Modeling Cash Flows with Constant Leverage: A Note (in Spanish)
9 Pages Posted: 12 Jul 2005
Date Written: June 28, 2005
It is widely known that if the leverage is constant over time, then the cost of equity and the Weighted Average Cost of Capital (WACC) for the free cash flow, FCF, is constant over time. In other words, it is inappropriate to use a constant WACCFCF to discount the free cash flow (FCF) if the leverage changes over time. However, it is common to find analysts who inconsistently use a constant WACCFCF even if the leverage is not constant.
In this teaching note, we use a simple numerical example to illustrate how to model cash flows that are consistent with constant leverage. We verify the consistency of the example with two basic principles: conservation of cash flows and conservation of values.
Note: Downloadable document is in Spanish.
Keywords: WACC, constant leverage, cash flows
JEL Classification: D61, G31, H43
Suggested Citation: Suggested Citation