- CFA Exams
- CFA Level I Exam
- Study Session 10. Equity Valuation (2)
- Reading 27. Discounted Dividend Valuation
- Subject 1. Streams of expected cash flows
CFA Practice Question
An investor is trying to value the following companies:
Company B: profitable, large size, regular dividend-paying but the dividend policy does not bear a consistent relationship to the company's earnings.
Company C: regular dividend-paying. Its free cash flows align with its profitability. The investor is considering acquiring a controlling stake.
Company A: medium size, in the growth phase, highly profitable, large demand for capitals to keep growing.
Company B: profitable, large size, regular dividend-paying but the dividend policy does not bear a consistent relationship to the company's earnings.
Company C: regular dividend-paying. Its free cash flows align with its profitability. The investor is considering acquiring a controlling stake.
Free cash flow model is not appropriate to value:
A. A only.
B. A and C only.
C. B only.
Explanation: As the company has large capital demand, its free cash flow may be negative. Since prediction of free cash flow far in the future would be imprecise, FCF model cannot be used for growth companies.
User Contributed Comments 2
| User | Comment |
|---|---|
| yxten1 | But can FCF model be used when there's a controlling premium? I doubt |
| Cesarnew | yes it can be used - this issue is mentioned in the los |