Leigh€™s comment about not considering decreases in inventory to be a source of long - term growth in free cash flow for Holt is:
A. Inconsistent with a forecasting perspective.
B. Mistaken because decreases in inventory are a use rather than a source of cash.
C. Consistent with a forecasting perspective because inventory reduction has a limit, particularly for a growing firm.

Ryan Leigh is preparing a presentation that analyzes the valuation of the common stock of two companies under consideration as additions to his firm€™s recommended list, Emerald Corporation and Holt Corporation. Leigh has prepared preliminary valuations of both companies using an FCFE model and is also preparing a value estimate for Emerald using a dividend discount model. Holt€™s 2007 and 2008 fi nancial statements, contained in Exhibits 4 - 24 and 4 - 25 , are prepared in accordance with U.S. GAAP.

EXHIBIT 4-24 Holt Corporation Consolidated Balance Sheets (US$ millions)

EXHIBIT 4-25 Holt Corporation Consolidated Income Statement for the Year Ended 31 December 2008 (US$ millions)

Total revenues ..............................................................$3,323
Cost of goods sold .........................................................1,287
Selling, general, and administrative expenses ................858
Earnings before interest, taxes, depreciation,
and amortization (EBITDA) ..........................................1,178
Depreciation expense .....................................................270
Operating income ............................................................908
Interest expense .............................................................195
Pretax income .................................................................713
Income tax (at 32 percent) ..............................................228
Net income .....................................................................$485

Leigh presents his valuations of the common stock of Emerald and Holt to his supervisor, Alice Smith. Smith has the following questions and comments:

• €œI estimate that Emerald €™ s long - term expected dividend payout rate is 20 percent and its return on equity is 10 percent over the long - term. €
• €œWhy did you use an FCFE model to value Holt€™s common stock? Can you use a DDM instead? €
• €œHow did Holt€™s FCFE for 2008 compare with its FCFF for the same year? I recommend you use an FCFF model to value Holt€™s common stock instead of using an FCFE model because Holt has had a history of leverage changes in the past. €
• €œIn the past three years, about 5 percent of Holt€™s growth in FCFE has come from decreases in inventory. €

Leigh responds to each of Smith€™s points as follows:

• €œ I will use your estimates and calculate Emerald€™s long - term, sustainable dividend growth rate. €
• €œ There are two reasons why I used the FCFE model to value Holt€™s common stock instead of using a DDM. The first reason is that Holt€™s dividends have differed significantly from its capacity to pay dividends. The second reason is that Holt is a takeover target and once the company is taken over, the new owners will have discretion over the uses of free cash flow.€
• €œ I will calculate Holt€™s FCFF for 2008 and estimate the value of Holt€™s common stock using an FCFF model. €
• €œ Holt is a growing company. In forecasting either Holt€™s FCFE or FCFF growth rates, I will not consider decreases in inventory to be a long - term source of growth.€

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As of 31 December 2007 2008 Assets Current assets Cash and cash equivalents $372 $315 Accounts receivable 770 711 Inventories 846 780 Total current assets 1,806 1,988 Gross fixed assets 4,275 3,752 Less: Accumulated depreciation 1,176 906 2,846 3,099 Total assets $5,087 $4,652 Liabilities and shareholders' equity Current liabilities $443 Accounts payable $476 Accrued taxes and expenses 149 114 Notes payable 465 450 As of 31 December 2008 2007 Total current liabilities Long-term debt Common stock 1,090 1,007 1,575 1,515 525 525 Retained earnings Total liabilities and shareholders' equity 1,897 $5,087 1,605 $4,652