fcf formula cfa level 2

2. Northern defines Free Cash Flow as net cash provided by operating activities of forward-looking Free Cash Flow because components of the calculation. Free Cash Flow to the Firm (FCFF) See also: FCFE Tags: CFA Level I, CFA Level I Essentials, Financial Reporting and Analysis. FCFF includes bondholders and stockholders as beneficiaries when considering the money left over for investors. The FCFF calculation is an indicator of a.

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Equity - Cfa Level Ii

the pioneers of security analysis and the concept of “intrinsic value” – which should be determined independent of the market price, and primarily predicated on the earnings power of an investment or company; the use of the market multiple

developed “discounting” techniques, and calculated intrinsic value by finding the PV of all future dividends per share

the estimation of an asset’s value based on variables perceived to be related to future investment returnsbased on comparables, liquidation proceeds

the value of the asset given a hypothetically complete understanding of the asset’s investment characteristics – an investor’s view of the “true” or “real” value of an asset

market price is not = to “true,” intrinsic value

Rational efficient markets formulation: analysts won’t do the work, unless there is a sizable gain on potential returns, or when the expense to gather info is too great for the return

For analysts to have jobs the market must not be efficient – otherwise abnormal returns (or alpha) would not exist – the excess risk-adjusted return, the return beyond just mispricing

Investors may look to catalysts that would cause the market to re-evaluate a company’s prospects, and “fix” mispricing, potential earn risk-adjusted return/alpha

the assumption that the company will continue its business activities into the foreseeable future

a company’s value under a going concern assumption

a company’s value if it were dissolved and its assets sold individually

representing the price at which an asset (or liability) would change hands between a willing buyer and a willing seller when the former is not under compulsion to buy and the latter is not under any compulsion to sell regional health properties stock buy or sell

would take into account potential synergies and is based on the investor’s requirement and expectations

Applications of equity valuation

Selecting stocks – determining if a stock is fairly priced, overpriced, underpriced relative to its current estimated intrinsic value and relative to the prices of comparable securities

Inferring (extracting) market expectations – determining if fundamentals are reflected in a stock and the reasonableness of expectations in the market

Evaluating corporate events – post M&A, a divestiture, spin-off, leveraged buyout, etc.

Rendering fairness opinions via a third party (like an investment bank)

Evaluating business strategies and models – alternatives and the effect on stock price

Communicating with analysts and shareholders – discuss to determine company value

Appraising private business – perhaps via an IPO

Share-based payment (compensation) – special valuation models typically accomplish this

Understanding the business

Forecasting company performance

Selecting the appropriate valuation model

Converting forecasts to a valuation

Applying the valuation conclusions

the elements of industry and competitive analysis

having a framework to organize thoughts about the industry and to better understand a company’s prospect

should highlight which aspects of a company’s business present the greatest challenges and opportunities, and should be further investigated/monitored, or undergo sensitivity analysis

i. Intra-industry rivalry
ii. New entrants
iii. Substitutes
iv. Supplier power
v. Buyer power

citibank customer service phone number india Porter’s three strategies for above average returns

i. Cost leadership
ii. Differentiation
iii. Focus/Targeted

Absolute valuation models

specifies an asset’s intrinsic value – most important type are present value models (specifies that the value of an asset must be related to the returns that investor expects to receive from holding that asset); dividend discount model, FCFE model, FCFF model (cash flows before debt payments), residual income models (based on accrual accounting in excess of opportunity cost of generating through earnings); asset-based valuation

set up bank mobile vibe account estimates an asset’s value relative to another asset (typically within the industry)– includes very popular multiples methods: P/E

Broad criteria needed for choosing an appropriate valuation approach

Consistent with the characteristics of the company being valued

Appropriate given the availability and quality of data

Consistent with the purpose of valuation, including the analyst’s perspective

the return earned from investing in an asset over a specified time period

HPR = price appreciation + dividend yield -or- for expected HPR = expected price appreciation + dividend yield

