1. Explain the concept of "free" cash flows. What makes them "free"?

Free cash flows are cash flows that are generated by the operations of the firm and, after making necessary investments in future operating and investing activities, are unencumbered and available to be distributed to shareholders and debtholders.

2. The theory supporting free cash flow-based valuation is that

free cash flows into the firm are value-relevant to common equity shareholders because they represent the cash flows that will be available to pay future dividends to the equity shareholders.

3. How do free cash flows available for debt and equity stakeholders differ from free cash flows available for common equity shareholders?

Free cash flows available for debt and equity stakeholders include cash flows that are available to repay debtholders, whereas free cash flows available for common equity shareholders do not.

4. Describe which types of cash flows are not free for common equity shareholders?

Cash flows required to repay debt principal and cash flows required to pay interest expense

5. The free cash flow-based valuation approach cannot be used for firms that generate negative cash flows.

false

6. Conceptually, why should you expect valuation based on dividends and valuation based on the free cash flows for common equity shareholders to yield identical value estimates?

All of these answer choices are correct.

7. If the firm borrows cash by issuing debt, how does that transaction affect free cash flows for common equity shareholders?

In that period, borrowing increases cash flows available for equity shareholders but reduces the available cash flows in future periods when the debt must be repaid.

8. Suppose you are seeking to value a stream of expected future cash flows that will be used to pay all future debt and equity holder financing claims. What is the appropriate discount rate?

The weighted-average cost of capital

9. Suppose you are valuing a healthy, growing, profitable firm and you project that the firm will generate negative free cash flows for equity shareholders in each of the next five years. Explain how a free-cash-flows approach can produce positive valuations of a firm that is expected to generate negative free cash flows over the next five years.

You can use the free cash flows-based valuation approach in this case and determine a positive value of the firm as long as the long-run cash flows (beyond the five-year forecast horizon) will be positive.

10. Describe circumstances when free cash flows to equity shareholders and free cash flows to all debt and equity stakeholders will be identical.

When the firm is only financed by common shareholders' equity, with no outstanding debt or preferred stock