Answer Question Essay Example | Topics and Well Written Essays - 750 words

Answer Question - Essay Example The FCFE approach pertains to the common stockholders. Unlike the FCFF, which incorporates the EBITDA, the ownership perspective holds that neither does EBITDA account for different capital frameworks nor does it account for cash flow from bondholders. Common stockholders argue that EBITDA fails to allow for adjustments from reinvesting cash flows to improve the value of the company in the long-term. Many financial analysts utilize historical data to establish the ex ante risk premium. Such an approach to predict future performance of stocks and bonds raises some validity concerns within the commercial markets. Besides being difficult to establish the data series and time period to use, some analysts argue that historical data is ambiguous and is not a legitimate method to forecast future returns. In addition, historical data sets are viewed as being independent to each other and are equally distributed over the time period. However, returns on investments are negatively correlated to each other. Statistical Stationarity: The previous financial performance may not indicate the future financial performance in a financial market. For example, in the U.S., changes in the stock market in the 20th century indicate a stationery return series. a. When the Return on Capital (ROC) reduces, the Return on Equity (ROE) significantly reduces, ceteris paribus. Shareholder equity forms part of investment capital. If the capital invested fails to realize the forecasted capital gains, the net income attributable to share holder equity significantly reduces. b. A decrease in leverage increases the return on equity. Reduced long-term debt stimulates capital investments based on shareholders’ equity; that is, low long-term debt induces investments based on shareholders’ equity. Capital investments based on shareholders’ equity would increase the return