Required alpha = actual return - required return

Expected alpha = expected return - required return

Realized holding period return

for returns in the past, the actual realized holding period return (HPR)

is the minimum level of expected return that an investor requires in order to invest in the asset over a specified time period, given the asset’s riskiness

Return from convergence of price to intrinsic account number discover bank

when a mispricing converges to its intrinsic value; or the equilibrium and anticipated outcome when the investor’s value estimate is more accurate than the market’s, as reflected in the market price

Investor’s expected rate of return

the required return + a return from convergence of price to value

E(R) = Rr + (Vo – Po)/Po

reflects the compensation required by investors for delaying consumption

RFR + risk premium (of the required compensation for the risk of the CF) americas best eyeglasses frames

Internal rate of return (IRR)

the hurdle rate, the point at which NPV = 0, or the breakeven point

assuming:

the market is efficient and the appropriate ‘g’ is used

Intrinsic value = year ahead dividend / required return – expected dividend growth rate

Required return estimate = year ahead dividend / market price + dividend growth rate td bank atlanta

is the incremental return (premium) that investors require for holding equities rather than a risk-free asset

Used to determine the required return, which is found via CAPM or the build-up method

Historical estimation approach to find ERP

found by calculating the mean value of the differences between broad-based equity-market-index returns and government debt returns over the same period

Must determine the most appropriate equity index to represent equity market returns, the time period for computing the estimate (longer time period = more precision, but may have issues with consistent stationarity), the type of mean calculated (arithmetic or geometric (compounded), the proxy for the risk-free return (long term government bond return, or short-term government debt instrument returns – T-bills

Geometric mean is always less than the arithmetic mean, expect when the returns for all periods are equal

Survivorship bias in finding ERP

eliminating poorly performing or defunct companies from the membership index

causes the historical estimates to inflate the equity risk premium

Forward-looking estimation approach (or ex ante estimates) for finding ERP

using forward estimates to determine equity risk premium

eliminates the issue of nonstationarity or data biases, but also is subject to estimation errors and potential “behavioral biases”

Gordon growth model – GGM equity risk premium estimate = dividend yield on the index based on a year-ahead aggregate forecast on dividends and market value + consensus long-term earnings growth rate – current long-term government bond yield

Macroeconomic model estimates: finding ERP with forward financial and economic estimates

Capital asset pricing model (CAPM)

assumes investors are risk averse and that they make investment decisions based on the mean return and variance of returns of their total portfolio

Investors evaluate the risk of an asset in terms of the asset’s contribution to the systematic risk (risk that cannot be diversified away, or Beta here) of their total portfolio

Under CAPM r = RFR + Beta(Equity Risk Premium)

Required return is determined by RFR + multiple risk premiums, not just one within CAPM

where Risk Premium = Factor Sensitivity X Factor Risk Premium

is a multifactor model using three factors: the market risk premium (Rm – RFR), the market cap factor (small cap – large cap premium), and the value return premium (high – low P/B premium) – high P/B is a value bias vs. low P/B is a growth bias

Under Fama-French, r = RFR + Bmrkt(RMRF) + Bsize(SMB) + Bvalue(HML)

Pastor-Stambaugh model (PSM)

amazon app store gift card fcf formula cfa level 2 taking FFM one step further and adjusting for illiquidity

Under PSM, r = RFR + Bmrkt(RMRF) + Bsize(SMB) + Bvalue(HML) + Bliq(LIQ)

Five-factor macroeconomic model

adjusts required return after RFR for confidence risk, time horizon risk, inflation risk, business cycle risk, market timing risk

where Risk Premium = Factor Sensitivity X Factor Risk Premium

Macroeconomic multifactor models include economic variables that affect the expected future cash flows of companies and/or the discount rate that is appropriate to determining their PV

fcf formula cfa level 2 "bond yield plus risk premium"

more commonly used among closely held businesses, private businesses (less/not exposed to market risks, aka no beta)

Under build-up method, r = RFR + Equity risk premium +/- one of more premia (discounts)

Here premia/discounts do not apply beta adjustments, and often pertain to size and perceived company-specific risks, so r = RFR + ERP + Size premium + Co-specific premium

