Jesus, do you no understand that it doesn’t matter when the firm starts operating at constant growth or not? All that matters is when the $5.25 FCFE occurs (which I have shown) is at time 5 (not time 4) and when the terminal value is to be computed (which I have also shown to be at time 5 since it is given that the FCFE occurs at time 5). Unless you are saying that the 5.25 FCFE takes place at time4 and the valuation occurs at that time4 you and Schweser are wrong.
YES, the FCFE of 5.25 IS at the end of year 5… but here’s the thing… When you discount based upon a constant growth model, you are discounting from the BEGINNING of the constant growth period, using the NEXT YEAR’S FCFE… Which is 5.25 as you said. The formula for Gordon Growth in year 0 (in this case the beginning of constant growth since we are only calculating the terminal value) is: V(year 0) = FCFE(year 1) / (r - g) V(year 0) = 87.5 FCFE(year 1) = 5.25 r = 11% g = 5% So yes, you are calculating the terminal value at the beginning of constant growth, and yes, you are using the FCFE at the end of year 5… and that’s why Schweser’s question is correct. Understand?
No, because using the time5 FCFE of 5.25 and dividing by r-g gives you the terminal value of the company at time4, not time5 like the question asks (i…e the question asks what is the terminal value “AT THAT TIME” since above you agree with me that “THAT TIME” means time5 then we need the time6 FCFE which we divide by r-g to get the terminal value “AT THAT TIME,” that time of course being time5).
Agree with adavy here