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What risks are inherent in using the expected future cash flow method of evaluating projects? In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?

What risks are inherent in using the expected future cash flow method of evaluating projects? In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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What risks are inherent in using the expected future cash flow method of evaluating projects?

In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?

 

Consider the following scenario and answer all the questions thereafter. Scenario Mary Jones is a trader in the Treasury of Caliandra Bank. It is now January and she just bought 60 March futures contracts on Standard Bank Startup (Pty) Ltd is an innovative technology company. They have experienced reasonable growth over the last few years and have consulted you as they face several key decisions. The Owners' Equity and Liabilities section of the balance sheet of the company on 31st December 2021 is as follows: Share Capital: Retained Income Total Owners' Equity Preference Shares Loan from Bank Total Owners' Equity + Debt = 35,000,000 1,000,000 19,000,000 20,000,000 5,000,000 10,000,000 The Ordinary Shares consist of 1,000,000 ordinary shares with a par value of R10 each. The owners, who also own the company, are contemplating listing the business on the JSE Alternative Exchange in order to raise funds to fund further expansion. They are unsure as to what list price they should be asking for. You know one of the owners personally and he knows you recently completed your Finance and Investments Qualification and has asked for your help. The company has produced the following forecasts for the next 5 years (R'000): Profit after Tax Depreciation Change in Net Working Capital Net Capital Expenditures Free Cash Flows FY2 FY3 FY4 FY5 5,300 7,000 5,500 5,900 6,400 800 900 950 1,000 1.100 +700 -300 -450 -550 -1,200 -1,300 -500 -900 5,600 4,800 5,900 5,950 FY1 +650 +450 9,200 The Free Cash flow is expected to grow at a rate of 3% of the fifth year's forecast. Using the information available, you have computed the Weighted Average Cost of Capital (WACC) of Startup (Pty) Ltd to be 12.2%.
Transcribed Image Text:Consider the following scenario and answer all the questions thereafter. Scenario Mary Jones is a trader in the Treasury of Caliandra Bank. It is now January and she just bought 60 March futures contracts on Standard Bank Startup (Pty) Ltd is an innovative technology company. They have experienced reasonable growth over the last few years and have consulted you as they face several key decisions. The Owners' Equity and Liabilities section of the balance sheet of the company on 31st December 2021 is as follows: Share Capital: Retained Income Total Owners' Equity Preference Shares Loan from Bank Total Owners' Equity + Debt = 35,000,000 1,000,000 19,000,000 20,000,000 5,000,000 10,000,000 The Ordinary Shares consist of 1,000,000 ordinary shares with a par value of R10 each. The owners, who also own the company, are contemplating listing the business on the JSE Alternative Exchange in order to raise funds to fund further expansion. They are unsure as to what list price they should be asking for. You know one of the owners personally and he knows you recently completed your Finance and Investments Qualification and has asked for your help. The company has produced the following forecasts for the next 5 years (R'000): Profit after Tax Depreciation Change in Net Working Capital Net Capital Expenditures Free Cash Flows FY2 FY3 FY4 FY5 5,300 7,000 5,500 5,900 6,400 800 900 950 1,000 1.100 +700 -300 -450 -550 -1,200 -1,300 -500 -900 5,600 4,800 5,900 5,950 FY1 +650 +450 9,200 The Free Cash flow is expected to grow at a rate of 3% of the fifth year's forecast. Using the information available, you have computed the Weighted Average Cost of Capital (WACC) of Startup (Pty) Ltd to be 12.2%.
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