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1. for getting g, whether it’s PBIT or dividend, we can either use the formula of “dividend growth from past dividend patterns” or “growth using the earnings retention model(gordon’s growth model)” ?
2.. for g calculation, they have used DVM model for estimating dividend growth from past dividend patterns.
However if we use g = r x b (Gordon’s growth model)
r is the rate of return to equity ( which is cost of equity) and b is the earnings retention rate ( which is rfr).
then it will be 3.2%[7-3.8] x 11% = 35.20%Im abit confused in using Gordon’s model for getting g…
3. for getting perpetuity of FCFE, shouldn’t it be Ke(cost of equity) not cost of capital ?
Or is it just assuming that we couldn’t get cost of equity in the question therefore we have assumed cost of capital is same as Ke ??
4. i think last time you told me that we must ignore interest when calculating free cash flow(since debt interest is accounted in WACC). When we look at the formula for Free cash flow to the firm, we do not include interest but for free cash flow to the equity, they do include interest.
Then for free cash flow to the equity calculation, if we include the debt interest(As per formula), doesn’t the final value accounts the debt interest twice since debt interest is also accounted in the WACC and in the calculation of free cash flow ?
5. for most of p4 questions so far in the past year exam questions, they have asked for free cash flow to the firm. Is there any questions in the past they have asked for the free cash flow to the equity ?
1 & 2 Which method you use depends on the information given. r is Gordons growth model is the rate of return reinvestment, which is not the return to equity. I explain all this in my lectures. In this question you do not know the return on reinvestment and the question specifically tells you how to calculate the growth.
3. The question specifically asks you to use free cash flow to the firm, and this is discounted at the WACC, not at the cost of equity.
4. For free cash flow to equity, we do subtract the interest and then discount at the cost of equity, not at the WACC. I explain this in my lectures.
5. Yes, but I can’t remember which.
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