$3.$ Free cash flow and financial statements

The primary objective of the corporate management team is to maximize shareholder wealth. The company$$s board of directors and the shareholders evaluate and review managerial actions based on the growth in the value of the firm.

Based on your understanding of what determines a firm$$s value, review the following:

What does the value of a firm depend on$?$

Option A The firm$$s ability to generate positive cash flows now and in the future

Option B The firm$$s past ability to generate positive cash flows

Which of the options is most accurate?

Option B

Option A

When determining the value of a firm, which of the following statements is true?

A financial asset is considered to have value only if it is acquired at its market value.

A financial asset is considered to have value only if it has the ability to generate positive cash flows.

A financial asset is considered to have value only if it is acquired at its book price.

Managers strive to increase the value of a firm. An increase in the intrinsic value of the firm$$s stocks is a good measure of the increase in the value of the firm. Intrinsic value of a firm$$s stock price is determined by calculating the present values of its free cash flows $($FCF$)$ discounted at a rate called the weighted average cost of capital $($WACC$).$

Tyler is a team member in Corporate Finance at a digital$-$content production company. He is required to forecast the free cash flows that the company will be able to generate in the next three years. Tyler takes into account only the following equation in his calculation:

FCF $=$ Sales Revenues $$ Operating Costs $$ Operating Taxes

Will his calculation be an appropriate estimate of the FCF$?$

Yes

No

Why or why not? Check all that apply.

Because his calculation fails to include the increase in the working capital required to grow sales

Because his calculation fails to include the costs of the firm$$s interest and dividend payments

Because his calculation fails to recognize the increase in sales revenues

Because his calculation fails to include both the working capital and capital expenditures necessary to sustain the company$$s operations