12: 55 (6) Unfolding Capital Cash Flow Valuation

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14/12/2021, 12:55

(6) Unfolding Capital Cash Flow Valuation | LinkedIn

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Unfolding Capital Cash Flow

Valuation

Published on August 17, 2018

Parag Nawani

13 articles

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“Price is what you pay. Value is what you get.” 

Warren Buffett

might mean that it is important to find the true value of a company so

that an investor doesn’t end up paying more price than its value.

The total value of a firm is equal to the sum of its future cash flows.

There are two methods to value the future cash flows- either using the

free cash flow method or the capital cash flow method. Both of these

approaches will provide the same result, but the process is different.

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14/12/2021, 12:55

(6) Unfolding Capital Cash Flow Valuation | LinkedIn

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This article provides insights into the capital cash flow method and will

compare it with the free cash flow approach.

The capital cash flow method differs from the free cash flow method

mainly in the way that the discount rate used in the former is the pre-

tax WACC (weighted average cost of capital). The latter excludes

interest tax shields from the cash flow assumptions and thus uses after-

tax WACC for valuation. This might not come as a big difference, but

there are instances where the free cash flow method is comparatively

difficult to apply- like when the debt policy of a company is assumed as

a target amount rather than a target percentage; or when the capital

structure of a company changes over time. The cost of capital is to be

calculated every year in these instances going by free cash flow

method, due to which it is difficult to apply this method in these cases.

In the capital cash flow method, interest tax shields are included in the

cash flows itself, and there is no need to calculate the cost of capital

every year.