- CFA Exams
- CFA Exam: Level II 2021
- Study Session 11. Equity Valuation (3)
- Reading 28. Free Cash Flow Valuation
- Subject 2. Computing FCFF and FCFE from net income, EBIT, EBITDA, or CFO

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**CFA Practice Question**

An analyst is reviewing the following data with respect to York Co.:

B. $904,210,884

C. $835,468,669

- 5 million shares outstanding
- Market risk premium is 6%
- Debt to total capital ratio is 30%
- Risk-free rate is 3%
- York Co beta is 0.92
- Long term debt of $215 million has an interest cost of 7%
- Tax rate is 40%
- Current free cash flow to the firm (FCFF) is $24 million
- FCFF is expected to grow 21% over the next two years, 17% in the third year,
- And thereafter, grow at a constant rate of 3%

Which of the following would best estimate the total value of the firm?

A. $1,008,221,095

B. $904,210,884

C. $835,468,669

Correct Answer: B

Step 1. Compute WACC. WACC = 0.3 x 7% x (1 - 0.4) + 0.7 x 8.52% = 7.224%. Note that 8.52% = 3% + 0.92 x 6%.

Step 2: Forecast future period FCFF:

Step 3. Compute the terminal value of the firm at the point that its growth rate stabilizes (since growth stabilizes in year 4, we calculate terminal value as of the end of the year 3):

V

_{3}= FCFF_{4}/(WACC - g) = 42,345,286/(0.07224 - 0.03) = 1,002,492,566Step 4. Compute the PV of all interim FCFFs and the terminal value.

V

_{0}= 29,040,000/1.07224 + 35,138,400/1.07224^{2}+ 41,111,928/1.07224^{3}+ 1,002,492,566/1.07224^{3}= 904,210,884###
**User Contributed Comments**
9

User |
Comment |
---|---|

blackberry1 |
THAT TAKES LOT OF TIME |

aravinda |
just making sure -- is this right? debt/capital = debt / (debt + equity) |

Allen88 |
yep, it's right aravinda |

REITboy |
I did it completely differently (wrong, I guess), but got the right answer. I used Ke of 8.52% instead of WACC to discount back the FCFF (=689), then added back the value of the LT debt. Don't know why it worked, but it did.. |

quanttrader |
wow what a very long section! |

endurance |
pretty straightforward.... 1) WACC, 2) cash flows, 3) term value, 4) CF menu on the BAII |

davcer |
total capital=capital + liabilities |

sahilb7 |
This is too loooooooooooooooooooooong! |

ashish100 |
Just like how my paycheck is going to look like.. |