On the second Mock there were a couple questions regarding valuation of a firm using the DDM approach in a way I’d never seen it used before. Although I got these questions correct, I was hoping to get a little more clarity from you guys. When calculating the intrinsic value of a firm using the DDM, does the firms’ FCFE replace the Dividend on the top of the denominator and the WACC replace Ke on the bottom. Or more simply put, is this the correct formula to use: (FCFE * 1+g) / (WACC - g)
I can’t see this being right, because if you use free cash flow to equity, your appropriate discount rate would be the cost of equity. You have already paid out your debt obligations. If it was free cash flow to the firm (before paying out interest), you would have to use the company’s capital structure, including its debt weighting, meaning WACC. I’m thinking it’s: operating free cash flow/(WACC - growth rate of operating free cash flow)
and operating free cash flow would be for the next term, OFCF(1+g) similar to dividend payment of next period in the calculation of DDM.
ahhh it’s OFCF… makes sense now. Got it. Thank you guys.
It’s just one person!
For FCFF use WACC, use Ke for FCFE. I believe this would help: http://www.analystforum.com/phorums/read.php?11,758413,758420#msg-758420
I read the costant-growth FCFE valuation model is: FCFE*(1+g)/(r-g) where r =required rate of return on equity because FCFE is the cash flow going to common stockholders. While the FCFF valuation approach estimates the value of the firm as the present value of future FCFF discounted at the weighted average cost of capital (WACC) because FCFF is the cash flow available to all suppliers of capital.