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…
Financial Determinants of Growth Rates
Sustainable Growth Rate Sustainable growth rate (SGR) is the growth rate of dividends (and earnings) that a company can maintain for a given return on equity (ROE), assuming that the capital structure remains unchanged, and no additional common stock is…
Spreadsheet (General) Modeling
Dividend discount models assume a stylized pattern of dividend growth. However, the dividend growth may follow a variety of patterns. Therefore, spreadsheet modeling is used to forecast any dividend pattern. In addition, spreadsheets allow analysts to build complicated models, perform…
The Required Rate of Return the Gordon Growth Model and the H-model
Given all the inputs to a dividend discount model (DDM) except the required return, the IRR can be calculated and used as a substitute for the required rate of return. This IRR can be interpreted as the expected return on…
The Value of Common Shares using Multiperiod Models
Two-Stage Dividend Discount Model There are two approaches to the two-stage dividend discount model: i. The General Two-Stage Model Under this model, a company’s growth is divided into two sections—one where it experiences high growth and the second where its…
Terminal Value
Valuing a stock involves assuming that its growth rate will slow down to a long-term rate comparable to the economy. The value projected at the end of the high-growth stages based on the long-term growth rate is known as the…
