Question #113

Reading: Reading 21 Free Cash Flow Valuation

PDF File: Reading 21 Free Cash Flow Valuation.pdf

Page: 58

Status: Unattempted

Correct Answer: A

Part of Context Group: Q113-114 First in Group
Shared Context
- Regarding the handbook's statements on free cash flow techniques: Statement 3 Statement 4 A) Correct Correct B) Incorrect Correct C) Correct Incorrect
Question
The most appropriate model for valuing Fite Inc. is the:
Answer Choices:
A. free cash flow to equity model
B. free cash flow to the firm model
C. dividend discount H-model
Explanation
A dividend discount model is inappropriate, as dividends are not related to the earnings stream. In addition, as this is a takeover situation a free cash flow approach is more suitable as the acquirer has control and discretion over the distribution of the total free cash flow. With dividend discount models a minority, interest is assumed (i.e., no control over dividend policy). FCFF model is preferred to FCFE as FCFE is negative and volatile and leverage is high.
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