CFA Level II: Equity Investments - Free Cash Flow Valuation Part I(of 2)

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This series of video covers the following points :

-There are two ways to estimate the equity value using free cash flows.

-An entire firm and all its cash flows (FCFF) are discounted, with the relevant discount rate being the weighted average cost of capital (WACC) because it reflects all the firm’s sources of capital. The value of the firm’s debt is then subtracted to calculate the equity value.

-Only the free cash flows to equity (FCFE) are discounted, with the relevant discount rate being the required return on equity. This provides a more direct way of estimating equity value.

-In theory, both approaches should yield the same equity value if the inputs are consistent. However, the FCFF approach would be favored in two cases.
The firm’s FCFE is negative.

-The firm’s capital structure (mix of debt and equity financing) is unstable. The FCFF approach is favored here because a) the required return on equity used in the FCFE approach will be more volatile when the firm’s financial leverage (use of debt) is unstable and b) when using historical data to estimate free cash flow growth, FCFF growth might reflect the firm’s fundamentals better than FCFE growth, which would fluctuate as debt fluctuates.

-FCFF and FCFE approaches to valuation

-value of a company by using the stable-growth, two-stage, and three-stage FCFF and FCFE models.

-appropriate adjustments to net income, earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation, and amortization (EBITDA), and cash flow from operations (CFO) to calculate FCFF and FCFE.

-approaches for forecasting FCFF and FCFE.

-approaches for calculating the terminal value in a multistage valuation model


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-This Video lecture was recorded by our popular trainer for CFA, Mr. Utkarsh Jain, during one of his live CFA Level II Classes in Pune (India).
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