Consistent Methods of Valuing Companies By Dcf: Methods and Assumptions

21 Pages Posted: 18 Aug 2006

See all articles by Ian A. Cooper

Ian A. Cooper

London Business School

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Date Written: August 2006

Abstract

In this note we discuss four common methods of valuing firms:

1.Discounting operating free cash flow at the weighted average cost of capital.

2.Discounting equity free cash flow at the cost of equity.

3.Valuing the firm using adjusted present value.

4.Discounting the capital cash flow at the unlevered cost of capital.

We examine four alternative assumptions about leverage policy and how they affect three things: discount rates, the present value of tax savings, and how to use the above methods. We describe alternative ways of implementing the valuation methods consistently, and how to choose between them. Finally, we show how inconsistent application can lead to errors that are subtle but large. The use of incorrect formulas can result in an estimate of the present value of the tax saving that is double its correct value.

Keywords: discounted cash flow, APV, WACC, leverage policy, value of tax shields, equity cash flow

JEL Classification: G12, G31, G32, M21

Suggested Citation

Cooper, Ian Anthony and Nyborg, Kjell G., