Free Cash Flow Valuation

Correct Answer: The company's current price-to-earnings (P/E) ratio

The company's current price-to-earnings (P/E) ratio is least likely to be a key driver in a free cash flow valuation model for a mature company. A free cash flow valuation model focuses on projecting a company's future cash flows and discounting them back to present value. The key drivers are typically factors that directly impact the company's cash flow generation ability, such as revenue growth rate and profitability over the forecast period. The discount rate, based on the company's cost of capital, is also a crucial input as it determines the present value of those future cash flows. On the other hand, the current P/E ratio is more of a market-based valuation multiple that reflects the market's expectations and sentiment towards the company. It does not directly factor into the fundamental cash flow projections in a DCF model. While the P/E ratio can be used for relative valuation purposes, it is not a key driver of the intrinsic value estimate derived from a company's discounted free cash flows.

Correct Answer: Depreciation and amortization

When calculating the free cash flow to the firm (FCFF), depreciation and amortization are added back to net income. This is because these non-cash expenses reduce net income but do not actually represent a cash outflow. Capital expenditures and increases in working capital are subtracted from net income when calculating FCFF, as they represent cash outflows that are not captured in the net income figure. Interest expense is subtracted from operating income to arrive at net income, so it would not be added back. Non-cash charges are a broad category that could include depreciation and amortization, but may also include other items that are not necessarily added back when calculating FCFF.

Correct Answer: The company's working capital requirements grow at the same rate as its stable growth rate.

The most appropriate assumption about a company's working capital requirements during the stable growth phase when using the FCFF valuation approach is that they grow at the same rate as the company's stable growth rate. During the stable growth phase, a company's growth has slowed down to a steady, sustainable level. As a result, its working capital needs, which are tied to its operations and sales, would also be expected to grow at this stable rate. Assuming zero working capital requirements during the stable growth phase is incorrect because even mature companies have ongoing working capital needs to support their operations. Assuming a constant percentage of revenue, typically higher than during the high-growth phase, is also incorrect. As a company matures and its growth slows, its working capital needs as a percentage of revenue would typically decrease and stabilize, not increase.