CFA Level 2 - Equity Session 12 - Reading 43 Free Cash Flow Valuation - LOS c

University
CFA Institute
Course
CFA Level 2 - Equity
Pages

3

Academic year

2023
Author

anon
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27

CFA Level 2 - Equity Session 12-Reading 43 Free Cash Flow Valuation - LOS c (Practice Questions, Sample Questions) 1. The following information is derived from the ﬁnancial records of Brown Company for the year ended December 31, 2004: Sales$3,400,000 Cost of Goods Sold (COGS)(2,100,000) Depreciation(300,000) Interest Paid(200,000) Gain on Sale of Old Equipment400,000 Income Taxes Paid(300,000) Net Income$900,000

Brown issued bonds on June 30, 2004 and received proceeds of$4,000,000.Old equipment with a book value of $2,000,000 was sold on August 15,2004 for $2,400,000 cash.Brown purchased land for a new factory on September 30, 2004 for$3,000,000, issuing a $2,000,000 note and paying the balance in cash.Cash ﬂow from operations less capital expenditures is: A) $2,200,000. B) $200,000.C) $6,200,000. <Explanation> A) Brown’s cash ﬂow from operations (CFO) was $800,000 = ($900,000 Net Income + $300,000 depreciation ?$400,000 gain).Capital expenditure cash ﬂows were ?$1,000,000 for the factory and$2,400,000 cash received from sale of the old equipment for a netinﬂow of cash of $1,400,000.$2,200,000 = ($800,000 + $1,400,000) 2. Free cash ﬂow to the ﬁrm (FCFF) adjusts earnings before interest and taxes (EBIT) by: A) subtracting investments in ﬁxed capital and working capital. B) deducting taxes, adding back depreciation, and deducting theinvestments in ﬁxed capital and working capital. C) adding taxes, deducting depreciation, and adding back theinvestments in ﬁxed capital and working capital <Explanation> B) As presented in the reading: FCFF = EBIT (1 – tax rate) + Dep – FCInv – WCInv.

3. In computing free cash ﬂow, the most signiﬁcant non-cash expense is usually: A) deferred taxes.B) capital expenditures. C) depreciation. <Explanation> C) Depreciation is usually the largest non-cash expense. 4. Which of the following items is NOT subtracted from the net income to calculate free cash ﬂow to equity (FCFE)? A) Interest payments to bondholders. B) Subtractions to notes payable.C) Additions to cash. <Explanation> A) Interest payments to bondholders are included in the income statement and are already subtracted to calculate netincome.