Question #117 - Reading 21 Free Cash Flow Valuation

Reading: Reading 21 Free Cash Flow Valuation

PDF File: Reading 21 Free Cash Flow Valuation.pdf

Page: 60

Status: Unattempted

Shared Context

- Which of the following statements regarding forecasting FCFE using the components of free cash flow method and net borrowing is most accurate? A) Net income already accounts for interest expense; therefore, net borrowing is not needed. B) Investment in fixed capital and net borrowing are assumed to offset each other. C) The target debt-to-asset ratio accounts for the financing of new investment in fixed capital and working capital.

Question

Should dividend-based and free cash flow from equity (FCFE) based valuations result in different equity values for a firm?

Answer Choices:

A. Yes, dividend-based valuations would be higher for firms with large, consistent dividends

B. No, both models should result in the same value

C. Yes, the free cash flow from equity valuation would be higher if there were a premium associated with control of the firm

Explanation

The ownership perspectives of dividend-based and FCFE based valuations are different. Dividend-based valuations take the perspective of minority shareholders, while FCFE based valuations take the perspective of an acquirer who will assume a controlling position in the firm. If investors were willing to pay a premium for a controlling position in the firm, then the equity value computed under the FCFE approach would be higher.

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