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Valuing FCFE
The value of equity can also be found by
discounting FCFE at the required rate of return
on equity (r):
1
FCFE
Equity Value
(1 )
t
t
t
r
Dividing the total value of equity by the number of outstanding shares gives the
value per share.
Single-stage constant-growth
FCFF valuation model
FCFF in any period is equal to FCFF in the
previous period times (1 + g):
FCFF
t
= FCFF
t1
(1 + g).
The value of the firm if FCFF is growing at a
constant rate is
Subtracting the market value of debt from the
firm value gives the value of equity.
Single-stage, constant-growth
FCFE valuation model
FCFE in any period will be equal to FCFE in
the preceding period times (1 + g):
FCFE
t
= FCFE
t1
(1 + g).
The value of equity if FCFE is growing at a constant
rate is
0 1
FCFE (1 ) FCFE
Equity Value
g
r g r g
Computing FCFF from Net Income
FCFF = Net income available to common
shareholders
Plus: Net Non-Cash Charges
Plus: Interest Expense times (1
Tax rate)
Less: Investment in Fixed Capital
Less: Investment in Working capital
Computing FCFF from CFO
FCFF = Cash Flow from Operations
Plus: Interest Expense times (1
Tax rate)
Less: Investment in Fixed
Capital
The best place to find historical non-cash
charges is to review the firms statement of
cash flows.
Non-Cash Item Adjustment to NI to arrive at CF
Depreciation Added Back
Amortization of intangibles Added Back
Restructuring Charges (expense) Added Back
Restructuring Charges (income resulting
from reversal)
Subtracted
Losses Added Back
Gains Subtracted
Amortization of long-term bond discounts Added Back
Amortization of long-term bond premium Subtracted
Deferred taxes Warrants special attention
Finding FCFE from FCFF
Free cash flow to equity is cash flow available to
equity holders only. It is therefore necessary to
reduce FCFF by interest paid to debtholders and to
add any net increase in borrowing (subtract any net
decrease in borrowing).
FCFE = Free cash flow to the firm
Less: Interest Expense times (1 Tax rate)
Plus: Net Borrowing
Or
FCFE = FCFF Int(1 Tax rate) + Net borrowing
Finding FCFE from NI
Subtracting after-tax interest and adding
back net borrowing from the FCFF
equations gives us the FCFE from NI or
CFO:
FCFE = NI + NCC Inv(FC) Inv(WC)
+ Net borrowing
FCFE = CFO Inv(FC) + Net borrowing
Finding FCFF from EBIT
FCFF = EBIT (1 Tax rate) + Dep Inv(FC) -
Inv(WC)
Finding FCFF from EBITDA
FCFF = EBITDA(1 Tax rate) + Dep(Tax rate) -
Inv(FC) Inv(WC)
To get FCFF from EBITDA, multiply EBITDA times (1
Tax rate), add back depreciation times the tax rate, and then
subtract the investments in fixed capital and working capital
Forecasting FCFF
When forecasting FCFE, analysts often simplify
the estimation of FCFF and FCFE. Equation 3-7
can be restated as
FCFF = NI + Int (1 Tax rate)
(Capital spending Depreciation) Inv(WC)
which is equivalent to
FCFF = EBIT (1 Tax rate)
(Capital spending Depreciation) Inv(WC)
The components of FCFF in these equations are
often forecasted in relation to sales.
Forecasting FCFE
FCFE can be written as
FCFE = NI (1 DR)(Capital Spending
Depreciation)
(1 DR)Inv(WC)
When building FCFE valuation models, the
logic, that debt financing is used to finance
a constant fraction of investments, is very
useful. This equation is pretty common.
Two-stage FCF models
The two most popular versions of the two-
stage FCFF and FCFE models are:
the growth rate is constant (or given) in stage
one, and then it drops to the long-run
sustainable rate in stage two.
the growth rates are declining in stage one,
reaching the sustainable rate at the beginning
of stage two. This latter model is like the H
model for dividend valuation.
A general expression for the two-stage FCFF
valuation model is
1
1
FCFF FCFF 1
Firm Value= +
(WACC- ) (1+WACC) (1+WACC)
n
t n
t n
t
g