Question

Which of the following statements about the FCF valuation model are true? Check all that apply.

A. The FCF valuation model recognizes that a firm's value is a function of its risk—including its use of debt and equity financing and the markets in which it operates.
B. The model is useful because it examines the relationship between a company's risk, operating profitability, and value of the firm's operations.
C. The model can be applied to companies that either pay or do not pay a dividend—but it cannot be applied to privately-held companies.
D. A company's FCFs are a function of how efficiently and effectively the firm's managers use the company's operating assets and, in turn, the profitability of the company's primary business activities.

Answer 1

The FCF valuation model does account for a firm's risk and the efficiency of management and is applicable to both public and private firms, whether or not they pay dividends. The correct statements are A, B, and D.

Step-by-step explanation:

In evaluating the truthfulness of statements about the Free Cash Flow (FCF) valuation model, we find that:

• A is true because the FCF valuation model does recognize that a firm's value is influenced by its risk, which encompasses both financing risk from debt and equity and operational risk from the markets in which it operates.
• B is also true as it addresses the model's usefulness in exploring the relationship between a company's risk, operating profitability, and the firm's operational value.
• C is partially incorrect because while the FCF model can be applied to companies that do not pay dividends, it can still be applied to privately-held firms provided there is sufficient information to calculate free cash flows.
• D is true because a company's FCFs are indeed a reflection of the managerial effectiveness in using the company's assets and the resultant profitability of the business's primary activities.

Therefore, the correct statements about the FCF valuation model are A, B, and D.