Question

7. Determinants of intrinsic value

Which of the following correctly represents a firm’s fundamental value?

The ratio of the firm’s free cash flows and its weighted average cost of capital.

The present value of the firm’s expected free cash flows.

The difference between the firm’s free cash flows and its costs.

The following table presents some of the current year’s financial data for the Happy Giraffe Construction Company. Complete the table by computing Happy Giraffe’s free cash flows and fundamental value (rounded to the nearest whole dollar) based solely on this year’s information:

Variable	Value
Sales revenue	$400,000
Operating costs and taxes	$45,000
Required investments in operating capital	$20,000
Weighted average cost of capital	15%
Annual free cash flow
Fundamental value

Assuming all other things being equal, if Happy Giraffe’s costs of equity decreases, the firm’s      will     

Answer 1

7) The correct answer is the present value of the firms expected free cash flows. The firm's fundamental value is calculated by discounting the future value of the cashflows to bring it to today's present time period which is its present value.

Assuming the sales are based on cash basis and this cashflow stream is going to occur forever The free cash flow would be 400000 - 45000 - 20000 335,000.00 The fundamental value of the firm in this case would be free cash flow/ WACC 335000/0.15 2,233,333.33 Assuming all other things being equal, if happy giraffe's cost of equity decreases, the firm value will increases.