USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You are using the free cash flow to equity (FCFE) technique to analyze the U.S. equity market. The beginning FCFE is $90, and the required rate of return is 10 percent. Free cash flows are expected to grow at a 10 percent rate for the next two years and then grow at a constant rate of 7 percent forever.
-Compute the current earnings multiple if the dividend payout ratio for the aggregate market is 60 percent, the required rate of return is 11 percent, and the dividend growth rate is 8 percent.
A) 15
B) 20
C) 25
D) 30
E) 35

Question

Quizplus · Accepted Answer

To solve this problem, we need to calculate the current FCFE using the given information and then divide the current market price by the FCFE to get the earnings multiple.

First, we can use the FCFE formula to calculate the current FCFE:
FCFE = (1 - dividend payout ratio) * net income + depreciation and amortization - capital expenditures - change in net working capital
FCFE = (1 - 0.6) * (0.08 * current market price) + 0 - 0 - 0
FCFE = 0.032 * current market price

Next, we can use the FCFE to calculate the current market price using the FCFE model:
current market price = FCFE / (required rate of return - FCFE growth rate)
current market price = 0.032 * current market price / (0.11 - 0.07)
current market price = $128

Finally, we can calculate the earnings multiple by dividing the current market price by the current FCFE:
earnings multiple = current market price / FCFE
earnings multiple = 128 / (0.032 * 128)
earnings multiple = 20

Therefore, the answer is B) 20.