Which of the following is a condition for the value of equity obtained from free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) approaches to be same? A) Growth rate used in both approaches should be equal. B) Market value of bonds should be higher than the book value. C) Market value of bonds should be lower than the book value. D) Assumptions of the growth rate should be consistent in both approaches.
A) is most correct D) would have been the answer if A) wasn’t here (how can the growth rates be inconsistent if they are the same?)
What if the cost of that debt is really high? Would that make a difference?
I am with D here … but too subjective queston.
Thats why I questioned them being the same. They can be consistent in both growth rates are positive or trending up.
Your answer: D was correct! The value of equity from both approaches will be the same when the assumptions of growth rate are consistent in both approaches (this does not mean that same growth rate is used for both approaches, but the growth rate in earnings should reflect effect of leverage) and bonds (debt outstanding) are correctly priced.