Adjustments for control or minority interest are often NOT included in the r calculation

Under bond yield plus risk premium (for companies with publicly traded debt, r = YTM of co’s l-t fcf formula cfa level 2 + risk premium (equity related risk), where the YTM of debt includes the real interest rate and a premium for expected inflation and a default risk premium

Beta estimation for public companies

Beta is determined by the least squares regression of an asset’s return on the index’s returns – often termed unadjusted or raw historical beta

Actual beta is influenced by your choice of index, time period, and the frequency of observations

Adjusted beta = (2/3)(unadjusted or “raw” beta) + (1/3)(1.0)

Beta estimation for thinly traded public companies and non-public companies:

Use a public company comparable and adjust for leverage by first unleveraging the found equity beta from the public company comparable, and then leveraging consistent with the non-public company

strengths and weaknesses of methods used to estimate the required return on an equity investment

Beta can be a poor predictor of future average return, due to idiosyncratic risk in the market

Multifactor models bring in additional factors, but these are estimates that can increase error

FFM neglects the illiquidity factor

Build up methods are more for private companies, as it removes beta

factoring in International considerations in required return estimation

Exchange rates impact historical means, best to use the local currency historical records

Data and model issues in emerging markets – use a country spread model for the equity risk premium where ERP estimate = ERP for a developed market + country premium

Where country risk premium is typically the sovereign bond yield spread

Weighted average cost of capital (WACC)

the company’s weighted after tax cost of debt + its weighted cost of equity

WACC = (MVD/(MVD + MVE)) * rd * (1 – T) + (MVE/(MVD + MVE)) * re

Evaluating the appropriateness of using a particular rate of return as a discount rate, in terms of CF

Returns used as discount rates must match the type of cash flows being discounted

Nominal cash flows must be discounted by nominal rates

Cash flow to equity fcf formula cfa level 2 discounted at Re, while cash flow to the firm is discounted by the firm’s cost of capital, usually WACC, because this would include debt holders

puts a cap on the profit potential, because industry participants will keep prices low or boost investments to deter new competitors (and increase barriers to entry)

Seven main barriers to entry: supply-side economies of scale, demand-side economies of scale, customer switching costs, capital requirements, incumbency advantages independent of size, unequal access to distribution channels, restrictive government policy

Bargaining power of suppliers

powerful suppliers can often capture more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry participants (includes raw materials, but also labor)

Powerful suppliers come in different forms:
a. Suppliers are more concentrated than the industry it sells to
b. Supplier group does not depend heavily on the industry for its revenues
c. Industry participants face switching costs in changing suppliers
d. Suppliers offer differentiated product
e. There is no substitute for what the supplier group provides
f. Supplier group can credibly threaten to integrate forward into the industry

Bargaining power of buyers

powerful customers can capture more value by forcing down prices, demanding better quality or more service (increasing costs), and generally play industry participants off one another

Powerful customers come in different forms:
a. There are few buyers, and/or volume of purchases exceed the size of a single vendor
b. Industry products are standardized or undifferentiated
c. Buyers have few switching costs in changing vendors
d. Buyers can credibly threaten to integrate backward and produce/service themselves

Price sensitivity of buyers occurs when:
a. The product needed is a significant portion of its cost structure or procurement budget
b. Buyer group earns low profits, is cash-strapped, or under pressure to cut costs
c. Quality of buyers’ products/services is little affected by an industry’s product
d. Industry’s product has little to no effect on buyer’s other costs

Threat of substitute products or services tiny homes for sale san antonio

when a substitute performs the same or a similar function as an industry’s product by a different means

Threat of substitute is high when:
a. it offers an attractive price-performance trade-off
b. the buyer’s cost of switching to the substitute is low

Rivalry among existing competitors

in the form of: price discounting, new product introductions, advertising campaigns, and service improvements – the degree to which a rivalry reduces industry profitability depends on intensity and the basis on which they compete

