FREE CASH FLOW (FCF), ECONOMIC VALUE ADDED (EVA) AND NET PRESENT VALUE (NPV):

FREE CASH FLOW (FCF), ECONOMIC VALUE ADDED (EVA) AND NET PRESENT VALUE (NPV):
A Reconciliation of Variation of Discounted-Cash-Flow (Dcf) Valuation

INTRODUCTION:
“Discounted cash flow basically use for investment decision making and valuation is well entrenched in finance theory and practice”
Reconciliation:
FCF is more extensions of DCF concept to security valuation (techniques).
EVA is DCF concept to performance evaluating
NPV is a traditional application of DCF thinking (sometimes use for investment project selection)

1. CASH FLOW
“Basically is one of most important pieces of financial information, simply mean the differences between amount money that came and went out”
1. A. The cash budget identity
àComponent: operating revenues and cost, net security issuance, interest payment, dividend payment, taxes paid and net investment.
àPractice: investor need to bring the number into conformity with reality
Source = use
Rt + ∆CBt = Qt + Int++ Div t+ Taxes t + ∆l t + ∆WC t
1. B. Dividend
Dividend= (NPATt + depreciation) – total net investment + net debt issuance
1. C. Division of cash flow among investor
“Proponent of the FCFE method emphasize that free-cash-flow to equity is “….dividend that could be paid to shareholder”
--the difference between FCFE and dividend paid in given year may be characterized as investment in “excess marketable securities” and its omission from consideration is moot so long as such investment have zero NPV
Note: CFD = interest payment - net debt issuance
1. D. taxes
One of the components of cash flow to equity
Taxes: tax with no debt financing – interest-tax – shield benefit
Note: Adjustment is important!!!!!
E. Free cash flow to the firm
“ CFF is the sum of cash flow to equity (CFE) and cash flow to debt holders (CFD), reduced by the interest-tax-shield benefit from the cash flow to debt holder.
CFF = NOPAT1 + depreciation + total net investment
“CFF can be expressed as after tax operating profit from otherwise equivalent unlevered firm + dep – total net investment

2. VALUATION (basically to confirmed the conceptual equivalent of Various DCF procedures, given necessary information regarding cash flow)
“Three most basic business context in which issues arise are project valuation, security valuation, and firm valuation”
Purposeà to show conceptual consistency in valuation
2. A. equity by the dividend discount approach
2. B. Equity valuation by the free cash flow equity approach
Nb: for the A and B à same formula
2. C. debt valuation
2. D. total firm valuation
Similar with the CFF, but they are sigma before the formula
2. E. Project valuation
2. F. Economic profit (EP) and economic value added
“The concept of economic profit (EP) boil down to simple restatement of total firm valuation that “reallocates” investment expenditure from the period in which they are made to period over which their resulting benefit”
“the relocation assigns to each period an “EVAtm depreciation” component representing the “Usage” of portion of the cost of the firm assets plus “a capital charge” representing the opportunity cost of the remaining net investment in the firm.

3. MEASUREMENT ISSUE
Practice: the valuation task is carried out using information from a firm’s financial and tax accounting records.
Important use of valuation concepts requiring use of accounting information is determining of managerial compensation
3. A Derivation of operating cash flow from accounting profit
“As a result of application of the realization and matching principles and tax rules, accounting statement reporting of periodic revenues and cost may dedicative considerably from actual cash flow relating to the same revenues and cost item.
3. B. Derivation of economic profit from accounting profit
“as evidenced by the expression for economic profit, the economics profit approach discounted economics profit, rather than cash flow, and is therefore not only concerned with reconciliation of accounting profit and cash flow, but also focuses on issues defining the capital investment in the firm”

4.CONCLUSSION
Conceptually --- are equivalent