Assume that a company has no debt and no plans to ever have debt; thus, FCFF = FCFE WACC = Re Thus, a FCFF model should product identical results as a FCFE model, EXCEPT for cash. Normally, you would subtract cash in a FCFF model. I am assuming you would not do this if they don’t have debt? (I believe the reason you subtract cash is because it can be used to offset debt exposure)
Does anyone know?
well, not all cash is the same color. they taught us to differentiate minimum cash level for running a business (part of working cap) and “excess” cash. Only the latter could be used to offset debt.
OK, so say you have “excess” cash, but no debt, would you still subtract the excess cash to find intrinsic value in a FCFF model?
If it’s excess cash, it’s normally added (like any other unproductive asset) to the value of the firm as derived from earnings or cash flow measures. E.g. take GE. If someone dies and leaves it a $100m van Gogh painting in their will, then GE’s earnings or CF don’t change a bit, but the value of the firm is increased by the value of this unproductive asset.
so if you were performing a FCFE model (which doesn’t account for cash, assets, etc) then would you still add it back to the value of equity? I have never heard of adding back cash unless you are trying to value the firm. Basically, a FCFE model should equal FCFF model if there is no debt in their capital structure (and no expectations of future debt) In a FCFF model, you are supposed to add back excess cash to get firm value. From here, Equity value = Firm value - MV of debt.(thus cash is included in this calculation). If there is no debt, then Equity value = Firm value (where cash was added back) In a FCFE model, I don’t believe you are supposed to add back the excess cash. My point is…these would come up with 2 different values (1 with excess cash accounted for, and 1 without)
Hey guys, The ideas discussed are very interesting. Could you related those with the curriculum (i.e. state which pages relate with the treatment of excess cash). Thanks