Intensity of a rivalry is greatest when:
a. Competitors are numerous and have equal market shares
b. Industry growth is slow
c. Exit barriers are high
d. Rivals are highly committed to the business and have leadership aspirations
e. Firms cannot read each others' signals well due to a lack of familiarity, different approaches, or different goals

Price Wars are more likely to occur when:
a. Products or services of rivals are nearly identical and low switching costs for buyers
b. Fixed costs are high and marginal costs are low
c. Capacity must be expanded in large increments to be efficient
d. The product is perishable

How competitive forces drive industry profitability

Industries with benign competitive forces will be able to achieve higher profitability, while industries with fierce competitive forces will not be as profitable

Determines how much profitability is retained by companies in the industry versus bargained away by customers and suppliers, limited by substitutes, or constrained by potential new entrants

Industry growth rate: a fleeting factor

growth does not tend to mute rivalry, because an expanding pie offers opportunities to all competitors. Fast growth can put suppliers at an advantage, or low barriers to entry will attract new entrants. Even high growth cannot guarantee profitability if there are powerful customers or suppliers, or substitutes are attractive

Technology and innovation: a fleeting factor

advanced technology or innovations do not by themselves make an industry attractive; low tech industries with price-insensitive buyers, high switching costs, or high entry barriers are often more profitable

Government: a fleeting factor

involvement is neither good or bad, its more 2 thessalonians 3 5 how specific policies impact the five forces

Complementary products and services: a fleeting factor

when the customer benefits from two products combined vs. each product in isolation (computer hardware and software, worthless fcf formula cfa level 2 – similar to government in that it impacts profitability by how it affects the five forces

how can positioning a company, exploiting industry change, and shaping industry structure be used to achieve a competitive advantage?

Know what the average profitability of its industry is and how that has been changing over time

Positioning the company – or building defense against the competitive forces or finding a position in the industry where the forces are weakest

Exploiting industry change – claim a new strategic position with an understanding of the competitive forces and their underpinnings

Shaping industry structure – when a company exploits industry change by recognizing and reacting to the inevitable: leading an industry towards new ways of competing that alter the five forces for the better. You want competition to follow your lead in this scenario – it may cause re-dividing of profitability (reducing the share of profits that go to buyers, suppliers, and substitutes), expanding profit pool (the expanding pie benefits all)

Defining the industry – by the five competitive forces, drawing correct industry boundaries, a separate strategy for each distinct industry

Key components for an industry analysis model

a. Industry classification: life cycle position, business cycle

b. External factors: technology, government, social, demographic, foreign

c. Demand analysis: end users, real and nominal growth, trends and cyclical variation around trends

d. Supply analysis: degree of concentration, ease of entry, industry capacity

e. Profitability: supply/demand analysis, cost factors, pricing

f. International competition and markets

Life Cycle Stage: Pioneer citizens savings bank in clarks summit pa

product acceptance is questionable and implementation of business strategy is unclear; high risk and many failures

product acceptance is established; roll-out begins and growth accelerates in sales and earnings; proper execution of strategy remains an issue

industry trend line corresponds to general economy; participants compete for share in a stable industry

Life Cycle Stage: Decline

shifting tastes or technologies have overtaken the industry, and demand for products steadily decreases nearest wells fargo atm to my current location

Industry Classification: Growth

pnc points visa credit card login multi family homes for sale in methuen ma above-normal expansion in sales and profits occurs independent of the business cycle

Industry Classification: Defensive fcf formula cfa level 2

stable performance during both ups and downs of chase bank offers for new checking account business cycle how do i pay my auto loan with capital one

Industry Classification: Cyclical

profitability tracks the business cycle, often in an exaggerated manner

Impact of external factor: Technology

the focus is first on survival – new technology can be a blessing and a curse – responses often come in two forms: copy the competition or buy the competition

Impact of external factor: Government

regulation plays a valuable role in promoting worker safety, consumer protection, and fair play. Government influence cuts both ways – harming industries with too much oversight, or supporting industries to prosper

Impact of external factor: Social changes

flexing to lifestyle and fashion changes – fashion being less predictable, and lifestyle changes having greater longevity

