The free-cash-flow theory supports the notion that the market gain from an LBO is basically the present value of the firm's future cash flows that were kept from being wasted.

Question

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The free-cash-flow theory believes that the value of an LBO comes from the savings generated from keeping excess cash from being wasted, and these savings eventually translate into increased cash flows and value for the company. Therefore, the market gain from an LBO is essentially the present value of these future cash flows that were preserved.

The Free-Cash-Flow Theory Supports the Notion That the Market Gain