IDEAS home Printed from https://ideas.repec.org/p/ebg/iesewp/d-0451.html
   My bibliography  Save this paper

Valuing companies by cash flow discounting: Ten methods and nine theories

Author

Listed:
  • Fernández , Pablo

    (IESE Business School)

Abstract

This paper is a summarized compendium of all the methods and theories on company valuation using cash flow discounting. The paper shows the ten most commonly used methods for valuing companies by cash flow discounting: 1) free cash flow discounted at the WACC; 2) equity cash flows discounted at the required return to equity; 3) capital cash flows discounted at the WACC before tax; 4) APV (Adjusted Present Value); 5) the business's risk-adjusted free cash flows discounted at the required return to assets; 6) the business's risk-adjusted equity cash flows discounted at the required return to assets; 7) economic profit discounted at the required return to equity; 8) EVA discounted at the WACC; 9) the risk-free rate-adjusted free cash flows discounted at the risk-free rate, and 10) the risk-free rate-adjusted equity cash flows discounted at the required return to assets. All ten methods always give the same value. This result is logical, since all the methods analyze the same reality under the same hypotheses; they only differ in the cash flows taken as starting point for the valuation. The disagreements in the various theories on the valuation of the firm arise from the calculation of the value of the tax shields (VTS). The paper shows and analyses 9 different theories on the calculation of the VTS: No-cost-of-leverage, Modigliani and Miller (1963), Myers (1974), Miller (1977), Miles and Ezzell (1980), Harris and Pringle (1985), Damodaran (1994), With-cost-of-leverage and Practitioners method. The paper contains the most important valuation equations according to these theories, and also shows the changes that take place in the valuation equations when the debt's market value does not match its book value.

Suggested Citation

  • Fernández , Pablo, 2002. "Valuing companies by cash flow discounting: Ten methods and nine theories," IESE Research Papers D/451, IESE Business School.
    • Handle: RePEc:ebg:iesewp:d-0451
    as

