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Negative Projected Cash Flow And Profitability Of A Firm

Question

Answer the following questions relating to Discounted Cash Flow (DCF) projections and valuations.

(a)    Michael Hudson asks a rhetorical question (tongue in cheek): “What’s not to like about free cash flows? They’re free! Duh!” Briefly, what is your understanding of free cash flows? Also, does a negative projected free cash flow in a future year imply that the firm is not operating profitably in that year? Why or why not?
(b)    “Wussup with the whole little ‘g’ thing?” asks James DeStephens. He is referring to the perpetual growth rate assumed to hold after the terminal date T, beyond which details of future Income Statements and Balance Sheets are not explicitly projected. Explain briefly why we commonly assume that free cash flows grow at a constant assumed rate g after the terminal date.
(c)    “This is so confusing,” mutters an exasperated Apoorva Patel, “I’ve been brought up to believe that growth is a good thing. High growth should be better than low growth.” He was referring to the discussion in class about PDI’s assumed terminal growth rate. The different growth scenarios considered all showed the same valuation. Is it possible for higher growth to result in reduced value? Explain why or why not?


Summary

The question belongs to Finance and it discusses about discounted cash flow projections and valuations. Questions such as negative free cash flow implying the firm not operating profitably, future income statements and balance sheets not explicitly being projected, etc have been answered.

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