The Value Of Cash Flow

Free cash flows are the monies available for distribution to all investors after paying current expenses, taxes, and making the investments necessary for growth.

To obtain Free Cash Flow For The Firm (FCFF), I added back the D&A, less

For instance, Book values might be realistic in mark-to-market accounting situations, where the firm has just started up, or where the firm consists substantially of working capital. On the other hand, Liquidation estimates would be more realistic in cases where the firm will indeed liquidate. Replacement values might indicate market values where the firm experiences high inflation. In any comparison to this, DCF and multiples give very direct estimates of market values. DCF will dominate where the firm has no earnings to capitalize or when assets consist mostly of intangibles that are not currently reflected in earnings.

He can use two methods to determine the value of the company: discount cash flow (DCF) approach and /or comparison with similar companies, which are publically traded.

Constructing Free Cash Flows allows the calculation for NPV, which enables an even comparison of inflows and outflows of the competing projects. EBITDA does not take into account the Income Tax. Unlevered Net Income (ATCF) does not account for the separation of depreciation, capital expenditures, and changes in Net Working Capital.

It is focused on cash flow rather than accounting practices and allows for different components of a company to be valued separately. Conversely, the biggest challenge of the DCF method is that the determined value is only as accurate as the information it is given, that being the FCF, TV and discount rates. In other words, if the information given to determine the DCF isn’t accurate then the fair value for the investment won’t be accurate and the model won’t be helpful when assessing stock prices due to the inaccuracies. Furthermore, DCF is only good for long term values not short term investing. “The bottom line is that DCF is a rigorous valuation approach that can focus your mind on the right issues, help you see the risk and help you separate winning stocks from losers and help reduce uncertainty.” (McClure, 2011) So, now that we’ve looked at CAPM and DCF, what can we conclude?

in our calculations, as this company exhibited dramatic value differences to others in the sample, (likely to skew our results and prove misleading). Using the average of the revised sample field for each ratio, we inserted Torrington’s values where appropriate to generate an entity value. The findings generated two values for Torrington, 606 million and 398 million. Taking the average of these two numbers, Torrington exhibited a relative value of 502.41 million. Because of the lack of related information given in the case, and the often large differences in measures amongst competitors, different capital structures, internal management strategies, there remained many unknowns in our model. We decided it would be best to use this valuation to reaffirm our assumptions in our DCF valuation. (Please see exhibits)

The DCF does not consider right away the option to turn down a movie if it generates a negative NPV; we had to come up with a way to include that in our model. Also, changes in the future inflows or costs will generate volatility. Finally, we need to remember that the DCF method generates more volatility when the cash flows are uncertain in the future. Since in this example we have inflows 4 years in the future and costs 3 years in the future, we have some variability there that can change the output of the valuation when time comes true.

* Determine the investment’s value without leverage, VU, by discounting its free cash flows at the

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

As discounted cash flow method assumes all equity financed acquisition, it presents more comparable value for the real option values shown. The value of Apache’s possibility to decide whether to exploit the reserves equals the difference between DCF value and the real option value.

The free cash flow method is used to gauge “a company’s cash flow beyond that necessary to grow at the current rate… [to ensure companies] make capital expenditures to continue to exist and to grow” (Drake, n.d.). Calculation of free cash flows utilizes various components, including a firm’s value, cash flow forecasts, a firm’s capital structure, the cost of capital, and/or discounted cash flows.

In DCF valuation (Chart 2), long-term growth rate is assumed to be 4%. Change in working capital is calculated as the average of 1997 and 1996 figure and is assumed to be constant for simplicity. Terminal value is valued at $69,398.1 million and NPV is $51,525 million. Stock price will be $37.07, indicating an exchange ratio at 0.46. This is a very conservative valuation as our DCF price is lower than Amoco’s current market price.

5. If debt is used to finance this project, should the interest payments associated with this new debt be considered cash flows?

I. Introduction of company valuation methods and process........................................................3 1. Abstract................................................................................................................................3 2. Valuation methods...............................................................................................................3 2.1 Balance sheets – Based methods