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Hi,
Please, help me with Q1 from the P4 pilot paper. I just cannot understand the solution to point (c). It is required to estimate the value of Flihi using free cash flow to equity (FCFE), however, in answers, they calculate free cash flow (FCF), i.e. they do not take into account repayment of debt, and then discount it at cost of equity to arrive to company’s value of equity. BPP and Kaplan (and some other books on valuation) say that I either discount future FCFs at cost of capital (WACC) to get enterprise value (Debt+Equity) or future FCFEs at cost of equity to get value of equity. Could someone explain this inconsistency in solution?you are right that to calculate FCFE we should deduct debt repayment…but this rule only applies when we can be sure that debt repayment is done every year…as Q1 of pilot paper..current repayment of dollar 31 million of secured loans is unlikely to continue in future..so on assumption that company wont repay debt in future this figure has not been used in calculating FCFE…not only this..we should include only those figures which is likely to be continued in future over our appraisal period to calculate relevant cash flows.
Hi, why you said the company will not repay the secured loan in the coming years. I can see they paid 25M in 2004 and 31M in 2005 which shew a trend for this practice. And there are no clear figure for the balance of secured loan. Or we should assme this repayment will not happy in the future?
Thanx, anjan, you explanation seems to be quite reasonable, however, I agree with danielnq2008, that it is far from being obvious. Having done some more past exam papers, I found out that there are a lot of such ‘traps’ 🙁
In these type of situation we are allowed to make reasonable assumptions..we will get full marks for it…but remember our assumptions should be reasonable,,even though there is trend of repayment but it would be difficult to predict precisely the amount of repayment in next six years..so considering the situation i would make assumption of no further repayment…
but it does not mean you cannot make assumption of repayment in future..but considering uncertainty due to lack of further information..it is better we make former assumption..and calculate the required figure..however you should be given credit even if you calculate on the basis of assumption of repayment.
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