Comparison of EP and FCF
1 Abstract
When appraising an investment, it’s necessary to find the right valuation method do apply based on the internal and external conditions. This paper will focus on the differences and similarities when using the economic profit (EP) or the discounted cash flow (DCF) method when appraising an investment. When applied correctly, both valuation methods yield the same result; however, each model has certain benefits in practice. The DCF method uses future cash flows projections and discounts them with a suitable rate in order to calculate the present value of the investment. The economic profit input is less than DCF valuation. The metric needs data extracted from income statement and balance sheet to calculate the surplus value between NOPAT and capital cost rate. Given that the two methods yield identical results and have different but complementary benefits, we recommend creating both DCF and economic-profit models when valuing an investment.
2 Introduction
When an investment is appraised, it is necessary to find suitable valuation methods to apply based on the company’s internal and external conditions. There are many different valuation approaches. However all those valuation methods can be categorized into 4 types based on the sources of input and valuation process. Figure 1 shows the list of the four main valuation approaches and different models involved in each approach (B. Steens 2013, sheet page 79).Figure: 1
Among the many ways to value an investment, the next chapter focuses particularly on two, DCF and discounted economic profit. When applied correctly, both valuation methods yield the same results; however, each model has certain benefits in practice. DCF remains a favourite of practitioners and academics because it relies solely on the flow of cash in and out of the company, rather than on accounting-based earnings. The discounted economic-profit
When appraising an investment, it’s necessary to find the right valuation method do apply based on the internal and external conditions. This paper will focus on the differences and similarities when using the economic profit (EP) or the discounted cash flow (DCF) method when appraising an investment. When applied correctly, both valuation methods yield the same result; however, each model has certain benefits in practice. The DCF method uses future cash flows projections and discounts them with a suitable rate in order to calculate the present value of the investment. The economic profit input is less than DCF valuation. The metric needs data extracted from income statement and balance sheet to calculate the surplus value between NOPAT and capital cost rate. Given that the two methods yield identical results and have different but complementary benefits, we recommend creating both DCF and economic-profit models when valuing an investment.
2 Introduction
When an investment is appraised, it is necessary to find suitable valuation methods to apply based on the company’s internal and external conditions. There are many different valuation approaches. However all those valuation methods can be categorized into 4 types based on the sources of input and valuation process. Figure 1 shows the list of the four main valuation approaches and different models involved in each approach (B. Steens 2013, sheet page 79).Figure: 1
Among the many ways to value an investment, the next chapter focuses particularly on two, DCF and discounted economic profit. When applied correctly, both valuation methods yield the same results; however, each model has certain benefits in practice. DCF remains a favourite of practitioners and academics because it relies solely on the flow of cash in and out of the company, rather than on accounting-based earnings. The discounted economic-profit