Approaches for Calculating the Terminal Value
The terminal value can be calculated using a: Single-stage (constant-growth) model. Valuation multiples approach. Under the valuation multiples approach, there are two ways this can be done. $$\begin{align*} & \text{Terminal value in year }n \\ &=\text{Justified trailing P⁄E}\times\text{Forecasted earnings…
Sensitivity Analysis in FCFF and FCFE Valuations
Sales growth and profit margins depend on the growth phase of the firm and the profitability of the industry. Growth rates and duration of growth are difficult to forecast. The base year values of FCFF and FCFE growth models…
Estimating a Company’s Value using the Free Cash Flow Model
The following two examples will do a good job at putting in application the theoretical models we have learned previously Example: Simple Two-Step FCF Models $$\small{\begin{array}{l|r}\text{Current sales per share} & 9 \\ \hline\text{Sales growth for the first three years}…
Single-Stage, Two-Stage, and Three-Stage FCFF and FCFE Models
Single-Stage (Constant-Growth) Free Cash Flow Models FCFF Calculation Assuming FCFF grows at a constant, \(g\), the next period’s FCFF will be: $$\text{FCFF}_\text{t}=\text{FCFF}_{\text{t}-1} (1+\text{g})$$ If FCFF grows at a constant rate, the value of the firm is calculated as: $$\text{Firm…
Net Income and EBITDA as Proxies for Cash Flow in Valuation
Using other measures of earnings like net income, EBIT, EBITDA, or CFO in the discounted cash flow model would give a wrong estimate of a company’s value. Net income inappropriately: Includes the effects of non-cash charges like depreciation that…
Effects of Financing Decisions on Future FCFF and FCFE
Dividends, share repurchases, and share issuance do not affect FCFF and FCFE. The reason for this is that FCFF and FCFE are cash flows available to investors, while dividends and share repurchases are uses of these cash flows. Therefore,…
FCFE vs. the Dividend Discount Model
The free cash flow valuation approach is preferred over the dividend discount model (DDM) because: Many corporations pay no or minimal cash dividends. Using the DDM would require assuming a period in the future when dividends will be paid,…
Forecasting Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE)
Forecasting FCFF and FCFE There are two approaches used to forecast FCFF and FCFE: Applying a constant growth rate to the current free cash flow: This assumes the historical growth rate will apply to the future. This would be…
Calculating FCFF and FCFE
Consider the following information regarding ABC Ltd: $$ \textbf{Income Statement (in \$ million)} $$ $$\small{\begin{array}{l|r|r} & \textbf{2020} & \textbf{2019} \\ \hline\text{Sales} & 294 & 212 \\ \hline\text{COGS} & 132 & 106 \\ \hline\text{Gross profit} & 162 & 106 \\…
Computing FCFF and FCFE
Computing FCFF from Net Income FCFF is the cash flow available to a firm’s capital providers after deducting operating expenses, working capital expenses, and fixed capital investments. FCFF can be calculated from net income as: $$\begin{align*}\text{FCFF}&=\text{Net Income}+\text{Net Non-Cash Charges}+\text{Interest…
