Constant Growth Free Cash Flow to the Firm Valuation Model
Free cash flow to the firm models value an entire company rather than a share of the stock. The valuation formula is essentially the same as the dividend discount model, but there are some important differences.
Under a free cash flow to the firm model, Value = FCFF1/(WACC - g)
Compare this to the Gordon growth model, where the value of a stock is estimated as D1/(r-g).
Again, the formula is nearly identical. It is simply a present value function. What has changed is the type of cash flow being discounted and the rate used to discount it.
When valuing a stock, the dividends received are an appropriate cash flow. The discount rate should be the required return for equity investors.
When valuing a firm, the cash flow is the cash flows the company will generate. The appropriate discount rate is the firm’s weighted average cost of capital or WACC.
For more information, see all articles on: Valuation See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
