Mark Miller, CFA is an analyst for Rust Belt Partners, an investment fund specializing in industrial product companies based in the Midwest. His boss, Larry Steele, asked him to investigate the value of the stock of Precision Valves, a mature industrial valves company that had emerged from bankruptcy five years before. Miller was asked to value Precision Valves considering both the Free Cash Flow to Equity (FCFE) and Dividend Discount Model (DDM) approaches. The following is a summary of relevant financial data for Precision Valves, for its fiscal year ended December 31, 2005: Exhibit 6-1 Relevant Financial Data As of December 13, 2005 DOLLAR AMOUNTS IN THOUSANDS Revenue 850,000 Gross Margin 238,000 Selling, General & Administrative Expense 170,000 Operating Income 68,000 Interest Expense 6,000 Profit Before Taxes 62,000 Income Tax Expense @ 35% 21,700 Net Income After Taxes 40,300 Depreciation Expense 32,000 Capital Expenditures 38,000 Amortization Expense 2,750 Precision Valves also reported its balance sheet for the years ended December 31, 2004 and 2005 as follows: Exhibit 6-2 Precision Valves Balance Sheets DOLLAR AMOUNTS IN THOUSANDS December 31, 2004 December 31, 2005 Cash 25,000 30,000 Current Assets (Non-Cash) 60,000 68,050 Property, Plant & Equipment, Net 275,000 281,000 Intangible Assets, Net 55,000 52,250 Goodwill 180,000 180,000 Total Assets 595,000 611,300 Current Liabilities (Debt-Free) 60,000 62,000 Long-Term Debt 105,000 95,000 Other Long Term Liabilities 40,000 40,000 Stockholders’ Equity 390,000 414,300 Total Liabilities & Stockholders’ Equity 595,000 611,300 The following is additionalinformation on Precision Valves and on Capital Markets as of January 31, 2006: Exhibit 6-3 Additional Information Dividends for fiscal year 2005 (in thousands) 16,000 Common shares outstanding 8,000 Risk-free rate 4.5% Precision Valves Beta 1.3 Equity Risk Premium 5.0% 36. When deciding whether the single stage DDM method or the single state FCFE method is more appropriate when valuing the per share value of Precision Valves, Miller concludes that: A. it doesn’t make a difference, since both methodologies result in the same value per share. B. the FCFE approach is better, because it more accurately reflects the dividend “potential” of Precision Valves. C. since Precision Valves’ return on equity exceeds its cost of equity capital, he should be using a residual income method instead. D. the DDM approach is better, because, as a potential minority shareholder of Precision Valves, Rust Belt is not in a position to compel the company to change its dividend policy.

Tricky question… C - Incorrect deduction. D - The shareholder ownership is not mentioned for the company B - FCFE doesn’t seem to reflect dividend A - Most Appropriate. Because more often DDM, FCFE and FCFF result in similar values. Is A the correct answer?

i would go with B.

No the answer is D… ofcourse…i agree the answer is logical but there is nothing in the problem that says so… BTW it is old boston paper

D for me