Equity Valuation:

Free Cash Flow to Firm Model

http://www.tinyurl.com/BrackerFCFF

Introduction FCFF = Net Income + Depreciation – Capital

Expenditures – Increase in NC Working Capital + Interest*(1 – T)

FCFF = CF from Operating Activities + Interest * (1 – T) – Capital Expenditures

FCFF is discounted at the WACC instead of the cost of equity.

FCFF is used to get the value of the FIRM. To get the value of the equity, you must subtract out the value of debt.

Example Assume you have forecasted the following for firm X: Number of Shares Outstanding 400,000 Current Debt $5,000,000 Tax Rate 30% WACC 9.75% Year 1 Year 2 Year 3 Year 4 Net Income $800,000 $850,000 $900,000 $940,000 Depr. $200,000 $250,000 $225,000 $275,000 Cap. Exp. $350,000 $100,000 $400,000 $300,000 Inc. in NC WC

-$50,000

$100,000

-$75,000

$25,000

Interest $300,000 $320,000 $330,000 $350,000

Constant Growth Rate following Year 4 4%

Step 1: Forecast FCFF Values FCFF1 = $800,000 + $200,000 - $350,000 – (-$50,000) + $300,000*(1 – 0.3) = $910,000 FCFF2 = $850,000 + $250,000 - $100,000 – $100,000 + $320,000*(1 – 0.3) = $1,124,000 FCFF3 = $900,000 + $225,000 - $400,000 – (-$75,000) + $330,000*(1 – 0.3) = $1,031,000 FCFF4 = $940,000 + $275,000 - $300,000 – $25,000 + $350,000*(1 – 0.3) = $1,135,000

Step 2: Solve for value of all FCFF in Constant Growth Stage

V4 = $18,979,930

Step 3: Solve for Value of Firm

CF0 = 0 CF3 = 1,031,000 CF1 = 910,000 CF4 = 20,114,930 CF2 = 1,124,000 k = 9.75%

NPV = V0 = $16,406,609

Step 4: Convert to Value per Share Value of Equity = $16,406,609 - $5,000,000

= $11,406,609

P0 = 11,406,609/400,000 = $28.52