Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

APPENDIX 11A: DERIVATION OF FEVA FORMULA

Equation 11.7 can be derived from a simple DCF model, such as the one stated in Equation 11.2. Also, a simple link exists between Equation 11.7 and Equation 11.10. First, consider the link between Equation 11.7 and Equation 11.2. Equation 11.2 states

With Ep as the equity risk premium (that is, RM − Rf), if

and

then we may redefine Equation 11.2 with a new expression for the cost of capital:

(11A.1)

If ke is redefined, the left side of Equation 11A.1 becomes

(11A.2)

If RfD and tDRf are both added and substracted, the left side of Equation 11A.2 can be

(11A.3)

Then, making additional adjustments to Equation 11A.1, we obtain the following, which is Equation 11.7 in the text:

The link between Equation 11.7 and Equation 11.10 is as follows. Equation ...