Which of the following free cash flow to equity (FCFE) models is most suited to analyze firms in an industry with significant barriers to entry? A) Two-stage FCFE Model. B) FCFE Perpetuity Model. C) E-Model (Three-Stage FCFE Model). D) Stable Growth FCFE Model.
A.
This question came up before and I am pretty sure its A. The firm will have a higher g then it will immediately drop down to a lower level. Think of a patent that expires in 20 years.
sorry didn’t see it was already posted - you are correct with A but I can not understand why? Sure the patent makes sense (so would anything that would limit competition) - but how did you interpret that from this question?
I don’t get this one… I would choose A, but don’t have a good explanation as to why… any insight into this one?
A
My understanding: With high barrier to entry, the firms initially earn high rate of return but gradually introduction of substitues by competitiors the rate of return declines and makes a case od 2 stage FCFE model
Could I possibly get this wrong a third time? A
I can buy that, although I could also make that argument for pretty much any firm that is not already in their stable growth phase.
Why does that make a case for the 2 stage and not 3 stage? (or H-model in the DDM scenario)
here the assumption with high entry barrier is the when the substitues are introduced the time is short enough to reduce the returns of existing firm. its very subjective how you want to treat this but 2 stage is considered appropriate
Def A) See my answer from a month ago when this was debated.
Think of it this way… A firm in an industry with significant barriers to entry is like a man close to dying that has significant barriers to life… so he has 2 periods one is period till he is alive and the other is after his death… that’s how i did all the PM stuff.