F-401
Financial Statement Analysis & Valuation
Nusrat Jahan Benozir
Lecturer
Department of Finance and Banking
University of Barishal
Cash flow and free cash flow concept
Cash flow is the net amount
of cash and cash equivalents being
transferred into and out of a
company. Positive cash flow Free cash flow (FCF) is the cash a
indicates that a company's liquid company produces through its
assets are increasing. operations after subtracting any outlays
of cash for investment in fixed assets like
property, plant, and equipment.
Cash Flows Within a Firm: Free Cash Flow
Free cash flow is cash flow from operations that results from investments minus cash used to
make investments.
Cash flow from operations (inflows) C1 C2 C3 C4 C5
Cash investment (outflows)
I1 I2 I3 I4 I5
Free cash flow
C1-I1 C2-I2 C3-I3 C4-I4 C5-I5
Time, t
1 2 3 4 5
The Discounted Cash Flow (DCF) Model
V0E V0F V0ND
VOF
The Continuing Value for the DCF Model
Capitalize terminal free cash flow with growth:
���� (1 + �)
��� =
�� − �
DCF Valuation: The Coca-Cola Company
In millions of dollars except share and per-share numbers. Required return for the firm is 9%
1999 2000 2001 2002 2003 2004
Cash from operations 3,657 4,097 4,736 5,457 5,929
Cash investments 947 1,187 1,167 906 618
Free cash flow 2,710 2,910 3,569 4,551 5,311
Discount rate (1.09)^t 1.09 1.1881 1.2950 1.4116 1.5386
Present value of free cash flows 2,486 2,449 2,756 3,224 3,452
Total present value to 2004 14,367
Continuing value (CV)* 139,414
Present value of CV 90,611
Enterprise value 104,978
Book value of net debt 4,435
Value of equity 100,543
Shares outstanding 2,472
Value per share $40.67
*CV = 5,311 x 1.05 = 139,414
1.09 - 1.05
Present value of CV = 139,414 = 90,611
1.5386
Steps for a DCF Valuation
Here are the steps to follow for a DCF valuation:
1. Forecast free cash flow to a horizon
2. Discount the free cash flow to present value
3. Calculate a continuing value at the horizon with an estimated growth rate
4. Discount the continuing value to the present
5. Add 2 and 4
6. Subtract net debt
Why Free Cash Flow is Not a Value-Added Concept
• Cash flow from operations (value added) is reduced by investments (which also
add value): investments are treated as value losses
• Value received is not matched against value surrendered to generate value
A firm reduces free cash flow by investing and increases free cash flow by
reducing investments:
Free cash flow is partially a liquidation concept!!
Note: analysts forecast earnings, not cash flows
Discounted Cash Flow Analysis:
Advantages and Disadvantages
Advantages Disadvantages
• Easy concept: cash • Suspect concept:
flows are “real” and ü free cash flow does not measure value added in the short run;
easy to think about; value gained is not matched with value given up.
they are not affected ü free cash flow fails to recognize value generated that does not
involve cash flows
by accounting rules ü investment is treated as a loss of value
ü free cash flow is partly a liquidation concept; firms increase free
• Familiarity: is a cash flow by cutting back on investments.
straight application of
familiar net present • Forecast horizons: typically requires forecasts for
value techniques long periods; terminal values for shorter periods are
hard to calculate with any reliability
• Not aligned with what people forecast: analysts
forecast earnings, not free cash flow; adjusting
earnings forecasts to free cash forecasts requires
further forecasting of accruals
When It Works Best
When the investment pattern is such as to produce constant free cash flow or
free cash flow growing at a constant rate.
Discounted free cash flow
+ discounted terminal value
Enterprise value
- Cash and cash equivalent
- Interest bearing debt
Equity value
v (Equity value / no. of share outstanding) = value per share
