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Discounted cash flow valuation methods: Examples of perpetuities, constant growth and general case

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  • Fernandez, Pablo

    ()
    (IESE Business School)

Abstract

This paper explores the discounted cash flow valuation methods. We start the paper with the simplest case: no-growth, perpetual-life companies. Then we will study the continuous growth case and, finally, the general case. The different concepts of cash flow used in company valuation are defined: equity cash flow (ECF), free cash flow (FCF), and capital cash flow (CCF). Then the appropriate discount rate is determined for each cash flow, depending on the valuation method used. Our starting point will be the principle by which the value of a company's equity is the same, whichever of the four traditional discounted cash flow formulae is used. This is logical: given the same expected cash flows, it would not be reasonable for the equity's value to depend on the valuation method.

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Bibliographic Info

Paper provided by IESE Business School in its series IESE Research Papers with number D/604.

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Length: 33 pages
Date of creation: 27 Jul 2005
Date of revision:
Handle: RePEc:ebg:iesewp:d-0604

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Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/
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Keywords: discounted cash flow valuation; cash flow valuation; value of tax shields; required return to equity;

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  1. Myers, Stewart C, 1974. "Interactions of Corporate Financing and Investment Decisions-Implications for Capital Budgeting," Journal of Finance, American Finance Association, vol. 29(1), pages 1-25, March.
  2. Kaplan, Steven N & Ruback, Richard S, 1995. " The Valuation of Cash Flow Forecasts: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 50(4), pages 1059-93, September.
  3. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
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