Intrinsic value of a firm

“Free” cash flows (be it FCFF/FCFE) are just another measure of cash flow, and all we have to do is to discount cash flows using the appropriate discount rate. For FCFF - appropriate (required rate of return) is WACC, since FCFF belongs to both creditors and shareholders FCFE - cost of equity - k, since these cash flows belong to equity investors only. The exact breakdown of FCFF/E is LII material, and my suggestion is not to worry about it right now, we might just get confused a bit more :wink:

I get the logic behind it, I just want to see how it is done. I’m trying to be accurate in what I learn:)

ok, here we go: FCFF = CFO - FCInv FCFE = CFO - FCInv + Net Borrowing that’s if you start with CFO. Then of course, you can start with NI, EBT, EBIT, EBITDA…

FCFF and FCFE are probably not going to be tested on Level 1 exams. if it is, the logic behind it goes as the firm does not pay dividends or does so inconsistently you cannot use DDM. You can also take the perspective of the owner vs investor. therefore the valuation of FCFF is discounted at WACC and FCFE by cost of equity this is so because FCFF is cashflow to the firm therefore cash available to the firm (not surprisingly.) You value whats left for the firm after paying Dividends, Interest, and reinvesting in fixed capital required to keep the company moving. This discounted by wacc gives the total market value of the firm. divided by average # of shares = price of share. Same goes to FCFE but this time its for equity’s perspective. Both give the same answer in any given situation. Took a class that used CFA book (equity asset valuation)

i told you map, as soon as we star this discussion there will be confusion :wink: jo_l, u might wanna retake that equity asset valuation course, since FCFF is a cash flow BEFORE Interest and Dividends, not after. Since FCFF presents a value of the firm, subtracting dividends and interest would understate the value of the firm. Dividends belong to shareholders and Interest to debtholders who both combined own the firm. FCFF = NI + NCC + I(1-T) - FCInv - WCInv if i remember correctly

before is correct. thanks for correction fisher. (add back deprication and interest expense)

i posted this before but FCFF should be discounted by WACC which gets you to an enterprise value of the firm. From there we subtract out debt and add cash to get to an equity market cap. This is the practical application of the FCFF.