Free Cash Flow Valuation

Question 1

Firm Value from FCFF

Answer 1

FCFF discounted at WACC

Question 2

Equity Value from FCFE

Answer 2

FCFE discounted at required return on equity

Question 3

Equity Value from Firm Value

Answer 3

Firm Value - Market Value of Debt

Question 4

FCFF from NI

Answer 4

FCFF = (NI + NCC - WCInv) + [ Int (1-tax) ] - FcInv

Question 5

CFO

Answer 5

NI + NCC - WcInv

Question 6

NCC

Answer 6

amortization of intangibles ADDED back
restructuring charges ADDED back
any other non-cash loss ADDED back
gains and losses on long-term assets REMOVED
income from restructuring charge reversals SUBTRACTED

Question 7

FcInv

Answer 7

CapEx - Proceeds from sales of long-term assets

Question 8

FcInv (if no assets were sold during year)

Answer 8

= CapEx = ( END Gross PPE - BEGIN Gross PPE)

Question 9

FcInv (if no assets were sold during year)

Answer 9

= END Net PPE - BEGIN Net PPE + depreciation

Question 10

Gross PPE

Answer 10

before depreciation

Question 11

Net PPE

Answer 11

after depreciation

Question 12

FCFF (from EBIT)

Answer 12

FCFF = [ EBIT * (1-tax) ] + Dep - FcInv - WcInv

Question 13

FCFF (from EBITDA)

Answer 13

FCFF = [ EBITDA * (1-tax) ] + Dep(tax) - FcInv - WcInv

Question 14

FCFF (from CFO)

Answer 14

FCFF = CFO + [ Int * (1-tax) ] - FcInv

Question 15

FCFE (from FCFF)

Answer 15

FCFE = FCFF - [ Int (1-tax) ] + net borrowing

Question 16

FCFE (from NI)

Answer 16

FCFE = NI + NCC - FcInv - WcInv + net borrowing

Question 17

FCFE (from CFO)

Answer 17

FCFE = CFO - FcInv + net borrowing

Question 18

FCFF with Preferred Stock

Answer 18

Add Pfd stock back to FCFF (assuming NI is to common shareholders after Pfd divs have been subtracted out)

Question 19

FCFE with Preferred Stock

Answer 19

Add Pfd stock new debt borrowing and net issuances by the amount of the Pfd stock

Question 20

Uses of FCFF

Answer 20

Uses FCFF = changes in cash balances + net payments to debt providers + net payments to equity stakeholders

Question 21

Uses of FCFE

Answer 21

Uses FCFE = changes in cash balances + net payments to equity holders

Question 22

Forecast FCFF or FCFE (historical with a growth rate)

Answer 22

Multiply by 1+g Assumes growth will be constant and fundamental factors maintained

Question 23

Forecast FCFE (use target debt-to-asset ratio)

Answer 23

FCFE = NI - [ (1-DR) * (FcInv - Dep) ] - [ (1 - DR) * WcInv ]

Question 24

Effect of dividends, share repurchases, and share issues

Answer 24

NONE. All are a use of cash; do not affect the cash flow available.

Question 25

Effect of changes in leverage

Answer 25

Small effect on FCFE. Example: decrease in leverage via debt repayment decrease FCFE in current year but increase forecasted FCFE in later years.

Question 26

Single-Stage FCFF Model

Answer 26

Value of firm = FCFF1 / (WACC - g) = FCFF0 * (1+g) / (WACC - g)

Question 27

Single-Stage FCFE Model

Answer 27

Value of equity = FCFE1 / (r - g) = FCFE0 * (1+g) / (r - g)

Question 28

Are FCFF and FCFE growth rates usually the same or different?

Answer 28

Different

Question 29

Two-Stage Model Examples

Answer 29

(a) FCFF in which FCFF is projected to grow at 20% for first 4 years and then 4% each year thereafter
(b) FCFE in which FCFE declines form 20% to 4% over 4 years and then stays at 4% forever
(c) FCFE model in which sales grow at 20% for 4 years, net profit margin constant at 8%, fixed capital investment equal to 60% of dollar INCREASE in sales, working capital investment equal to 25% of dollar INCREASE in sales and debt ratio is 50%. Given starting sales, we can forecast FCFE for the first 4 years.

Question 30

Terminal Value at the end of the first growth stage

Answer 30

Apply a single-stage free cash flow model at the point in time when growth settles to its long-run level

Question 31

Approaches for calculating Terminal Value

Answer 31

There are two:

(a) use a single-stage model
(b) use a multiple

Question 32

Terminal Value using Multiple

Answer 32

Terminal Value in year n = trailing PE * earnings in year n

Terminal Value in year n = leading PE * forecasted earnings in year n+1