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To find out the companys valuation using the FCF method
Do we discount it using the ke-g or WACC-g
In what circumstances do we use which one?Thank you
You don’t discount using either!!
If it is free cash flow to equity then you discount at the cost of equity.
If it is free cash flow then you discount at the WACC.
(What you wrote is not what you discount at, it is how you will do the discounting if it is an inflating perpetuity. If they are simply looking at 4 years (or 5 years or whatever) then you discount as normal using the tables at either the cost of equity or the WACC depending on whether it is free cash flow to equity or just free cash flow.
Hi sir,
This is regarding the assessment of the validity of the free cash flow model.
‘Our estimates of the value using NOPAT as a proxy for free cash flow produces values that are reasonably close to the current market valuation of both companies. The models value Burcolene at $12.855 bil and PetroFrancais at $11.873 bil compared with current market valuations of $13.1 bil and $12.5 bil respectively. The estimation error is 1.9% and 5.3% respectively.’
My questions are :-
(i) For FCF method, isn’t it we are using NOPAT all the while? How come in this question seems like NOPAT acts as a substitute?(ii) The 4 valuation figures are derived using FCF method right? The only difference is the smaller figures take into consideration the options outstanding and the pension deficit. Since the larger figures are 1 step behind, how can this form a basis for comparison? Is it right if we take the difference as errors…? Isn’t it we only make comparison if different methods are being employed to derive at the 2 sets of figures…?
Thanks…
(i) Cash flow is not the same as profits! That is why using NOPAT is a subsitute when we do not have enough information.
(ii) I don’t know why you refer to 4 valuation figures, and why you want to compare.
There is one valuation for each company (as the question asks for). The valuations are using FCF as adjusted for the pensions scheme in the case of one company, and as adjusted for the options in the case of the other.
We are not asked to compare the two (and there would be no relevance of doing so).Question mentioned that the free cash flow to all classes of capital invested can be reliably approximated as NOPAT less net reinvestment.
So NOPAT – net reinvestment is equal to cash flow or profit…?
I have already explained!
The P in NOPAT stands for profit, and profit is not the same as cash flows.
Usually, we calculate FCF by listing all the cash flows (in the same way as when appraising a project in both F9 and P4). However, when there is not enough information, then we have no choice but to use NOPAT as a proxy (a substitute, an approximation).
Hey John
Going back to your first point, how come when you use the cash flow basis to value a company sometimes you discount the FCF/FCFE over a period time and other times you don’t. Like in this question we are only looking at the current year cash flow, while in the Fly 4000 question we discount the growth of the cash flow over 5 years?
We always discount over the period given in the question – and we do in Burcolene!!
Using the dividend valuation formula is discounting on the basis that the cash flows continue in perpetuity! The formula calculate the PV on the basis that it is a perpetuity growing at a constant rate.
It is not simply looking at the current year at all.
Hi. In c I, why will npv fall by $ 2m to 13.893m? In the calculation below, why are they doing 180(1+x)^2 and so on?
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