When we valued Microsoft using DCF, we initially obtained a negative Firm value.

Question

BlackTom AI · Accepted Answer

The Gordon (perpetuity) form of the DCF is V = FCF1 / (r − g), so the relation between the discount rate r and the perpetual growth rate g is the core concept.

1) Relevant knowledge points and concepts
- Enterprise (firm) value from free cash flows uses V = FCF1/(r − g) for a stable perpetual growth assumption.
- If g approaches r the denominator shrinks and value explodes; if g = r the formula is undefined (infinite); if g > r the denominator is negative and a positive FCF produces a negative firm value.
- Other modeling mistakes (look-ahead bias, ignoring debt, or negative FCF) have different effects and do not necessarily produce the same symptom.

2) Step-by-step reasoning
- Start with the formula: V = FCF1/(r − g).
- Suppose FCF1 > 0. If you accidentally estimate g > r, then (r − g) < 0. Dividing a positive numerator by a negative denominator yields a negative V.
- If g ≈ r, the denominator is near zero and V becomes extremely large (unstable), which is another sign of an implausibly high growth estimate.

3) Calculation example with intermediate steps
- Let FCF1 = $2 billion, r = 8% (0.08), g = 12% (0.12).
- Compute denominator: r − g = 0.08 − 0.12 = −0.04.
- Value: V = 2 / (−0.04) = −50 (billion). This shows a positive FCF with g > r produces negative firm value.

4) Why the correct answer is correct
- A very large (or larger-than-r) growth rate flips the sign of the denominator in the perpetuity formula, directly producing a negative enterprise value when FCF is positive.

5) Why the other options are incorrect
- Look-ahead bias: an estimation bias that may cause optimistic projections but does not mechanically produce a negative V unless it results in g > r.
- Ignoring debt: that affects equity value adjustments (EV − net debt = equity), not the enterprise (firm) value computed from FCF.
- FCF negative: that would indeed give a negative value, but the specific described symptom in this valuation arose from an implausibly high growth assumption (g relative to r), not necessarily from negative FCF.

Conclusion: The negative firm value resulted from estimating a very large growth rate. This matches the provided answer: "This happened because we estimated a very large growth rate."

When we valued Microsoft using DCF, we initially obtained a negative Firm value.Single choice

Similar Questions

An analyst noticed that an investee company's governance was worsening. To account for this, the analyst is most likely to increase:

The market value of Caterpillar is 170$ per share, you perform valuation analysis with three methods. Which statement implies that future Caterpillar returns are expected to be higher than peer firms’?

What does DCF stand for?

Which of the following trees corresponds to a potential parse of the ambiguous sentence below, with correct syntactic categories? Some diagnostics are provided.

Which of the following sentences contain two non-finite verbs? Select all that apply.

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler