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

NOTES

1. If the free cash flow available to shareholders is considered to be the same as dividends, Equation 11.1 is also the Gordon constant-dividend-growth model (see Gordon 1962).

2. FCFe (i.e., Net earnings + Depreciation − Investments + Debt capacity for new investments) is the free cash flow available for shareholders. We assume that the best estimate for the debt capacity from new investments is Dg.

3. FCF (i.e., Operating profit after taxes + Depreciation − Investments = EBITDA − Investments, where EBITDA is earnings before interest, taxes, depreciation, and amortization) is the free cash flow available to the company.

4. We use EVA as a general expression that applies to all methodologies based on the spread between the return on investment and the opportunity cost of capital. As we show later in this chapter, we have chosen Leibowitz’s franchise factor model to represent this methodology (see, for example, Leibowitz and Kogelman 1990, 1992, 1994).

5. The term βd applies when bondholders share some business risk with equity investors. This risk exists (although it is extremely low), but for practical purposes, we assumed it to be zero.

6. Depreciation is deducted from gross investments. So, the formula could also be presented as operating cash flow less gross investments (EBITDA, or operating free cash flow).

7. The FEVA approach shows this.

8. Using the expected yield narrows the scope of what should be considered bankruptcy costs by excluding specific default risk. Using ...