    Download full text from publisher

    File URL: http://www.iese.edu/research/pdfs/DI-0451-E.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July.
    2. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(3), pages 719-730, September.
    3. Kaplan, Steven N & Ruback, Richard S, 1995. "The Valuation of Cash Flow Forecasts: An Empirical Analysis," Journal of Finance, American Finance Association, vol. 50(4), pages 1059-1093, September.
    4. Isik Inselbag & Howard Kaufold, 1997. "Two Dcf Approaches For Valuing Companies Under Alternative Financing Strategies (And How To Choose Between Them)," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(1), pages 114-122, March.
    5. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    6. Lewellen, Wilbur G. & Emery, Douglas R., 1986. "Corporate Debt Management and the Value of the Firm," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(4), pages 415-426, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    2. Irina Matyash, 2018. "Investment Attractiveness and Sustainable Growth of Telecommunication Companies: Value-Oriented Approach," Economy of region, Centre for Economic Security, Institute of Economics of Ural Branch of Russian Academy of Sciences, vol. 1(4), pages 1411-1423.
    3. Nangia, Vinay Kumar & Agrawal, Rajat & Reddy, K. Srinivasa, 2011. "Business Valuation: Modelling Forecasting Hurdle Rate," MPRA Paper 60420, University Library of Munich, Germany, revised 2011.
    4. Susanti Widhiastuti & Etty Murwaningsari & Sekar Mayangsari, 2018. "The Effect of Business Intelligence and Intellectuals Capital of Company Value Moderated by Management of Profit Riil," Journal of Accounting, Business and Finance Research, Scientific Publishing Institute, vol. 2(2), pages 64-78.
    5. Jennergren, L. Peter, 2004. "Continuing Value in Firm Valuation by the Discounted Cash Flow Model," SSE/EFI Working Paper Series in Business Administration 2004:15, Stockholm School of Economics.
    6. Shigufta Hena Uzma & J.P. Singh & Naveen Kumar, 2010. "Discounted Cash Flow and Its Implication on Intangible Valuation," Global Business Review, International Management Institute, vol. 11(3), pages 365-377, October.
    7. Barajas, Angel, 2004. "Modelo de valoración de clubes de fútbol basado en los factores clave de su negocio [Valuation model for football clubs based on the key factors of their business]," MPRA Paper 13158, University Library of Munich, Germany.
    8. Girish K. Nair & Lewlyn Lester Raj Rodrigues, 2013. "Dynamics of Financial System: A System Dynamics Approach," International Journal of Economics and Financial Issues, Econjournals, vol. 3(1), pages 14-26.
    9. Wnuczak Paweł, 2018. "Social value added (SVA) as an adaptation of economic value added (EVA) to the specificity of cultural institutions," Journal of Management and Business Administration. Central Europe, Sciendo, vol. 26(1), pages 100-120, March.
    10. Patrick Boisselier & Dominique Dufour, 2007. "Comptabilite Et Valorisation A L'Introduction Sur Alternext (2005-2006)," Post-Print halshs-00544917, HAL.
    11. Frederick DUBE & Brian BARNARD, 2019. "Equity Valuation based on a Random Process Modelling of Earnings and Equity Growth," Expert Journal of Economics, Sprint Investify, vol. 7(1), pages 1-31.
    12. Reddy, Kotapati Srinivasa, 2015. "Determinants of Cross-border Mergers and Acquisitions: A Comprehensive Review and Future Direction," MPRA Paper 63969, University Library of Munich, Germany, revised 2015.
    13. Fernandez, Pablo, 2006. "The correct value of tax shields: An analysis of 23 theories," IESE Research Papers D/628, IESE Business School.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Fernandez, Pablo, 2005. "Financial literature about discounted cash flow valuation," IESE Research Papers D/606, IESE Business School.
    2. Fernandez, Pablo, 2003. "Levered and unlevered Beta," IESE Research Papers D/488, IESE Business School.
    3. Fernandez, Pablo, 2003. "Equivalence of ten different methods for valuing companies by cash flow discounting," IESE Research Papers D/524, IESE Business School.
    4. Fernandez, Pablo, 2004. "Equivalence of ten different discounted cash flow valuation methods," IESE Research Papers D/549, IESE Business School.
    5. Fernandez, Pablo, 2004. "The value of tax shields is NOT equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 73(1), pages 145-165, July.
    6. Fernandez, Pablo, 2004. "Value of tax shields and the risk of the net increase of debt, The. Year 2004," IESE Research Papers D/544, IESE Business School.
    7. Fernandez, Pablo, 2006. "The correct value of tax shields: An analysis of 23 theories," IESE Research Papers D/628, IESE Business School.
    8. Ignacio Velez-Pareja & Julian Benavides Franco, 2011. "Cost of Capital when Dividends are Deductible," Brazilian Review of Finance, Brazilian Society of Finance, vol. 9(3), pages 309-334.
    9. Schauten Marc B. J., 2013. "Three discount methods for valuing projects and the required return on equity," Contaduría y Administración, Accounting and Management, vol. 58(1), pages 63-85, enero-mar.
    10. Fernandez, Pablo, 2007. "A more realistic valuation: APV and WACC with constant book leverage ratio," IESE Research Papers D/715, IESE Business School.
    11. Laurence Booth, 2007. "Capital Cash Flows, APV and Valuation," European Financial Management, European Financial Management Association, vol. 13(1), pages 29-48, January.
    12. Peter Brusov & Tatiana Filatova, 2023. "Capital Structure Theory: Past, Present, Future," Mathematics, MDPI, vol. 11(3), pages 1-30, January.
    13. Pasquale De Luca, 2017. "Debt Level and the Firm Levered Cost of Capital," International Journal of Economics and Financial Issues, Econjournals, vol. 7(5), pages 475-484.
    14. Schosser, Josef, 2008. "Bewertung ohne "Kapitalkosten": Ein arbitragetheoretischer Ansatz zu Unternehmenswert, Kapitalstruktur und persönlicher Besteuerung," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe 13, University of Passau, Faculty of Business and Economics.
    15. Richard Sweeney, 2014. "Equivalent valuations in cash flow and accounting models," Review of Quantitative Finance and Accounting, Springer, vol. 42(1), pages 29-49, January.
    16. Michael Dempsey, 2019. "Discounting methods and personal taxes," European Financial Management, European Financial Management Association, vol. 25(2), pages 310-324, March.
    17. Ian A. Cooper & Kjell G. Nyborg, 2008. "Tax‐Adjusted Discount Rates with Investor Taxes and Risky Debt," Financial Management, Financial Management Association International, vol. 37(2), pages 365-379, June.
    18. Michael Dempsey, 2015. "Stock Markets, Investments and Corporate Behavior:A Conceptual Framework of Understanding," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number p1007, September.
    19. Mike Dempsey, 2013. "Consistent Cash Flow Valuation with Tax†Deductible Debt: a Clarification," European Financial Management, European Financial Management Association, vol. 19(4), pages 830-836, September.
    20. Wolfgang Schultze & Martin Meyer, 2005. "Die Kapitalflussrechnung in der Unternehmensbewertung: Bewertungskalkül und Gestaltungshinweise," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 16(3), pages 289-324, September.

    More about this item

    Keywords

    Financial management; Company valuation;

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ebg:iesewp:d-0451. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Noelia Romero (email available below). General contact details of provider: https://edirc.repec.org/data/ienaves.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.