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Hi Sir,
The answer gives the formula used to calculate Me:
Me = (FCFxg)/(ke-g)
In which, I would want to clarify that:
1. FCF is free cash flow (it should be free cash flow to equity, right?)
2. growth rate should be growth rate of FCF. Why the answer use the growth rate of dividend (calculated by Gordon theory). I still not get the logic of this answer.Thank you,
I assume that you are looking at the original exam question and answer (I say that because if you are looking at it in a revision kit then it is possible that they might have amended the question, but if so it will say that).
To calculate the MV of the equity we use the free cash flow to equity (and the question specifies to do this). The examiners answer has used the free cash flow to equity, which is given in the question as being $2,600,000. The growth rate is that of the free cash flow to equity (which is the dividend growth rate).
So it means growth rate of free cash flow to equity equal to dividend growth rate?
Could you expain a little bit more on this?
Thank you so much!The free cash flow to equity is the amount available for dividend. even if it is not all paid out as dividend, if there is a constant payout ratio then automatically dividends and free cash flow to equity must inflate as the same rate.
It was the same in Paper FM (was Paper F9) and I illustrate this in my free Paper FM lectures on the cost of capital (chapter 17 of the Paper FM free lecture notes).
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