A. Why is the terminal value a disadvantage when using the free cash flow valuat

Question

A. Why is the terminal value a disadvantage when using the free cash flow valuation?

B. Remember the accounting equation is Assets = Liabilities + Equity. The conceptual framework for free cash flows separates this equation into the following categories: Select the correct one.

CA + LT A = CL + LT L + SE

OA + FA = OL + FL + OSE + FSE

OA + FA = OL + FL + SE

Non-FA + FA = Non-FL + FL + SE

C. Valuations using dividends and free cash flow in for common equity shareholders, should the two calculations yield the same results? (answer yes or no, then explain your response)

CA + LT A = CL + LT L + SE

OA + FA = OL + FL + OSE + FSE

OA + FA = OL + FL + SE

Non-FA + FA = Non-FL + FL + SE

C. Valuations using dividends and free cash flow in for common equity shareholders, should the two calculations yield the same results? (answer yes or no, then explain your response)

Explanation / Answer

PART A

When using discounted cash flow major portion of the value sometimes as much as 60% of the value is derived from the terminal value. So it becomes very important to determine the right comparables and assume reasonable growth rates. If a larger than expected growth rates are assumed then the terminal value can increase multiple fold giving an incorrect estimation of the price. Thus terminal value results in a disadvantage.

PART B

In a free cash flow situation, the equation

OA+FA=OL+FL+SE

where

OA is the operating assets

FA are fixed assets

OL is Operating liabilities

FL are fixed liabilities

SE is stock holder's equity

PART C

Valuation using dividends and free cash flow for common equity holders will not always lead to same valuation. This is mainly because the free cash flows and the dividends are not always the same. The rise in the dividends is much more stable for a company as compared to the free cash flows. Some companies do not pay dividends at all as well so to forecast when they will start paying dividends and how much is also a very un-certain event so the difference will always be there.

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