Question
Evaluate the statement: The free cash flow calculation method provides an overestimation of the true firm value, since it does not take into account the
Evaluate the statement: "The free cash flow calculation method provides an overestimation of the true firm value, since it does not take into account the interest payments that the firm needs to make to its debtholders".
| 1. partly correct. Ideally we would indeed want to correct for interest payments in free cash flow calculations. However, it is very hard to obtain an accurate estimate of the interests that companies are paying on their debt. For that reason, interest payments are usually not taken into account. | ||
| None of the answers | ||
| Completely correct. | ||
| The statement is incorrect, since interest payments are already included in free cash flow calculations (i.e. they are deducted from the cash flows in the numerator of the valuation formula). | ||
| The statement is incorrect, since the effect of the interest payments is already accounted for in the WACC of the company (used in the denominator of the free cash valuation formula). Including it in the cash flow calculation would lead to double counting. |
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