Introduction to Cash Flow Valuation Methods.pdf

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1、FortheexclusiveuseofG.REGENSBURGERHarvardBusinessSchool9-295-155Rev.October16,1995AnIntroductiontoCashFlowValuationMethodsRev.January19,1995Thisnoteprovidesanintroductiontothreecashflowvaluationmethods.Thethreemethodsdifferintheirmeasureofcashflowsandthediscountrateap

2、pliedtothosecashflows.Thenamesforthethreemethodscorrespondtothetypeofcashflowthatisusedinthevaluation:EquityCashFlow(ECF),CapitalCashFlow(CCF),andFreeCashFlow(FCF).Thethreemethodsprovideconsistentvaluationswhenappliedcorrectly.CapitalCashFlowsmeasurethecashflowavailab

3、letobothequityanddebtholders.ThebenefitsoftaxdeductibleinterestpaymentsareincludedintheCapitalCashFlow.TheappropriatediscountrateforCapitalCashFlowsisthepre-taxratecorrespondstotheriskinessoftheassetsofthefirm.Theriskinessoftheassetsisrelevantbecausethecashflowmeasure

4、includesallofthecashflowgeneratedbytheassetsandavailabletoallprovidersofcapital.EquityCashFlowsmeasurethecashflowavailabletostockholdersafterpaymentstodebtholdersaredeductedfromoperatingcashflows.Thepaymentstodebtholders,sometimescalledDebtCashFlows,includeinterestand

5、principlepayments.EquityCashFlowsequalCapitalCashFlowsminusDebtCashFlow.Becausedebtcashflowsarepaidoutofoperatingcashflowsbeforeequitycashflows,debtcashflowsaresaferthanequitycashflows.ThatmeansthatEquityCashFlowsareriskierthancashflowmeasuresthatcombineDebtCashFlowsa

6、ndEquityCashFlows.Andriskiercashflowshavehigherdiscountrates.TheFreeCashFlowmethod,liketheCapitalCashFlowmethod,valuesthewholefirm.ThedifferencebetweenCapitalCashFlowandFreeCashFlowisthetreatmentofthetaxbenefitsofdeductibleinterestpayments.TheCapitalCashFlowmeasureinc

7、ludesthesebenefitsascashflows;themorethetaxadvantages,thehighertheCapitalCashFlow.TheFreeCashFlowmethodincludesthetaxbenefitsofdeductibleinterestpaymentsinthediscountrate;themorethetaxadvantages,thelowerthediscountrate.Becausethetaxadvantagesofdebtareincludedinthedisc

8、ountrateintheFCFmethod,thecashflowsdonotincludethetaxbenefitsofdebt.FreeCashFlowsarethecashflowsthatwouldbeavailabletothefir