Impact of external factor: Demography

the science that studies the vital statistics of population: distribution, age, and income – keeping tabs on shifts here can prepare a company for industry shifts based on changing demographics, typically over long periods of time

Impact of external factor: Foreign Influences

our dependence on foreign goods, and its impact on industries when supply is disrupted (oil), and our dependence on foreign buyers for our exports

Top-down economic analysis

determining macroeconomic variables that affect sales

Determining industry demand by:

Top-down economic analysis

Categorizing where an industry is in the life cycle to provide a framework for demand forecasts

Determining the impact of external factors: by studying customers and supply analysis (determining whether supply can meet demand and at what cost, both in $s www refund selection time)

Factors that affect industry price practices:

a. Product segmentation (by brand name, reputation, or service)

b. Degree of industry competition (high concentration limits price movements)

c. Ease of industry entry (high barriers to entry keep pricing fluctuations or erosion limited)

d. Price changes in key supply inputs (depends on whether an industry can pass on pricing)

How inflation affects the estimation of cash flows for a company domiciled in an emerging market

Inflation distorts the financial statements, making it hard to make y/y historical comparisons, perform ratio analysis, or forecast performance

For emerging markets with high-inflation environments, historical analysis and forecasting should be done in both nominal and real terms when possible

1) In some situations nominal indicators are meaningless (e.g. capital turnover)
2) In some situations real indicators are problematic (e.g. to determine corporate income taxes)
3) Financial projections can be done in either real or nominal terms, and if done correctly, they should yield the same value

While some adjustments are made in hyperinflationary countries, to their financial statements, the following should be addressed:
i. Deflate growth into real terms, using an annual inflation index
ii. Capital turnover is often overstated, because fixed assets are carried at historical costs, either approximate the current costs of those long-term assets, or develop your own ratios based on capacity utilization and sales
iii. Operating margins can be overstated if depreciation is too low (based on those fixed assets) or large holding gains on slow-moving inventories
iv. Credit ratios and other capital structure health indicators may be distorted due to understated long-lived assets and floating rate debt at current currency units

Steps for forecasting the cash flow model to evaluate an emerging market company:

Accounting adjustments cannot affect free cash flow, thus you should project financial statements without any adjustments for inflation

Steps include:
1) Forecast operating performance in real terms (convert nominal BS and IS into real terms)

2) Build financial statements in nominal terms

3) Build financial statements in real terms

4) Forecast the future FCFs in real and nominal terms from the projected IS and BS

5) Estimate DCF Value in Real and Nominal terms
a. Ensure that the WACC estimates in real terms (WACCreal) and nominal terms (WACCnom) are defined consistently with the inflation assumptions in each year

Arguments for adjusting cash flows, rather than adjusting the discount rate, to account for emerging market risks (e.g. inflation, macroeconomic volatility, capital control, and political risk) in a scenario analysis

DCF approach simulates alternative trajectories for future cash flows – either business as usual of emerging market risks materialize

Adding country risk premium to the discount rate – simple, but there is no objective way to establish the country risk premium:
1) can historically obtain it, after the fact (once the new value is known, backing into it)
2) and adding the country risk premium to the discount rate when discounting expected value of future cash flows vs. the promised cash flows, essentially double counts the distress scenario (in cash flows and the discount rate)

DCF approach is recommended as it provides a more solid analytical foundation and more robust understanding of the value than incorporating country risk in the discount rate

Also most country risks can be diversified away – the discount rate should not reflect diversifiable risk (systematic risk) + country risk has different weight depending on the industry

Estimating the cost of capital (WACC) for emerging market companies

Use CAPM to calculate the cost of equity:

1) determine RFR – most emerging market government debt is not risk free, is often below investment grade, are not actively traded, and when it is traded its often in another currency – so start with 10-yr US government bond yield, adjust for inflation with the spread between emerging and developed inflation = a nominal RFR

2) determine Beta – relative to a well-diversified or global market index, and use international comparables

3) Determine MRP – excess returns between local equity markets and local bond returns are not a good proxy, so use a global estimate of 4.5-5.5%

