Is Growth rate of FCFE equal to Growth rate of Net Income (CBOK Reading 31, practice question 11)

CFA Level II Equities
#1

Hi,

In the CBOK reading 31 on Free cash flow valuation, practice question 11…

The question provides the following info:

“After three years, the growth rate of net income will be 8 percent and the net investment in operating assets (capital expenditures minus depreciation plus increase in working capital) each year will drop to 30 percent of net income.”

And in the answer provided in the CBOK, to determine Terminal Value, the author multiply the FCFE by 1.08, and in the denominator he/she takes the required rate of return subtract by 8%.

This implies that the author assumes that the FCFE growth rate is the NI growth rate, which in my opinion is not accurate. Because the Net investment in operating assets is not constant.

Or am I missing something here?

Many thanks.

#2

The growth rate of FCFE does not have to equal the growth rate of net income in the short run, for many reasons.

In the long run, I’d expect them to be close to equal.