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: $$\begin{align*}\text{FCFF}&=\text{Net Income}+\text{Net Non-Cash Charges}+\text{Interest…
Ownership Perspective implicit in the FCFE Approach
Under the free cash flow to equity (FCFE) approach, the ownership perspective is that of an acquirer who can change the firm’s dividend policy. This approach takes a control perspective, which assumes immediate recognition of value. On the other…
FCFF and FCFE Valuation Approaches
Present Value of FCFF The free cash flow to the firm (FCFF) valuation approach estimates the firm’s value as the present value of future FCFF discounted at the weighted average cost of capital: $$\text{Firm Value}= ∑_{\text{t}=1}^∞\frac{\text{FCFF}_\text{t}}{(1+\text{WACC})^\text{t}}$$ Using the weighted…
Stock Value
If the current market price is greater than the intrinsic value estimated using the DDM, the stock is overvalued. If it is equal to the intrinsic value obtained from the DDM, the stock is fairly valued. If it is less…
