Firm and Equity Valuation Using Free Cash Flow Models

In this chapter, we explore the firm's valuation and equity valuation using the free cash flow to the firm (FCFF) valuation model and the equity valuation using the free cash flow to equity valuation (FCFE). The chapter begins with a discussion on how to calculate the firm’s FCFF and FCFE from its net income (NI), earnings before interest and tax (EBIT), earnings before interest, tax, depreciation, and amortisation (EBITDA), and cash flow from operations (CFO). We then use the no-growth, single-stage (constant), two-stage, and three-stage (or the E-model) FCFE valuation models to value the firm’s equity. After discussing equity valuation, the chapter focuses on the firm's valuation and its equity using the no-growth, single-stage (constant) growth, two-stage growth, and three-stage growth FCFF valuation models. This chapter further illustrates the application of the concept of time value of money in corporate finance and valuation. We discount the FCFF to arrive at the firm’s present value and its FCFE to arrive at the present value of its equity. This valuation method is called the discounted cash flow (DCF) valuation approach and is widely used in valuation practice.