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

Kora Co has free cash flow to the firm of $12m next year, expected to grow at 3% indefinitely. Its WACC is 9%. Debt has a market value of $40m. Dividends are expected to be only $4m next year because of a conservative payout policy. Which statement about valuing Kora's equity is correct?

Equity is worth $160m. Free cash flow of $12m capitalised at 6% gives enterprise value of $200m, and deducting $40m of debt gives equity value. This does not depend on the dividend payout, and WACC is not suitable for discounting dividends.

  1. AFree cash flow gives equity of $160m, being $200m less $40m debt, regardless of the low dividend payoutCorrect
  2. BDividend model value of $4m/(0.09-0.03) is the correct equity value because dividends are the only cash shareholders receive
  3. CEquity is $200m because debt is already included in WACC
  4. DEquity is $240m, being $200m plus $40m debt

Explanation

Enterprise value = $12m/(0.09-0.03) = $200m. Deducting debt of $40m gives equity $160m. Free cash flow value reflects cash generated, not the payout chosen; dividend model with WACC is inconsistent, as WACC is not the cost of equity.

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