Operating Free Cash Flow Discounting Model
IB, SAPM Concept
The knol will have brief introduction to the concept, links to various knols on the concept, books on the concept and research papers on the concept.Authors
Index of concepts
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Subject: Investment Analysis
Chapter/Topic: Valuation of Equity Shares
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Concept Definition and Explanation
For cash flow discounting some use operating free cash flow and some use equity free cash flow.
Operating free cash flow is free cash flow before the payment of interest to the debt holders but after deducting funds needed (capital expenditure) to maintain the firm’s assets bases. Free cash flow to the firm also refers to the same thing. These cash flows are discounted using the firm’s weighted average cost of capital (WACC). The discounted value will be the total value of the firm and it includes the value due to the bond holders and other lenders.
V = Σ CFt/(1+i)t [t = 1 to ∞]
CFt = operating free cash flow of the firm in year t
i = WACC of the firms
For a mature firm, whose growth is less than that of WACC and can be estimated as a constant rate, we can use the simplified formula:
g = constant growth rate for infinite period.
References:
Reilly, Frank and Keith Brown, Investment Analysis and Portfolio Management, 7th Edition, Thomson-South Western, 2003
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Knols
Related Knols
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Books
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Research Papers
SSRN-Extended Dividend, Cash Flow and Residual Income Valuation, papers.ssrn.com/sol3/papers.cfm?abstract_id=1145201
On Comparing Cash Flow and Accrual Accounting Models , papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID282421_code010910600.pdf?abstractid=282421
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Concept Articles
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