To order copies or request permission to reproduce materials, call 1-80, write Harvard Business School Publishing, Boston, MA 02163, 02163, or go to. Copyright В© 2000 President and Fellows of Harvard College. Baldwin prepared this note as the basis for class discussion. Alternatively, under the APV method of valuation, the present value of interest tax shields may be added to the sum of FCFs discounted at k a. If a company has debt in its capital structure, the weighted average cost of capital (WACC) may be substituted for kaВ in equation 1. Rf is the risk-free rate rate and (rM вЂ“ rfВ ) is the market market risk premium.

О’aВ is the (systematic) risk of the business If a company has no debt in its capital structure, the appropriate cost of capital to use in this calculation is k aВ obtained from the Capital Asset Pricing Model: kaВ = rf + ОІ aВ (rM вЂ“ rfВ ) оЂЂоЂЃоЂ‚оЂѓоЂ‚оЂ„ Where FCFt is the Free Cash Flow Flow received at time t. The Fundamental Market Value of an Enterprise (FEV) equals the sum of its Free Cash Flows discounted at an appropriate cost of capital: FEV =ДЇCF1 FCF2 FCFT + 2 +' T (1 + k a ) (1 + k a ) (1В + k a ) Negative FCFs are shortfalls, which must be funded raising new debt or equity. Positive FCFs are thus available for purposes not included in the business plan, such as payment of interest or dividends, repayment of debt, repurchases of stock, or acquisitions. In the eyes of FMV investors, positive FCF is вЂњthrown offвЂќ by a business, and negative FCF is вЂњabsorbedвЂќ by the business. In contrast to Earnings, which measures what the business can produce at its current scale, Free Cash Flow measures what the business can produce under a specific plan of growth and capital investment. Fundamental Enterprise Valuation: Free Cash Flow Free Cash Flow (FCF) is the amount of money that can be paid out (or needs to be paid in) to a business as it implements a specific business strategy.

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