A Practical Guide for Consistency in Valuation: Cash Flows, Terminal Value and Cost of Capital

45 Pages Posted: 9 Dec 2003

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Antonio Burbano-Perez

Universidad de los Andes - Business School

Date Written: May 29, 2005

Abstract

Practitioners and teachers very easily break some consistency rules when doing or teaching valuation of assets. In this short and simple note we present a practical guide to call the attention upon the most frequent broken consistency rules. They have to do firstly with the consistency in the matching of the cash flows, this is, the free cash flow (FCF), the cash flow to debt (CFD), the cash flow to equity (CFE) and the tax savings or tax shield (TS). Secondly, they have to do with the proper expression for the cost of unlevered equity with finite cash flows and perpetuities. Thirdly, they have to do with the consistency between the terminal value and growth for the FCF and the terminal value and growth for the CFE, when there is a jump in the CFE due to the adjustment of debt to comply with the leverage at perpetuity. And finally, the proper determination of the cost of capital either departing from the cost of unlevered equity (Ku) or the cost of levered equity (Ke). In the Appendixes we show some algebraic derivations and an example.

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

JEL Classification: M41, G12, G31

Suggested Citation

Velez-Pareja, Ignacio and Burbano-Perez, Antonio, A Practical Guide for Consistency in Valuation: Cash Flows, Terminal Value and Cost of Capital (May 29, 2005). Available at SSRN: https://ssrn.com/abstract=466721 or http://dx.doi.org/10.2139/ssrn.466721

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

Antonio Burbano-Perez

Universidad de los Andes - Business School ( email )

Calle 18 Cra 1
Bogota
Colombia
+571 3394949 (Phone)

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