12: 55 (6) Unfolding Capital Cash Flow Valuation

CCF method

There is no change in the expected asset return which is used to

discount the capital cash flows. The interest tax shields, on the other

hand, do change, since the amount of debt outstanding changes with the

changing capital structure.

Application

In the case of a Leveraged Buy-Out (LBO), a company acquires a

target company using high levels of debt. These transactions generally

involve a changing capital structure with the debt level reducing over

the years. So, instead of using the FCF approach, if the analyst uses the

CCF approach, he would not have to recalculate the cost of capital for

each year separately, and thus makes his valuation much easier.

So, we see that there are instances where it is beneficial to use the CCF

approach rather than FCF approach, to find out the true worth of a

company. 

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