Unformatted text preview: egin with earnings before interest and taxes:
(EQ 11) ( ) non-cash
FCFF = EBIT 1 - tax +
− increase in
charges (income) expenditures working capital Recognizing that:
(EQ 12) ( ) ( ) ⎡
EBIT 1 - tax = Net
+ ⎢Interest 1- tax ⎥ ,
⎣ we can re-write equation 11 in terms of net income: 1 Michael Jensen, “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers,” American Economic Review, 76, no. 2 (May 1986), pp. 323–329. 2 If the company has preferred stock and the company pays preferred dividends, the free cash flow to
common equity (FCFCE) is the FCFE, less any preferred dividends.
3 (EQ 13) FCFF = ( ) ⎡
+ ⎢Interest 1- tax ⎥ +
− increase in
rate ⎦ charges (income) expenditures working capital
⎣ The FCFF is often referred to as the unlevered free cash flow because it is the cash flow before
interest on debt is considered.
We can reconcile the free cash flow to the firm with the free cash flow to equity by noting that the
difference between the two are:
Interest paid on debt, and
Net new debt financing.
In other words,
(EQ 14) net
Free cash flow to the firm = FCFE + ⎡ interest (1-tax rate ) ⎤ ⎢ expense
⎦ Valuation using free cash flow
The valuation of a company requires discounting the future cash flow to the present. The cash flows that
we use in this valuation are forecasted free cash flows. The model that we use to determine a value
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This homework help was uploaded on 02/24/2014 for the course BUS 101 taught by Professor Lipsitz during the Spring '14 term at International University.
- Spring '14
- Behavioral Finance