Medium2 marksMultiple Choice

Business ValuationsBusiness valuationsFree Cash FlowSection B

This question is part of a case study — click to read the full scenario(Case 21)

Section B - Case 2: Helios Co

Helios Co operates wind farms across Europe. It is looking to acquire a smaller competitor, Aura Ltd. To assess the acquisition, Helios needs to calculate its own Weighted Average Cost of Capital (WACC) and value Aura Ltd.

Helios Co Data:
Current share price: $4.50
Recent dividend paid (D0): $0.30
Historical dividends:
4 years ago: $0.24
3 years ago: $0.25
2 years ago: $0.27
1 year ago: $0.28

Using the historical dividend growth rate, what is Helios Co's estimated Cost of Equity (Ke) using the Dividend Valuation Model?

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ACCA · Question 23 · Business Valuations

Section B - Case 2: Helios Co

Helios Co is valuing the target company, Aura Ltd, using the Free Cash Flow to Firm (FCFF) method.

Which of the following correctly describes how to arrive at the Equity Value of Aura Ltd using this method?

Answer options:

Discount the FCFF at the Cost of Equity to find the Enterprise Value, then add the market value of debt.

Discount the FCFF at the WACC to find the Enterprise Value, then subtract the market value of debt.

Discount the FCFF at the Cost of Debt to find the Equity Value directly.

Discount the FCFF at the WACC to find the Equity Value directly.

How to approach this question

Remember the relationship: Enterprise Value = Equity Value + Debt Value. Therefore, Equity Value = Enterprise Value - Debt Value.

Full Answer

B.Discount the FCFF at the WACC to find the Enterprise Value, then subtract the market value of debt.✓ Correct

Free Cash Flow to the Firm (FCFF) represents the cash available to all providers of capital (both debt and equity). Therefore, it must be discounted at the Weighted Average Cost of Capital (WACC). The resulting present value is the Enterprise Value (or Value of the Firm). To find the value attributable only to shareholders (Equity Value), you must subtract the market value of the company's debt.

Common mistakes

Assuming discounting FCFF gives the Equity Value directly (Option D).

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Practice the full ACCA FM — Financial Management Practice Exam 2

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