Estimate the after-tax cost of debt: since the bond markets are unreliable and inconsistent in emerging markets use – developed market RFR + systematic part of the credit spread + inflation differential between local currency and developed currecy

Only taxes (or the tax rate) that are applied to interest expense should be considered with WACC

Calculating and interpreting the country risk premium:
1) don’t just use the sovereign risk premium, consider all estimates, avoid setting it too high (adjust for common sense, of what you know of the country)
2) Only apply the country risk premium to WACC if you are using “business as usual” cash flows

Dividend discount model valuation

defines cash flows as dividends, as this is the only cash flow for a stock holder with dividends, less volatile than earnings

when to use – the company should be dividend-paying, there should be a consistent dividend policy tied to the company’s profitability (consistent payout ratio), and investor takes a non-control perspective

returns to ownership (equity), the cash flows that are “free” from reinvestment needs, and if FCFF (to the firm) – also “free” from debt holders

when to use – applicable to any company, even dividend paying companies (especially if dividends fall short fcf formula cfa level 2 FCFE by a significant spread), appropriate for investors looking to take a control perspective, and when FCF aligns with the company’s profitability, but negative FCFs due to unprofitable companies, or intense capex requirements make this method illogical

Residual income valuation

earnings for a period in excess of the investor’s required return on beginning of the period investment (common stockholder’s equity), is essentially the economic gain; calculated by taking the company’s book value per share + PV of expected future retained earnings; can be viewed as a restatement of the dividend discount model

when to use – can be used regardless of the company’s dividend policy and even if FCFs are negative, is an attractive focus on profitability in relation to opportunity costs, but depends on the quality of accounting, which may result in potential distortions

used to find the terminal value of an asset (stock), based on indefinitely extending future dividends, a required rate of return, and a constant growth rate

Very sensitive to small changes in ‘r’ or ‘g’, as well as, the spread between ‘r’ and ‘g’

Vo = Do * (1 + g) / (r – g)

i. r must be > g, if = g or r<g, the equation is invalid
ii. g normally uses GDP as a basis

With a declining dividend (i.e. negative ‘g’) apply the same GGM formula

If dividends are growing at a constant rate, the stock value also grows at ‘g’ – total return = dividend yield + capital gains yield

Jaguar f type specs value of growth opportunities (PVGO)

the “value of growth”

is used to determine whether to pay out earnings as a dividend or fcf formula cfa level 2 reinvest them with a required return on equity of ‘x’ and distribute the ending value as a dividend in one year – any reinvestment at a rate below the required return on equity would not be in shareholder interests

offers a simple, practical approach to valuation and is appropriate when dividend paying companies have a staple dividend growth policy in line with earnings growth expectations

if g > r or g = r the equation is invalid; is also very sensitive to changes in ‘r’ and ‘g’, as well as, the spread between ‘r’ and ‘g’; only applicable to single-sage

Limitation to multi-stage DDM is that often the PV of the terminal stage represents a major portion (or more than 3/4) of the total value of shares

Circumstance that requires spreadsheet modeling vs. DDM or GGM

a. Would need to move beyond DDM and the GGM when a stable, indefinite dividend growth rate is not realistic, and progressive phases are more align with the company’s expectations

Characteristics of a growth phase

when the company enjoys rapidly expanding markets, high profit margins, and an abnormally high growth rate in EPS – is often coupled with negative FCFE, a low dividend payout ratio due to reinvestment, and prone to increased competition over time

Characteristics of a transitional phase

the transition to maturity, when EPS growth slows with competitive pressures, reducing profit margins and/or sales growth

EPS growth may be above average, but declining towards GDP

Meanwhile capex requirements also typically diminish enabling positive FCFE and increasing dividend payout ratios

Characteristics of a maturity phase

the company reaches equilibrium when investment opportunities each their opportunity cost of capital and ROE approaches the required return on equity

EPS and dividend growth reach their mature growth rate, and the company reaches a point where GGM can be applied to find “terminal value”

