Basic Concepts in Market-Based Cash Flow Valuation

Abstract:     
This is the first chapter of our book Principles of Cash Flow Valuation. It is an overview of what we present in the book. In this chapter, we present an informal introduction to the basic concepts and ideas in market-based cash flow valuation. The simplified exposition will provide sufficient background knowledge to understand the context of the materials that are presented in subsequent chapters. Later, in the appropriate chapters, we return to these ideas in valuation and explain them with detailed numerical examples. The reader will feel comfortable because she has already been exposed to the ideas informally in this chapter.

For some readers, the concepts and ideas in this chapter will be a review. For other readers who find the explanations and discussions to be too terse, we assure them that the topics will be explored in greater detail and more formally in subsequent chapters. Most readers will be familiar with the standard after-tax Weighted Average Cost of Capital (WACC) that is applied to the free cash flow (FCF). However, for many readers the WACC applied to the capital cash flow (CCF), a term that Professor Richard Ruback has coined and popularized, will be new. Later we explain the CCF in greater detail. Now we are simply surveying the main ideas in the domain of cash flow valuation. We are providing an informal sketch of the territory that we will be covering and hope that all readers will find this introductory overview useful.

Keywords: Cash flows, free cash flow, cash flow to equity, valuation, levered value, levered equity value, terminal value, cost of levered equity, weighted average cost of capital, WACC, cost of unlevered equity

JEL Classification: M21, M40, M46, M41, G12, G31, J33

working papers series