This lesson examines Free Cash Flow to the Firm (FCFF) and Free Cash Flow to Equity (FCFE) models, which are widely used for corporate valuation. It covers the calculation of free cash flows, the selection of appropriate discount rates, and the application of these models in corporate finance.

• Free Cash Flow Models (FCFF and FCFE): Free cash flow models are particularly useful when the company does not pay dividends, dividends differ significantly from the company’s capacity to pay dividends, or the investor takes a control perspective.

  • FCFF (Free Cash Flow to the Firm): Cash flow available to all investors (debt and equity holders). The firm value is the present value of FCFF discounted at WACC.

  • FCFE (Free Cash Flow to Equity): Cash flow available to common stockholders. The equity value is the present value of FCFE discounted at the cost of equity.

• Selecting the Right Valuation Model: The choice between DDM and free cash flow models depends on the company’s dividend policy, growth characteristics, and the analyst’s perspective (control vs. minority ownership). Advanced valuation courses explore the strategic use of valuation in areas such as corporate portfolio management, mergers and acquisitions, and divestitures .

• Valuation Standards and Frameworks: Valuation professionals must be aware of different standards and frameworks. The International Chart provides a comparison of business valuation standards promulgated by NACVA to the International Valuation Standards Council (IVSC), RICS, and the CBV Institute . The Domestic Chart compares NACVA standards to USPAP, ASA, and AICPA standards .

• Drivers of Corporate Value: Valuation is driven by the relationship between growth, return on invested capital (ROIC), and the cost of capital . The cost of capital is a key factor in determining shareholder value .