DCF Valuation Models: FCFF V/S FCFE
Discounted Cash Flow Valuation:
DCF is a fundamental technique of valuation which is based on the principle that the value of an asset will depend on the expected cash flows which the asset will generate in future.
Similarly the valuation of company will depend on all cash flows which the company will generate in the foreseeable future. DCF valuation gives the intrinsic value of the company which is equal to present value of those expected cash flows.
Higher expected cash flows will generate higher company value and lower expected cash flows will generate lower company value assuming other factors like Discount rateconstant.
There are various models in DCF valuation:
Free cash flow model is most widely used technique among DCF valuation approaches.
There are two different free cash flow models:
Let’s understand both these models in detail now.
Formula to calculate FCFF:
EBIT * (1 – tax rate) + NCC - Change in WC – Capital expense
If you know EBIT – Interest = PBT
Then you also know that
(EBIT – Interest)*(1- Tax rate) = PAT
If you open this equation, You can write it as
EBIT * (1 – Tax Rate) = PAT + Interest * (1 – Tax Rate)