Skip to content

ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows

A company pays low dividends but generates large FCFE. Why might an analyst prefer an FCFE valuation to a dividend valuation model?

FCFE reflects the cash available to shareholders whether or not it is paid out. Where dividends are low but the firm generates surplus cash after reinvestment and debt servicing, a dividend model would understate value, while FCFE captures the underlying earning capacity for equity holders.

  1. AFCFE ignores the cost of equity so it is easier to apply
  2. BFCFE reflects cash available to shareholders regardless of the amount actually distributedCorrect
  3. CFCFE includes cash flows to debt holders so values the entire firm
  4. DFCFE is always lower than dividends so it is more prudent

Explanation

FCFE measures cash that could be paid to shareholders after reinvestment and debt servicing, so it captures value even when payout is below capacity. It is still discounted at the cost of equity. It excludes debt holder flows, and it is not always lower than dividends.

Did you get it right without looking?

One question tells you little. A timed set on Valuation and the use of free cash flows shows your real accuracy, how long you take and where you lose marks.

Practise Valuation and the use of free cash flowsFree diagnostic mock

More Valuation and the use of free cash flows questions