Analytical Solution to the Circularity Problem When Using Discounted Cash Flow Valuation (Solución Analítica al Problema de la Circularidad Usando Flujos de Caja Descontados) (Spanish)

Innovar, Vol. 21, No. 42 octubre-diciembre, 2011. (Próximo a aparecer en inglés).

29 Pages Posted: 1 Aug 2010 Last revised: 23 Dec 2011

See all articles by Felipe Mejia-Pelaez

Felipe Mejia-Pelaez

Octum

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: July 31, 2010

Abstract

In this paper we propose an analytical solution to the circularity problem between value and cost of capital. Our solution is derived starting from a central principle of finance that relates value today to value, cash flow, and the discount rate for next period. We derive a general formulation for the equity value, E, the firm value and the weighted average cost of capital, WACC, without circularity.

We furthermore compare the results obtained using these formulas with the results using the Adjusted Present Value approach (no circularity) and the iterative solution of circularity based upon the iteration feature of a spreadsheet. We conclude that all methods produce the same answer.

Note: downloadable document is in Spanish

Keywords: Firm Valuation, Cost of Capital, Cash Flows, Free Cash Flow, Capital Cash Flow, WACC, Circularity

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

Suggested Citation

Mejia-Pelaez, Felipe and Velez-Pareja, Ignacio, Analytical Solution to the Circularity Problem When Using Discounted Cash Flow Valuation (Solución Analítica al Problema de la Circularidad Usando Flujos de Caja Descontados) (Spanish) (July 31, 2010). Innovar, Vol. 21, No. 42 octubre-diciembre, 2011. (Próximo a aparecer en inglés).. Available at SSRN: https://ssrn.com/abstract=1651585

Felipe Mejia-Pelaez

Octum ( email )

Carrera 35A 5A-170
Apt 1201 - Edificio Catay 8
Medellín, Antioquia
Colombia

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

Register to save articles to
your library

Register

Paper statistics

Downloads
370
Abstract Views
2,048
rank
79,758
PlumX Metrics