Finding "terminal value"

is often obtained with price multiples, but can also be found with DDM – in one or multi-stages of growth and applying one discount rate

Even if a company does not pay a dividend, but is profitable, can use DDM through finding a terminal value at some point in time when the company may pay a dividend or target a payout ratio: the first stage is = 0, second stage is <Dt / (r-g)> / (1 + r)^(t-1)

Two-stage DDM implication

abnormal growth + an abrupt shift to the mature stage fcf formula cfa level 2

abnormal growth + transition/declining period to mature growth

Three-stage DDM implication

abnormal growth + consistent slower 2nd growth phase + mature OR abnormal growth + linear decline in growth (H-Model takes over 2nd and 3rd phases to mature)

is the rate of dividend (and earnings) growth that can be sustained for a given level of ROE, assuming that the capital structure is constant through time and that additional common stock is not issued

Implications of g = ROE x b equation

suggests that ROE is = to r, or the required return on equity, at maturity, because in a mature phase a company can do no more than earn investor’s opportunity cost of capital

can assume that the higher ROE, the higher g

= profit margin * retention rate * asset turnover * financial leverage

= g

When spreadsheet modeling is used?

Spreadsheet modeling is used when there are complicated situations with varying expectations for growth and dividend payout progressions – often used when multi-stage is too timely to compute manually

Evaluation of whether a stock is over, fairly, or under-valued based on DDM estimate of value

If DDM values a stock above the market price, it would be deemed undervalued

If DDM values a stock at the market price, fairly price

If DDM values a stock below the market price, it would be deemed overvalued (it’s not worth as much as the market thinks based on your DDM analysis)

Free cash flow to the firm (FCFF)

is all cash available to the company’s suppliers of capital after all operating expenses (including taxes) have been paid and necessary investments in working capital (e.g. Inventory) and fixed capital (e.g. equipment) have been made.

Essentially FCFF = CFFO – capex (and is available cash to common stockholders, bondholders, and sometime preferred stockholders)

Discounted by WACC, since available to all suppliers of capital

If a company is levered with negative FCFE, or if the company is changing its capital structure, better to use FCFF to reflect those changes

Firm Value = FCFFt / (1 + WACC)^t this gives us the total firm value, to find equity value subtract market value of debt

Free cash flow to equity (FCFE)

switched at birth trailer is the cash flow available to the company’s holders of common equity after all opex, interest, and principal payments have been paid and necessary investments in WC and fixed capital have been made

Essentially FCFE = CFFO – capex – payments to debt holders

Discounted at required return for equity, because only available to equity holders

If capital structure is stable, it’s easier to use FCFE and more direct

Firm Value = FCFEt / (1 + re)^t

Contrast the ownership perspective implicit in the FCFE approach to the ownership perspective implicit in the dividend discount approach

FCFE approach takes the perspective of control, as FCFE is the cash flow available to the equity holder, compared to DDM, which is passive – investor is only concerned about dividend payout

Computing FCFF from Net Income

NI + net non-cash charges + interest expense * (1- T) – investment in fixed capital – investment in working capital (or current assets – current liabilities, ex cash, notes payable, and s-t debt)

FCFF = NI + NCC + Int(1 – T) – FCInv – WCInv

Note FCInv and WCInv will be the change in these balances on the BS

Typical NCC include: D&A, restructuring expenses (income is subtracted), losses or gains on assets, amortization of bond discounts or (premiums), deferred taxes added back but unique

Deferred tax assets arise when tax payments are higher than taxes reported on the IS, if this situation, however is expected to reverse in the near future, deferred tax assets should not be subtracted to avoid underestimating future FCFs

Computing FCFE from Net Income

FCFE = NI + NCC – FCInv – WCInv + Net Borrowing

Note FCInv and WCInv will be the change in these balances on the BS; WCInv = current assets – current liabilities, ex cash, notes payable, and s-t debt

Typical NCC include: D&A, restructuring expenses (income is subtracted), losses or gains on assets, amortization of bond discounts or (premiums), deferred taxes added back but unique

