\"In the equity free cash flow model, if the value for the ND (net debt) is nega
ID: 2657613 • Letter: #
Question
"In the equity free cash flow model, if the value for the ND (net debt) is negative, it means that in the period, the principal repayment is higher than the newly issued debt." True or false?
Select one:
a. True
b. False
The risk-free rate is 4%; the market risk premium is 8%. LDC Company’s stock has a beta of 1.5. The last dividend was $4, and the dividend growth rate (g) is expected to be a constant of 10%. The stock’s current market price (P0) is $70.
If you buy the stock now, what is the expected rate of return for the first year? Assume that the stock price will reach the equilibrium level at t=1 if it is currently mispriced.
Select one:
a. 21.53%
b. 24.75%
c. 18.43%
d. 15.87%
Based on the following data, what is the free cash flow for year 1?
Year
1
Revenue
665.00
Fixed costs
80.00
Variable costs
250.00
Additional investment in NWC
15.00
Additional investment in operating long-term assets
90.00
Depreciation
75.00
Tax rate
0.40
Select one:
a. $121
b. $126
c. $137
d. $103
e. $116
Year
1
Revenue
665.00
Fixed costs
80.00
Variable costs
250.00
Additional investment in NWC
15.00
Additional investment in operating long-term assets
90.00
Depreciation
75.00
Tax rate
0.40
Explanation / Answer
FCFE = Net Income - Net Capital Expenditure +/- Change in Net Working Capital + New Debt - Debt Repayment.
1. Option a is correct because New Debt - Debt repayment is negative then principal payment is more than new debt
2. Under CAPM cost of Equity = Risk Free rate + Beta * Market Risk Premium = 4% + 1.5 *8% = 16%
Price of Stock = Dividend *(1+Growth)/(Cost of equity - Growth) = 4* (1+10%)/(16%-10%) = 4.4/0.06 = 73.33
Price of stock After 1 year = 73.33*(1+Growth) = 73.33*(1+10%) = 80.66
Expected rate of return after First year = (80.66 + 4.4 -70)/70 = 21.53%
c)FCFE = Revenue - Fixed cost - Variable Cost - Depreciation) * ( 1- tax rate) + Depreciation - additional investment in NWC - additional investment in operating expenses = (665 - 250 -80 - 75)*(1-40%) + 75 - 90 -15 = 126
option b correct option.
Best of Luck. God Bless
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