Further, the terminal value has also been calculated. Here, we focus predominantly on constructing FCFF for the historical year and forecast years (3) using part of the management forecast data. The two-step DCF analysis includes the calculation of the FCFF (historical and forecast years) and a terminal value among several other steps. In such situations, an alternative FCFF formula can be used:įCFF = Net Income + D&A + Interest Expense (1-tax rate) – CAPEX – Change in Net Working Capital Free Cash Flow in Firm (FCFF) – ExampleĪssume that Company A (metals industry) has provided both historical data (Year 0) and forecast information for three years (Year 1 to Year 3) to complete a discounted cash flow (DCF) valuation analysis. Sometimes valuation teams do not have access to detailed information on a company, particularly in the case of private companies. Next, the DCF terminal value can be calculated either by the perpetual growth or explicit multiple methods. The FCFF calculation starts with EBIT, which can be forecast as a margin on sales or a more detailed operating profit forecast can be constructed. Further, the tax must be deducted to arrive at FCFF (some practitioners use marginal tax rate, while others use a long-term expected effective tax rate). Tax on EBIT)ĭ&A = Depreciation and Amortization (non-cash expenses)ĭepreciation and amortization are non-cash expenses and therefore have to be added back, while capital expenditure and changes in net working capital have to be subtracted, in order to arrive at the FCFF. NOPAT (or EBIAT) = Net Operating Profit After Tax (i.e. The FCFF is calculated using the following formula:įCFF = NOPAT + D&A – CAPEX – Changes in Net Working Capital This (terminal) value includes the value of all expected free cash flows of a business beyond or outside a particular forecast period. Thereafter, in such valuation analysis, the FCFF with a terminal growth rate can also be used to calculate the terminal value of a business. The FCFF of a business has to be computed first by the valuation team for both the historic year and the forecast years (typically 3-5 years) in a discounted cash flow valuation analysis – that wants to assess the cash generating ability of a business to evaluate its intrinsic value. The underlying objective of calculating the FCFF is to gain an insight into what the true cash inflows and outflows of a company are. For the calculation of the historical and forecast period FCFF of a business, the management needs to provide both historical data and forecast information on certain variables.Calculation of FCFF is the first step in the two-step DCF model – it can also be used to calculate the terminal value of a business.The FCFF of a company provides an insight into its underlying cash inflows and outflows.
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