Unformatted text preview: ions of free cash flow. We look at definitions of free cash flow, free cash flow to
equity, and free cash flow to the firm. But there are actually many different calculations to represent
these cash flows and, to add to the confusion, many are simply referred to as free cash flow.
Estimating free cash flow for future periods using current financial information presumes that the
current performance is representative of the company and its ability to generate cash flows. Variation
in capital expenditures from year to year, combined with the typical variability in net income, suggest
that a better benchmark may use some type of averaging of cash flows from several periods, not just
one fiscal period.
The benefit of free cash flow is still debated. While free cash flow provides financial flexibility, it also
provides temptation to invest in non-value adding projects.
The value estimated using free cash flows should be evaluated with respect to the sensitivity of the
estimate to the specific calculation of free cash flow, the assumptions regarding growth rates, and the
assumptions imbedded in the calculation of the appropriate cost of capital. Online resources for additional information on free cash
5. Damadoran, Aswath, “Firm Valuation: Cost of Capital and APV Approaches,” Chapter 15.
Damadoran, Aswath, “Free Cash Flow to Equity Discount Models, Chapter 14.
Mills, John, Lynn Bible, and Richard Mason. “Defining Free Cash Flow,” The CPA Journal, 2002.
Motley Fool, Foolish Fundamentals: Free Cash Flow.
Tarter, John, Federal Reserve Bank of Cleveland, Supervision & Regulation Department, “EBITA a
Useful Cash-Flow Tool, But No Substitute for Good Judgment.”
6. Value-Based Management.net, “Earnings Before Interest, Taxes, Depreciation and Amortization.” 6...
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- Spring '14
- Behavioral Finance, ........., Generally Accepted Accounting Principles