Question

These statements are true of false? Explain.

1) In DCF valuation, a company can increase its return on equity (ROE) by increasing
its leverage ratio if and only if its return on capital (ROC) exceeds its after-tax cost of
debt (rd x (1 - Tc)). (Assume all other inputs are fixed.)

2) In the context of the dividend discount model (DDM), a company can always increase
its intrinsic equity value by increasing its dividend payout ratio if and only if ROE < re.
(Assume all other inputs are fixed.)

3) After-tax interest expenditures are included in the calculation of free cash flow
to the firm (FCFF).

4) Cash dividends and share repurchases (buy-backs) are irrelevant for the calculation
of free cash ow to equity (FCFE).

Answer 1

1)
TRUE

2) In the context of the dividend discount model (DDM), a company can always increase
its intrinsic equity value by increasing its dividend payout ratio if and only if ROE < re.
(Assume all other inputs are fixed.)
TRUE

3) After-tax interest expenditures are included in the calculation of free cash flow
to the firm (FCFF).
FALSE

4) Cash dividends and share repurchases (buy-backs) are irrelevant for the calculation
of free cash ow to equity (FCFE).
FALSE