Free cash flow to the firm (FCFF) represents the amount of cash flow from operations available for distribution after depreciation expenses, taxes, working capital, and investments are accounted for and paid. FCFF is essentially a measurement of a company's profitability after all expenses and reinvestments. It is one of the many benchmarks used to compare and analyse a firm's financial health
The Free Cashflow to Firm Single Stage Model allows investors to calculate the value of Free Cashflow to a Firm with consideration to the firm’s Working Average Cost of Capital (WACC) and the assumed stable growth rate of a firm.
In order to calculate the Free Cashflow to Firm using the FCFE Single Stage Model, investors have to assume that free cashflows to a firm will not change over time. The second assumption is that the growth rate will be lower than the working average cost of capital.
The Working Average Cost of Capital (WACC), often also referred to as the Weighted Average Cost of Capital, is the percentage rate of return a business needs to generate in order to compensate, on average, both the debt and equity capital providers to the business. The WACC of a firm can be calculated as follows:
WACC = (w (E) * r (E) ) + (w (D) * r (D) *(1-tax rate) )
Where w is the weight of debt or equity, r is the rate of return on debt or equity, D is the value of debt, E is the value of equity, and the tax rate is the rate of tax the company pays.
The Free Cashflow to Firm (FCFF) Single Stage Model assumes that a company's Free Cashflow to Firm is going to continue to rise at a constant growth rate indefinitely. You can use that assumption to figure out what a fair price is to pay for the share or investment today based on those future FCFF payments.
The value of cashflow expected next year or period. Assuming the free cashflow will be the same for this year and accounting for growth (g), the FCFF1 value can be calculated by multiplying the value of FCFF this period (FCFF0) by 1+g (growth rate).
FCFF1 = FCFF0 * (1+g)
This is the terminal value of a firm to investors after considering the values of growth, FCFF payments and WACC, and then calculating the value of a firm with those variables.
Consider a firm with Free Cashflow to Firm next year of $300 million, is expected to grow (g) at a rate of 4% each year forever, and has a Working Average Cost of Capital (WACC)is 10%. Using the FCFF Single Stage Model, the value of the firm can be calculated as follows:
V = FCFF1 / (WACC – g)
V = 300,000,000 / (0.1 – 0.04)
V = 5,000,000,000
Using the FCFF Single Stage Model, the present value of a firm today can be calculated to equal $5 billion. This value can be used by investors to determine whether or not a firm is a viable choice for investment. The value can be compared to other firms within the industry to get a better picture of where the firm stands in the industry or market.
Knowing the company’s free cash flow to firm enables management to decide on future ventures that would improve the shareholder and investor value. Having an abundant FCFF indicates that a company is capable of paying their monthly dues. Companies can also use their FCFF to expand business operations or pursue other short-term investments.
Investors investigating a company and considering investment may evaluate the Free Cashflow to a Firm, investing if they consider the FCFF value to be healthy and promising for future investment ventures.
The Free Cashflow to Firm (FCFF) Single Stage Model measures a company’s financial performance by calculating the potential terminal value of a firm today. It shows the cash that a company can produce after deducting the purchase of assets such as property, equipment, and other major investments from it’s operating cash flow, while taking into consideration growth and the working average cost of capital.
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