CFA Level I · CFA Level I Exam · Discounted Cash Flow (DCF) and Growth Models
An analyst values a young firm that pays no dividends and has negative free cash flow to the firm now, but is expected to turn strongly positive in several years. Which approach is most appropriate?
A multistage free cash flow model with a terminal value is most appropriate. The firm pays no dividends and has negative cash flow today, so constant-growth dividend models cannot be applied, while explicit forecasts followed by a terminal value capture the later positive cash flows.
- AGordon growth dividend discount model
- BMultistage free cash flow model with a terminal valueCorrect
- CSingle-stage dividend discount model using payout ratio
Explanation
With no dividends and negative current cash flow, single-stage models fail. A multistage FCF model explicitly forecasts the years until cash flows turn positive and then applies a terminal value.
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