Ammad Zaheer
CHAPTER
4
FREE CASH FLOW
VALUATION
LEARNING OUTCOMES
After completing this chapter, you will be able to do the following :
• Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity
(FCFE).
• Describe, compare, and contrast the FCFF and FCFE approaches to valuation.
• Contrast the ownership perspective implicit in the FCFE approach to the ownership perspective implicit in the dividend discount approach.
• Discuss the appropriate adjustments to net income, earnings before interest and taxes
(EBIT), earnings before interest, taxes, depreciation, and amortization (EBITDA), and cash flow from operations (CFO) to calculate FCFF and FCFE.
• Calculate FCFF and FCFE when given a company’s financial statements prepared according to International Financial Reporting Standards (IFRS) or U.S. generally accepted accounting principles (GAAP).
• Discuss approaches for forecasting FCFF and FCFE.
• Contrast the recognition of value in the FCFE model to the recognition of value in dividend discount models.
• Explain how dividends, share repurchases, share issues, and changes in leverage may affect
FCFF and FCFE.
• Critique the use of net income and EBITDA as proxies for cash flow in valuation.
• Discuss the single-stage (stable-growth), two-stage, and three-stage FCFF and FCFE models (including assumptions) and explain the company characteristics that would justify the use of each model.
• Calculate the value of a company by using the stable-growth, two-stage, and three-stage
FCFF and FCFE models.
• Explain how sensitivity analysis can be used in FCFF and FCFE valuations.
• Discuss approaches for calculating the terminal value in a multistage valuation model.
• Describe the characteristics of companies for which the FCFF model is preferred to the
FCFE model.
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146
Equity Asset Valuation
1. INTRODUCTION TO FREE CASH FLOWS
Discounted cash flow (DCF) valuation views the intrinsic
4
FREE CASH FLOW
VALUATION
LEARNING OUTCOMES
After completing this chapter, you will be able to do the following :
• Define and interpret free cash flow to the firm (FCFF) and free cash flow to equity
(FCFE).
• Describe, compare, and contrast the FCFF and FCFE approaches to valuation.
• Contrast the ownership perspective implicit in the FCFE approach to the ownership perspective implicit in the dividend discount approach.
• Discuss the appropriate adjustments to net income, earnings before interest and taxes
(EBIT), earnings before interest, taxes, depreciation, and amortization (EBITDA), and cash flow from operations (CFO) to calculate FCFF and FCFE.
• Calculate FCFF and FCFE when given a company’s financial statements prepared according to International Financial Reporting Standards (IFRS) or U.S. generally accepted accounting principles (GAAP).
• Discuss approaches for forecasting FCFF and FCFE.
• Contrast the recognition of value in the FCFE model to the recognition of value in dividend discount models.
• Explain how dividends, share repurchases, share issues, and changes in leverage may affect
FCFF and FCFE.
• Critique the use of net income and EBITDA as proxies for cash flow in valuation.
• Discuss the single-stage (stable-growth), two-stage, and three-stage FCFF and FCFE models (including assumptions) and explain the company characteristics that would justify the use of each model.
• Calculate the value of a company by using the stable-growth, two-stage, and three-stage
FCFF and FCFE models.
• Explain how sensitivity analysis can be used in FCFF and FCFE valuations.
• Discuss approaches for calculating the terminal value in a multistage valuation model.
• Describe the characteristics of companies for which the FCFF model is preferred to the
FCFE model.
145
c04.indd 145
12/14/09 7:42:09 AM
146
Equity Asset Valuation
1. INTRODUCTION TO FREE CASH FLOWS
Discounted cash flow (DCF) valuation views the intrinsic