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Sir…………
While calculating the Value of equity it has been found that in some examples(from different text books), Cash flows have been discounted at cost of equity to derive at equity value directly and in some examples by discounting at WACC and then deducting the debt vaule.I am a bit confused here to which of the methods to be used…….
At present my understanding is that if the question asks about FCF to equity then Ke should be used to reach directly to the shareholder wealth and if it asks about Value of the firm then WACC should be used. …..Is that correct?
One more doubt:
While calculating FCF in some examples interest has been deducted and in some examples interest has not been. What could be the reason.
Thanks,
Krishna.You are correct, cash flow to equity is discounted at the cost of equity to get value of equity.
Free cash flow is discounted at WACC to get the total value of the firm (which includes equity and debt).When calculating free cash flow you do not deduct interest (it is accounted for when discounting at WACC).
When calculating free cash flow to equity you do deduct interest (to arrive at what is left for equity).
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