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CCF and ECF Valuation: Ashutosh Dash

This document discusses various methods for valuing companies using discounted cash flow analysis, including free cash flow to the firm (FCFF), free cash flow to equity (FCFE), and cash flow to debt (FCFD). It explains that FCFF is not equal to FCFE + FCFD due to interest tax shields. The capital cash flow method (CCF) and excess cash flow (ECF) methods are presented as alternatives for valuing leveraged firms. Examples are provided to illustrate terminal value calculations, equity valuation using backward induction, and the pros and cons of the ECF method when debt is risky.

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Aditya Anand
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339 views24 pages

CCF and ECF Valuation: Ashutosh Dash

This document discusses various methods for valuing companies using discounted cash flow analysis, including free cash flow to the firm (FCFF), free cash flow to equity (FCFE), and cash flow to debt (FCFD). It explains that FCFF is not equal to FCFE + FCFD due to interest tax shields. The capital cash flow method (CCF) and excess cash flow (ECF) methods are presented as alternatives for valuing leveraged firms. Examples are provided to illustrate terminal value calculations, equity valuation using backward induction, and the pros and cons of the ECF method when debt is risky.

Uploaded by

Aditya Anand
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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CCF and ECF Valuation

Ashutosh Dash
Fundamentals of FCFF
Depends on valuation components
Assets not being used in current operations,
or whose cash flows are not operating
should be valued separately
Cash Flows - The Starting Point
FCFF FCFE FCFD
EBIT (1-t) Net Income
Adjustments:
Depreciation + +
CAPEX (-) (-)
Changes in WC +/(-) +/(-)
Interest +
Principal - +
Repayment
New Debt + (-)
Proceed
FCFF, FCFE & FCFD - The Relation
Do you think FCFF = FCFE+FCFD ?

FCFF ≠ FCFE + FCFD or FCFF ≠ CCF

Why?
FCFF = EBIT (1-t) + Dep – Capex – Inc WC
FCFE+FCFD = NI + Int + Dep – Capex – Inc WC

FCFE+FCFD = CCF
EBIT (1-t) + Dep – Capex – Inc WC + Int (t)

Hence FCFE+FCFD = FCFF + Interest tax Shield


Fundamentals of CF valuation
Approach 1 Approach II

Unlevered Cash Flow Discounting


(FCFF) Factor
(Unlevered
WACC)
Levered Discounting Cash Flow
Factor (CCF)
(WACC)
CCF Method – The
Essentials
Capital Cash Flow Method
Unlevered Cost of Capital
Applying DCF Techniques – Word of
Caution
With low leverage,
◦ It does not matter whether one values equity
directly or as assets-minus-debt
◦ Equity may be evaluated directly, by
discounting expected equity cash flows at the
cost of equity

What if the leverage is high and the


amount of debt changes over time?
High levered Firm – The concerns
Though firm is solvent, default is more
likely
Valuing the assets is a bit trickier because
of more and riskier tax shields and high
cost of financial distress
ECF Method
An Illustration
Additional Information
 Salesfigure in Base year – 100Mn
 Cash Balance at 0 year end – 5M
 Financing

◦ Senior Debt 40Mn @ 10%


◦ Junior Debt 50Mn @ 15%
◦ Equity 13Mn
 LBO Fund invests 12Mn for 80% stake, rest by
management
 Cash Horizon 5 years
 Exit Multiple: 6-8*EBIT or 10-14 *P/E ratio
 Depreciation amount id invested for asset replacement
Income Statement - Projection
Cash Flow & Cash Account
Farm Capitalization
Terminal Value & IRR Analysis
Terminal Value & IRR Analysis
(II)
Equity Value with Target IRR
Equity Value, Enterprise Value and Price
Backward Induction Method
Formulas used in BI Method
EV based on Backward
Induction
ECF Method – Pros and Cons
 Any DCF technique is flawed when debt is risky
 When debt is riskless, ECF produces correct value
 Still better in LBOs as the discount rate is high
 ECF
◦ Provides a biased estimate of firm value when debt is
risky,
◦ the sign of the bias is known, and
◦ the magnitude of the bias can be calculated
 WACC and APV - incorporate the promised tax
shield, rather than the expected tax shield

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