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Growth and Return on Invested Capital, Required Rate of Return, Competition

3. How does growth and return on invested capital drive free cash flow? Illustrate with an example employing constant and non-constant growth rates.

7. Why might large firms experience lower rates of growth than smaller firms? What is the danger of having a large company attempt to match the growth of a small company?

3. Why is the required rate of return on common stock greater than on bonds?

5. If interest on debt is deductible in arriving at taxable income, and dividends on stock is not so, how does that situation alter the optimal capital structure?

9. How is competition in the product markets related to the valuation of the firm in the economic profit model?

10. In the economic profit model (i.e. EVA), is the opportunity cost of equity capital treated as cost, as debt capital is?

11. How can management's plan to change the outlays for new capital investment impact the enterprise DCF model's estimate of business valuation?

12. When interest rates rise, how does that impact the cost of capital?

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3. How does growth and return on invested capital drive free cash flow? Illustrate with an example employing constant and non-constant growth rates.

Return on invested capital usually leads to more revenue and earnings for a company that leads to higher growth in the company. Since more earnings would lead to increase in free case flow, so growth and return on invested capital will result in more cash inflow for the company. (Mckinsy et al, 2003).

A constant growth stock is a stock whose dividends are expected to grow at a constant rate in the foreseeable future. This condition fits many established firms, which tend to grow over the long run at the same rate as the economy whereas non-constant growth stocks presents a more general approach which allows for the dividends/growth rates during the period of rapid growth to be forecast. Then, it assumes that dividends will grow from that point on at a constant rate which reflects the long-term growth rate in the economy That implies both constant and non-constant growth rates result in better cash flow for the company.

7. Why might large firms experience lower rates of growth than smaller firms? What is the danger of having a large company attempt to match the growth of a small company?

Large firms and small firms have different characteristics and have different level of performances for same invested capital. Both kind of firms have different economies of scale, different cost of capital, different cost curves, and different ...

Solution Summary

The solution examines the growth and return on invested capital. How the competition in product markets relates to the valuation of the firm in the economic profit model is given.

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