity. The following information was collected from the financial statements of Bankers Industrial Corp (BIC) for the year ended December 31, 2013. Earnings before interest and taxes (EBIT) = $6.00 million. Capital expenditures = $1.25 million. Depreciation expense = $0.63 million. Working capital additions = $0.59 million. Cost of debt = 10.50%. Cost of equity = 16.00%. Stable growth rate for FCFF = 7.00%. Stable growth rate for FCFE = 10.00%. Market value of debt = $20.00 million. Book value of debt = $22.50 million
Explanation
Since the FCFF is the cash available to all the investors, the after-tax weighted average cost
of capital should be used as the discount rate in FCFF models.
(Module 21.1, LOS 21.a)
The following information was collected from the financial statements of Bankers Industrial Corp (BIC) for the year
ended December 31, 2013.
Earnings before interest and taxes (EBIT) = $6.00 million.
Capital expenditures = $1.25 million.
Depreciation expense = $0.63 million.
Working capital additions = $0.59 million.
Cost of debt = 10.50%.
Cost of equity = 16.00%.
Stable growth rate for FCFF = 7.00%.
Stable growth rate for FCFE = 10.00%.
Market value of debt = $20.00 million.
Book value of debt = $22.50 million.
Outstanding shares = 500,000.
Interest expense = $2.00 million.
New Debt borrowing = $3.30 million.
Debt repayment = $2.85 million.
Growth rates for two-stage growth model for FCFE:
25.0% for Years 1-3.
6.0% for Years 4 and thereafter.
BIC is currently operating at their target debt ratio of 40.00%. The firm's tax rate is 40.00%.