A firm which does not pay dividends can be valued by discounting all its FREE CASH FLOWS by its WACC
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A firm which does not pay dividends can be valued by discounting all its FREE CASH FLOWS by its WACC. Free Cash Flows = the cash flows actually available for distribution to investors after the company has made all the new products, and working capital necessary to sustain ongoing operations.

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A firm which does not pay dividends can be valued by discounting all its FREE CASH FLOWS by its WACC

Free Cash Flows = the cash flows actually available for distribution to investors after the company has made all the new products, and working capital necessary to sustain ongoing operations

  • Free Cash Flows = NOPAT – Net Investment in Operating Capital

NOPAT = The Net Profit that a company would generate if it had no debt and held no non-operating assets

  • NOPAT = EBIT (1-Tax Rate)

Net Investment in Operating Capital = Change in Operating Capital


Operating Capital discounting all its FREE CASH FLOWS by its WACC = Net Fixed Assets + Net Operating Working Capital

Net Operating Working Capital = the working capital acquired with investor-supplied funds i.e.

Current Assets – (Accounts Payable + Accruals)


Balance Sheet: Assets discounting all its FREE CASH FLOWS by its WACC

2000

1999

Cash

7,282

57,600

AR

632,160

351,200

Inventories

1,287,360

715,200

Total CA

1,926,802

1,124,000

Gross FA

1,202,950

491,000

Less: Deprec.

263,160

146,200

Net FA

939,790

344,800

Total Assets

2,866,592

1,468,800


Liabilities and Equity discounting all its FREE CASH FLOWS by its WACC

2000

1999

Accts payable

524,160

145,600

Notes payable

720,000

200,000

Accruals

489,600

136,000

Total CL

481,600

1,733,760

Long-term debt

1,000,000

323,432

Common stock

460,000

460,000

Retained earnings

(327,168)

203,768

Total equity

132,832

663,768

Total L&E

2,866,592

1,468,800


Income Statement discounting all its FREE CASH FLOWS by its WACC

2000

1999

Sales

5,834,400

3,432,000

COGS

5,728,000

2,864,000

Other expenses

680,000

340,000

(573,600)

228,000

EBITDA

116,960

18,900

Depr. & Amort.

EBIT

(690,560)

209,100

Interest exp.

176,000

62,500

EBT

(866,560)

146,600

Taxes (40%)

(346,624)

58,640

Net income

(519,936)

87,960


What was the free cash flow (FCF) for 2000? discounting all its FREE CASH FLOWS by its WACC

FCF = NOPAT – Net investment in Operating Capital

= -$414,336 – ($1,852,832 – 1,187,200)

= -$414,336 – $665,632

= -$1,079,968.


net operating profit after taxes (NOPAT)? discounting all its FREE CASH FLOWS by its WACC

NOPAT = EBIT(1 – Tax rate)

NOPAT00 = -$690,560(1 – 0.4)

= -$690,560(0.6)

= -$414,336.


Operating Capital discounting all its FREE CASH FLOWS by its WACC

Operating

capital

= Net fixed assets + NOWC

= $939,790 + $913,042

= $1,852,832.

= $1,187,200.

Operating

capital00

Operating

capital99


Issues regarding the free cash flow method
Issues Regarding the Free Cash Flow Method discounting all its FREE CASH FLOWS by its WACC

  • Free cash flow method is often preferred to the dividend growth model--particularly for the large number of companies that don’t pay a dividend, or for whom it is hard to forecast dividends.

(More...)


Fcf method issues continued
FCF Method Issues Continued discounting all its FREE CASH FLOWS by its WACC

  • Similar to the dividend growth model, the free cash flow method generally assumes that at some point in time, the growth rate in free cash flow will become constant.

  • Terminal value represents the value of the firm at the point in which growth becomes constant.


FCF estimates for the next 3 years are discounting all its FREE CASH FLOWS by its WACC-$5, $10, and $20 million, after which the FCF is expected to grow at 6%. The overall firm cost of capital is 10%.

0

1

2

3

4

...

k = 10%

g = 6%

-5 10 20 21.20

-4.545

8.264

15.026

21.20

0.04

530 = = *TV3

398.197

416.942

*TV3 represents the terminal value of the firm, at t = 3.


The firm s value would therefore be
The firm’s value would therefore be discounting all its FREE CASH FLOWS by its WACC

$416.942


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