L5_FCF_Models - Free Cash Flow Models Estimating Growth...

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Free Cash Flow Models
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2 Estimating Growth Rates: ROE ROE x ) p (1 ROE x r g r r For DDM, FCF discount models, growth often estimated : Retention ratio = 1- p r p r ( payout ratio ) :% earnings paid out as dividends
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3 The Discount Rate: the CAPM ) r β(r r r f m f often able to use the CAPM to determine the discount rate to use in our valuation: Where: r f risk-free rate.  beta of the share. r m market return. r m r f market risk premium.
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4 Free Cash Flow: Definition Cash flow generated by company that can be paid to shareholders without affecting ability to continue operating at current level Cash available to shareholders after: Funding capital requirements Working capital needs Debt refinancing needs
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5 Free Cash Flow Models Equity value = PV (expected future cash flows) Valuation based on cash flow , rather than dividends Therefore, independent of dividend policy
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6 Free Cash Flow Valuations Advantage General to companies regardless of dividend policies and capital structures Disadvantage Cannot be used with negative cashflows (as initially for most growth companies).
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7 Use FCF when… The company has positive free cash flows The company pays no dividends The company has no clear dividend policy The company pays less dividends than its cashflow allows The company’s dividend pol icy is not related to its earnings capacity Company is possible acquisition target – new owners may distribute cash flow differently
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8 Free Cash Flow to Firm (FCFF) Do not confuse with FCFE, which is more generally used Definitions of FCFF: Cash available to pay to all the firm’s investors (both shareholders and bondholders) Cash available before interest payments to bondholders and/or new bond issues ( i.e. , new loans from bond investors)
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9 Free Cash Flow to Equity (FCFE) Definitions of FCFE: Cash available to pay to shareholders Cash available after interest payments to bondholders and/or new bond issues ( i.e. , new loans from bond investors) The correct basis for a direct valuation of equity
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10 FCFF vs. FCFE Free Cash Flow to Firm Working Capital Capital Investments Operating expenses (excl. interest) Revenue Interest Expenses (Bonds) Free Cash Flow to Equity Net Bond Borrowing
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11 Preference Dividends
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L5_FCF_Models - Free Cash Flow Models Estimating Growth...

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