1. Fundamentals of the free cash flow corporate valuation model Aa Aa E Several methods can be used to compute the intrinsic value of a share of a company's common stock. One method uses the free cash flow (FCF) valuation model, while the another method uses the dividend discount model The FCF valuation model computes a firm's intrinsic value-also called its the value of its operating activities (Vop) and the value of firm's nonoperating entity assets value-as the sum of , where: dividing the firm's expected future free cash flows by its weighted average Vop is computed by cost of capital. A firm's nonoperating assets include its highly marketable short-term Securities in which a firm invests its temporarily available excess cash, and its investments in other businesses. Which of the following statements about the FCF valuation model are true? The model has limited applicability because it fails to adjust for a firm's riskiness-particularly that created by managers' decisions to use debt in the firm's capital structure, or decisions regarding the payment of cash dividends. X The model is useful because it demonstrates the relationship between quality of the decisions that managers make and the value of their company. O A company's FCFs are a function of how effectively managers control the firm's costs, manage its operating and nonoperating assets, and generate sales revenues. The FCF valuation model recognizes that a firm's value is a function of its risk-including its use of debt and Which of the following statements about the FCF valuation model are true? The model has limited applicability because it fails to adjust for a firm's riskiness-particularly that created by managers' decisions to use debt in the firm's capital structure, or decisions regarding the payment of cash dividends. X The model is useful because it demonstrates the relationship between quality of the decisions that managers make and the value of their company. A company's FCFs are a function of how effectively managers control the firm's costs, manage its operating and nonoperating assets, and generate sales revenues. The FCF valuation model recognizes that a firm's value is a function of its risk-including its use of debt and equity financing and the markets in which it operates. Consider the case of Purple Panda Pharmaceuticals: Next year, Purple Panda is expected to earn an EBIT of $13,000,000, and to pay a federal-plus-state tax rate of 35%. It also expects to make $3,250,000 in new capital expenditures to support this level of business activity, as well as $20,000 in additional net operating working capital (NOWC). Given these expectations, it is reasonable to conclude that next year Purple Panda will generate an annual free cash flow (FCF) of (rounded to the nearest whole dolla Next, based on your estimate of Purple Panda's next year's FCF and making the stated assumptions, complete the following table: Purple Panda can sustain this annual FCF forever Value the company has a weighted average cost of capital of 10.62%, Attributes of Purple Panda Total Entity Value Value of Common Equity Intrinsic value (per share) the market value of debt and preferred stock are $21,949,153 and $12,193,974 respectively, ILUL the company does not currently own any marketable securities, and there are 30,000 shares of Purple Panda outstanding
