Question

1. You value a company using the discounted free cash flow model and the residual operating income model. You are surprised that the valuations are different. Which of the following could be the cause?

	A.	Your forecast horizon is too short
	B.	You have assumed that weighted-average cost of capital (WACC) will be constant in the future
	C.	You have forecasted that the company’s leverage will stay constant
	D.	You have forecasted sales growth to converge to the long-run economic growth rate
	E.	Your steady state forecast has net operating assets growing at the terminal growth rate

Answer 1

Residual operating income (ROPI) Model and discounted free cash flow (DCF) Model have same valuation result when expected pay offs are forecasted for an infinite horizon. The difference between the Valuation result caused by :

A. Your forecast horizon is too short :(TRUE) - When forecast done for an infinite time line Valuation result will be identical. For a short period time will generate difference in end result.

B. You have assumed that weighted-average cost of capital (WACC) will be constant in the future (FALSE) - It does not affect as it will be same for both scenario.

C. You have forecasted that the company’s leverage will stay constant (FALSE) It does not affect as it will be same for both scenario.

D.You have forecasted sales growth to converge to the long-run economic growth rate (FALSE) It does not affect as it will be same for both scenario.

E.Your steady state forecast has net operating assets growing at the terminal growth rate (FALSE) It does not affect as it will be same for both scenario.