- CFA Exams
- CFA Level I Exam
- Topic 5. Equity Investments
- Learning Module 8. Equity Valuation: Concepts and Basic Tools
- Subject 3. Present Value Models: The Dividend Discount Model
CFA Practice Question
The best description of the measure of cash flow to use when estimating the total value of a firm is the operating free cash flow ______.
B. prior to interest payments on debt but after deducting funds needed for capital expenditures
C. after adjustment for payments to debt holders but before dividend payments to common stockholders
A. prior to interest payments on debt
B. prior to interest payments on debt but after deducting funds needed for capital expenditures
C. after adjustment for payments to debt holders but before dividend payments to common stockholders
Correct Answer: B
The appropriate cash flow for estimating the total value of a firm is the operating free cash flow prior to interest payments on debt but after deducting funds needed for capital expenditures.
User Contributed Comments 3
| User | Comment |
|---|---|
| lvjunzhang | why not C? |
| ascruggs92 | CapEx is typically a necessary investment to keep the business running. For example, if oil companies didn't acquire new land and equipment to drill, it would eventually run out of oil to drill and/or it's rigs would break, then they would go out of business. For this reason it wouldn't make sense to count it in free cash flow (measure of cash flow used in estimating firm value) because it is a constant and necessary cash outflow that will not be available to equity holders. To put it simply - think of CapEx spending as the initial cash outflow used in the NPV for a project. |
| khalifa92 | FCFE = CFO - FCInv + Net borrowing |