Discounted Cash Flow Valuation Methods: Examples of Perpetuities, Constant Growth and General Case

Abstract

This paper explores the discounted cash flow valuation methods. We start the paper with the simplest case: no-growth, perpetual-life companies. Then we will study the continuous growth case and, finally, the general case.

The different concepts of cash flow used in company valuation are defined: equity cash flow (ECF), free cash flow (FCF), and capital cash flow (CCF). Then the appropriate discount rate is determined for each cash flow depending on the valuation method used.

Our starting point will be the principle by which the value of a company's equity is the same, whichever of the four traditional discounted cash flow formulae is used. This is logical: given the same expected cash flows, it would not be reasonable for the equity's value to depend on the valuation method.

Keywords: discounted cash flow valuation, cash flow valuation, value of tax shields, required return to equity

JEL Classification: G12, G31, G32