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Basic Question 4 of 4
Which of the following statements is (are) true with respect to the recognition of value in the free cash flow to equity (FCFE) model relative to the dividend discount model (DDM)?
II. For new and growing enterprises, the FCFE would be a better benchmark to discount than dividends.
III. FCFE can be influenced by such things as new share issues, whereas dividends are only ultimately derived from earnings.
IV. If a company has no net borrowing over a period, then its EBITDA may be used as a substitute for its FCFE.
I. If the investor will be exercising a heavily influence on the company's decisions, than the DDM would be more appropriate in valuing the company.
II. For new and growing enterprises, the FCFE would be a better benchmark to discount than dividends.
III. FCFE can be influenced by such things as new share issues, whereas dividends are only ultimately derived from earnings.
IV. If a company has no net borrowing over a period, then its EBITDA may be used as a substitute for its FCFE.
User Contributed Comments 5
| User | Comment |
|---|---|
| ssradja | IV. Also EBITDA is not net of capital expenditures. |
| surjoy | Net Borrowing that include new issues will influence FCFE. Then why III is incorrect? |
| DAPC | You are not borrowing when you issue shares. You are capitalizing the company. Net borrowing only accounts for Debt issuance/payments. (or so that is how i see it). |
| weiw | Why II is correct? FCF model can not be used for growing company according to the note. Maybe it's better than dividend since such companies don't typically issue dividends but still produce cash flows? |
| JohnnyWu | I figured DDM and FCF are equally bad for valuing new and growing companies. Most do not pay dividends and could have negative FCF due to high capex. |
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Learning Outcome Statements
compare the free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) approaches to valuation;
explain the ownership perspective implicit in the FCFE approach;
CFA® 2025 Level II Curriculum, Volume 4, Module 22.