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Stock valuation via free cash flow approach: Please explain how to find the the intrinsic firm...

Stock valuation via free cash flow approach: Please explain how to find the the intrinsic firm value, and then back out the intrinsic stock value per share. I'm currently doing this for the McDonalds stock

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Answer #1

Stock Valuation via Free Cash Flow approach:

Free Cash Flow to the Firm (FCFF) refers to the cash flows generated by a Firm before debt payment but after taking care of the reinvestment needs and taxes. It reflects the true cash flows to the firm as it excludes non cash expenses like depreciation.

FCFF= EBIT – Taxes + Depreciation (non-cash costs) – Capital spending – Increase in net working capital

Intrinsic Firm Value is calculated by discounting the Free Cash Flows to Firm at the WACC (cost of capital) of the Firm.

Using Gordon Growth Model, Value (Firm)= FCFF/ (WACC-growth rate)

Free Cash Flows to Equity (FCFE) refers to the cash flows generated by a Firm after taking care of the reinvestment needs, taxes and interest payments. It is calculated by the forllowing formula:

FCFE = (EBIT – interest – taxes) + depreciation (non-cash costs) - capital expenditures - increase in net working capital – principal debt repayments + new debt issues

How to calculate Value of Firm from FCFF:

FCFE = FCFF – Interest expense * (1 – tax) + Increase in debt

Intrinsic Value of Equity is calculated by discounting the Free Cash Flows to Equity using the Cost of Equity (Ke) of the Firm.

Using Gordon Growth Model, Value (Equity)= FCFE/ (Ke-growth rate)

Intrinsic value per share= Instrinsic value of Equity/ Outstanding no. of equity shares

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