- CFA Exams
- CFA Level I Exam
- Study Session 11. Equity Valuation (3)
- Reading 28. Free Cash Flow Valuation
- Subject 5. Free cash flow model variations

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**CFA Practice Question**

Uwe Henschel is doing a valuation of TechnoSchaft using the following information:

- 2003 sales per share = $100.
- Net profit margin = 20%.
- Net new investment in fixed capital = 30% of sales increase (50% of these investments is financed with debt).
- Investment in working capital = 20% of sales increase.
- Beta = 1.3.
- Risk-free rate = 4%.
- Equity risk premium = 6%.

He forecasts the following future sales pattern for the company:

The stock of the company is worth ______using the most appropriate type of FCFE model.

A. $261

B. $283

C. $272

**Explanation:**The company is growing at a constant rate. We use the single stage model in this case.

First we calculate free cash flows to equity for the company:

We then calculate the cost of equity, which will serve as the discount rate in our model: r = r

_{f}+ beta x equity premium = 0.04 + 1.3 x 0.06 = 0.118, or 11.8%.

The value of the company can be calculated using the single-stage model: Equity value V

_{2003}= FCFE

_{2004}/ (r - g) = 19.25 / (0.118 - 0.05) = $283.

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**User Contributed Comments**
6

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

robbe1 |
Implicit assumption is that working capital is entirely equity financed. |

art1997 |
Cash flow to equity does not depend on cost of working capital, only equity cost |

MikeRuz |
how did they find 0,75 (debt financing)? Can anyone help? |

MSRus |
1,5*0,5=0,75 |

philjoe |
depreciation? |

birdperson |
@MikeRuz -- use this formula FCFE = NI - [(1-DR)*(FCinv - Dep)] - [(1-DR)*(wcinv)] -- note here though that as @robbe1 said -- the WC was not debt financed.... so to answer your question.... 30% of increase (which was 5) = 1.5.... 1.5* DR (50%) = 0.75 |