Equity Valuation (FCFF & FCFE)

Question 1

Dividend Discount Model values the investment as

Answer 1

the present value of the expected future benefits

Question 2

Share repurchases

Answer 2

company uses cash to buy bac its own shares, equivalent to the payment of cash dividends of equity value in terms of the effect on shareholders’ wealth

Question 3

Managers use share repurchases for… (4)

Answer 3

Signalling belief their shares are undervalued (or to support share prices)
Flexibility in the amount and timing of distributing cash to shareholders
Tax efficiency in makers where tax rates on dividend exceed tax rates on capital gains
The ability to absorb increases in outstanding shares because of the exercise of employee stock options

Question 4

Dividend Payment Timeline

Answer 4

Declaration
Ex-Dividend
Record Date
Payment Date

Question 5

Gordon Growth Model assumption (1)

Answer 5

dividends grow indefinitely at a constant rate

Question 6

GGM model is used to value…

Answer 6

Dividend paying companies that are relatively insensitive to the business cycle and in a mature growth phase

Question 7

Multi-stage dividend discount models are used to value…

Answer 7

rapidly growing companies

Question 8

What valuation model do analysts prefer?

Answer 8

FCFE

Question 9

FCFE model assumes

Answer 9

dividend paying capacity should be reflected in cash flow estimates rather than expected dividends

Question 10

FCFE is a measure of… and … but…

Answer 10

dividend paying capacity and cash flow generated in a period that is available for distribution to common shareholders but can be used to value non-dividend paying stocks

Question 11

FCFE is discounted by the…

Answer 11

required return on equity

Question 12

FCFF represents…

Answer 12

cash flow available to the company’s suppliers of capital after all operating expenses (incl. tax) have been paid and investments in WC and fc have been made

Question 13

Equity Value =

Answer 13

FCFF - MV of Debt

Question 14

FCFF is discounted by

Answer 14

WACC

Question 15

Change in NWC =

Answer 15

Change in CA - Change in CL

Question 16

Net Borrowing =

Answer 16

debt issued - debt repaid

Question 17

Uses of FCFE

Answer 17

+ Increases (or - decreases) in cash balances
+ Payments to providers of equity capital (calculated as + cash dividends + share repurchases in excess of share issuance)

Question 18

Uses of FCFF (3)

Answer 18

+ Increases (or - decreases) in cash balances
+ Net payments to providers of debt capital (calculated as interest exp(1-T) + repayment of principal in excess of new borrowing)
+ Payments to providers of equity capital (calculated as + cash dividends + share repurchases in excess of share issuance)