Deferred tax assets arise when tax payments are higher than taxes reported on the IS, if this situation, however is expected to reverse in the near future, deferred tax assets should not be subtracted to avoid underestimating future FCFs

Approaches to forecasting FCFF and FCFE

Apply a constant growth rate to the current level of FCF (often based on history)

Forecast components of FCF – e.g. EBIT derived from sales forecasts, and then an appropriate EBIT margin, and determining capital needs – WCInv and FCInv – based on sales growth
1) Incremental FCInv = Capex – depreciation / increase in sales
2) Incremental WCInv = increase in WC / increase in sales

For FCFE forecasting, assuming the debt ratio remains constant – i.e. each new investment will be funded by debt, the same % that has been applied in the past

FCFE model value recognition vs. DDM

FCFE requires no dividend payment or an expectation for when dividends will be paid

Dividends are a discretionary decision of the board, so they may differ dramatically from FCFE

Dividends are cash flow actually going to shareholders whereas FCFE is the cash flow available to be distributed to shareholders without impairing the company’s value

FCF is appropriate to use in a change of control, because new owners will have discretion over the uses of FCF (including a dividend policy)

How dividends, share repurchases, share repurchases, share issues, and changes in leverage may affect future FCFF and FCFE

Potentially not much of a role, BUT…

Uses of cash and their portion of FCFF and/or FCFE could affect future FCFs – if dividend payout exceeds FCF, reinvestment for future NI growth may be limited, same as if share repurchase or leverage limited NI of CFFO in the future

Источник: https://www.cram.com/flashcards/equity-cfa-level-ii-2209075
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Note that the earnings used for this calculation are also known as net profit after tax or the bottom line of the income statement. Let us now look at how Free Cash Flow to Equity and Free Cash Flow to Firm can be calculated from EBITDA. Calculation of Free University of the west indies mona masters programmes Flows from EBITDA. When we have EBITDA, we can arrive at the free cash flows to equity by performing the following steps: In this video we will look at operating cash flow which is one of the key elements on a cash flow statement.

Operating and Cash Conversion Cycles CFA Level 1 - AnalystPrep

Free Cash Flow to Equity (FCFE) refers to the cash flow that is available to a company’s common stockholders after the company has paid all its operating expenses and borrowing costs and made the required investments in fixed capital and working capital. It is computed according to the following equation: FCFE = CFO – FCInv + Net borrowing Cash Flow From Operations (CFO) is the cash inflows and outflows of a company’s core business operations. It is an important line on the cash flow statement. The cash flow statement defines three types of cash flow: cash flow from operations, cash flow from investing activities, and cash flow from financing.

Net operating assets - Wikipedia

Net operating assets (NOA) are a business's operating assets minus its operating liabilities. NOA is calculated by reformatting the balance sheet so that operating activities are separated from financing activities. This is done so that the operating performance of the business can be isolated and valued independently of the financing performance. Management is usually not responsible for. Free Cash Flow = Operating Cash Flow – Capital Expenditure – Net Working Capital; Free Cash Flow = $300 million – $50 million – $125 million; Free Cash Flow = $125 million; Hence the Free Cash Flow For the year is $125 Million. Example #3. Taking an example of Exxon Mobil which has operating cash flow of $550 million. The capital.

Operating cash flow - Wikipedia

In financial accounting, operating cash flow (OCF), cash flow provided by operations, cash flow from operating activities (CFO) or free cash flow from operations (FCFO), refers to the amount of cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investment in securities. Operating activities include any spending or. Operating cash flow ratio measures the adequacy of a company’s cash generated from operating activities to pay its current liabilities.It is calculated by dividing the cash flow from operations by the company’s current liabilities. Operating cash flow ratio determines the number of times the current liabilities can be paid off out of net operating cash flow. In accounting, cash flow is a measure of changes in a company's cash account, specifically its cash income minus the cash payments it makes. It is the net amount of cash and cash-equivalents moving into and out of a business. Here we provide you with the cash flow from assets formula. To calculate net cash flow from assets deduct the value of operating cash flow from net capital spending and.

Net Cash Flow Formula

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