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future cash flows, forecasts and market structure

Answer true or false to each question with one or two sentences of explanation for each.

1. The greater the uncertainty of the future, the greater the need for alternative scenarios in projecting future cash flows.

2. The reliability of continuing value estimates is greater than of explicit forecast estimates.

3. Competition is a factor in forecasts that relates more to the pricing estimates in a forecast than to the costs to produce a firm's product.

4. Forecasting labor costs over the future is more difficult for an industry that is seriously restructuring than for a firm in the retailing sector.

5. Forecasting cash flows in the last five years for major airlines has become much easier than fifteen or twenty years ago.

6. The changing market structure facing a firm in its product market has more impact on a firms pricing policy than do changes in tax laws.

7. A firm's balance sheet is a stock statement while its income statement is a flow statement reflecting the changes in two consecutive balance sheets.

8. In Marshall's economic profit model, economic profit increases the more competitive are product markets.

9. Because of the time value of money, the discounted present values of a given absolute dollar amount are smaller for estimates of continuing value than the explicit forecasted values of the near term or explicit forecasts.

10. The Payback model has more significance in an industry with rapid technological change than in one where such rapid changes do not occur.

11. The greater the discontinuities in addition to a firm's fixed capital, the more difficult are forecasts of near term cash flows.

12. In times of rapid technological change in product markets and in the determination of such things as the labor to capital ratio, the assumptions in the continuing value model are less reliable than if the firm operated in product and resource markets where little change occurred.

13. As opposed to the Discounted Cash Flow (DCF) Models, the Economic Profit Model does not involve the estimation of future profits and cash flows.

14. Free cash flows (FCF) are subject to management decisions for increasing or decreasing capital investments.

15. Charges for depreciation must be added back to profits in calculating FCF.

16. Corporate taxes paid in-cash must be added back in determining FCF.

17. Growth is only a successful driver of increased business value if Return on Invested Capital (ROIC) exceeds weighted average cost of capital (WACC).

18. As industries become increasingly competitive, economic profit, as defined by Alfred Marshall, tends to increase in size.

19. As interest rates rise, in a persistent and significant manner, the WACC tends to decrease.

20. According to the Modigliani-Miller Model, in a tax-free world, the enterprise value of company is independent of the capital structure, that is, the ratio of debt to equity.

21. Return on Assets (ROA) and Return on Equity (ROE) are metrics determined by FCF.

22. On the balance sheet, the values of fixed assets are based on historical costs, not on the present value on expected FCF.

23. In estimating the WACC, we use the current cost of the capital components as viewed in current markets, rather than the historical costs, when the existing capital was raised.

24. If interest rate expense on debt capital is deductible in determining the tax liability, while dividends on capital stock are not, the component weight of debt capital will be greater than if dividends and interest rates were treated equally for tax purposes.

25. If you anticipated rising interest rates over the next several years and you wished to issue long-term debt bonds to raise capital, callable bonds would make more sense than if interest rates were to fall over the next few years.

Solution Preview

1. The greater the uncertainty of the future, the greater the need for alternative scenarios in projecting future cash flows. True.
In fact alternative scenarios are used in projecting cash flows, where historical information is not available. Scenarios attempt to show potential future cash flows that indicate how the current situation could develop into a future situation.

2. The reliability of continuing value estimates is greater than of explicit forecast estimates. False:
The reliability of the explicit forecast estimates is more reliable. The reason is that in continuity value estimates both the discount rate and the growth rate are assumption. Any of these can introduce inaccuracies.

3. Competition is a factor in forecasts that relates more to the pricing estimates in a forecast than to the costs to produce a firm's product. True
The extent of competition affects the prices. If there is perfect competition, the firm cannot influence prices; in case of monopolistic competition the firm can influence prices to some extent.

4. Forecasting labor costs over the future is more difficult for an industry that is seriously restructuring than for a firm in the retailing sector. True.
The industry that is seriously restructuring has a different organizational structure after the process is complete. The forecast for a restructuring industry must first forecast the organizational structure after restructuring before it estimates labor costs. In case of retailing industry the forecaster directly estimates the future labor costs.

5. Forecasting cash flows in the last five years for major airlines has become much easier than fifteen or twenty years ago. False.
The forecasting of cash flows in the last five years for major airlines has become much difficult than fifteen or twenty years ago. The fuel price increase is difficult to estimate, mergers and acquisitions are unpredictable, and when the economic upturn will occur is difficult to predict.

6. The changing market structure facing a firm in its product market has more impact on a firms pricing policy than do changes in tax laws. True.
The market structure determines the demand curve for the firm. Any change in market structure can lead to immediate change in prices. For instance, if there is a monopoly and ...

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