Chartered Financial Analyst (CFA) Level 1 Practice Exam

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What is the primary purpose of calculating Free Cash Flow to the Firm (FCFF)?

To assess equity value
To determine cash available to all providers of capital
To analyze operational efficiency
To evaluate market risk

The correct answer is: To determine cash available to all providers of capital

The primary purpose of calculating Free Cash Flow to the Firm (FCFF) is to determine the cash available to all providers of capital, including both equity and debt holders. FCFF represents the cash generated by the firm's operations after accounting for necessary capital expenditures but before any financial obligations such as debt repayments are met. This measure is crucial because it provides insight into the firm's capacity to generate cash flow that can be used not only to pay equity holders but also to satisfy debt obligations. By focusing on cash flows available to all capital providers, FCFF serves as a comprehensive indicator of financial health and operational success. It is particularly useful for valuation purposes, as it gives a clearer picture of the intrinsic value of the firm based on its ability to generate cash. While free cash flow can be used to assess equity value indirectly when analyzing the residual cash flow available to shareholders after debt obligations are paid, its primary focus is broader since it accounts for cash available to all sources of capital. This distinguishes it from measures that are strictly equity-focused.