Which of the following statements is CORRECT? The value of operations of a stock
ID: 2801646 • Letter: W
Question
Which of the following statements is CORRECT?
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 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.
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 constant growth model cannot be used for a zero growth stock, where free cash flows are expected to remain constant over time.
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 grow at a constant rate.
Explanation / Answer
Value of firm using constant growth model is calculated by using following formula:
Value of firm = FCF1 / (WACC - G)
Where,
FCF1 = Expected free cash flow in year 1.
WACC = Overall cost of capital of company
G = Growth rate in Free cash flow.
Option (E) is correct answer.
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