controlling interests in the stock of other companies.
The value of operations is the present value of all the future free cash flows that are
expected from current assets-in-place and the expected growth of assets-in-place
when discounted at the weighted average cost of capital:
The terminal, or horizon value, is the value of operations at the end of the explicit
It is equal to the present value of all free cash flows beyond the
forecast period, discounted back to the end of the forecast period at the weighted
average cost of capital:
The free cash flow model defines the total value of a company as the value of operations plus the
value of nonoperating assets plus the value of growth options.
A perpetual bond is similar to a no-growth stock and to a share of preferred stock in the following
All three derive their values from a series of cash inflows--coupon payments from the
perpetual bond, and dividends from both types of stock.
All three are assumed to have indefinite lives with no maturity value (M) for the perpetual
bond and no capital gains yield for the stocks.
The first step is to find the value of operations by discounting all expected future free cash flows
at the weighted average cost of capital. The second step is to find the total corporate value by
summing the value of operations, the value of nonoperating assets, and the value of growth
The third step is to find the value of equity by subtracting the value of debt and preferred
stock from the total value of the corporation. The last step is to divide the value of equity by the
number of shares of common stock.