La Correcta Formulación Del Costo De Capital Aplicada a Flujos De Caja Finitos Y Perpetuidades Para La Valoración De Empresas Por Métodos De Descuento De Flujos De Fondos Y Métodos De Creación De Valor (The Correct Formulation of the Cost of Capital Applied to Finite Cash Flows and Perpetuities for Companies Valuation by Methods of Discounted Cash Flows and Methods of Value Creation)

55 Pages Posted: 16 Jul 2013

Date Written: July 14, 2013

Abstract

There are various valuation methodologies applicable to both the financial evaluation of projects as to the valuation of companies. First, have developed methods of Discounted Cash Flows (DCF), which allow discounting, or bring to present value, a series of projected future cash flows over time. In subsequent years, have developed methods of Value Creation (VC), which assess the differences existing between the market value of assets, versus its book value. The difference between these two values is what is known as the creation of value.

However, when applying each existing methodology have been presented inconsistencies and contradictions in the obtained value which have led to the erroneous conclusion that each method provides a different market value. Such inconsistencies occur because of a topic that is not analyzed with the relevant scientific and mathematical rigor in traditional Corporate Finance books: the cost of capital.

The key to achieve a consistency of value in all the methods of both DCF as of VC is to use the correct formulation of Cost of Capital. The value of the company or project does not change only by the simple fact of use one method or another. Therefore, there must be consistency among all the methods when using the appropriate discount rate.

In the following pedagogical note is presented, through a series of equations and demos, the different expressions of cost of capital applicable to finite cash flows and to perpetuities, allowing to get the same result of market value for all the methods of valuation. In addition, it will be mathematically proved that the methods of Value Creation match in their result with the methods of Discounted Cash Flow.

Note: Downloadable document is in Spanish.

Keywords: Cost of Capital, Discounted Cash Flows, Value Creation, Tax Shield, Unlevered Beta, Cost of Equity, Traditional WACC, Adjusted WACC, Free Cash Flow, Capital Cash Flow, Equity Cash Flow, Adjusted Present Value, Economic Value Added, Cash Value Added, Net Value Added, Investment Recovery and Value Add

JEL Classification: G12, G31, G32, H25, M10, M21, M41

Suggested Citation

Romero, Fernando, La Correcta Formulación Del Costo De Capital Aplicada a Flujos De Caja Finitos Y Perpetuidades Para La Valoración De Empresas Por Métodos De Descuento De Flujos De Fondos Y Métodos De Creación De Valor (The Correct Formulation of the Cost of Capital Applied to Finite Cash Flows and Perpetuities for Companies Valuation by Methods of Discounted Cash Flows and Methods of Value Creation) (July 14, 2013). Available at SSRN: https://ssrn.com/abstract=2293727 or http://dx.doi.org/10.2139/ssrn.2293727

Fernando Romero (Contact Author)

CapaciTES ( email )

Av. Tanca Marengo Km 2.5
Av Francisco Orellana edif Las Camaras
Guayaquil, Guayas 090512
Ecuador

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