Which of the following statements is CORRECT? If a company has a WACC = 12% and

Question

Which of the following statements is CORRECT? If a company has a WACC = 12% and its free cash flow is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. The free cash flow valuation model for constant growth, Vop = FCF1/(WACC-g), can be used to value firms whose free cash flows are expected to decline at a constant rate, i.e., to grow at a negative rate. The value of operations of a stock is the present value of all expected future free cash flows, discounted at the free cash flow growth rate. The constant growth model cannot be used for a zero growth stock, where free cash flows are expected to remain constant over time. The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.

Explanation / Answer

The second statement is correct, i.e., in case of negative growth, you compute the value of firms using Vop = FCF1/ (WACC - g).

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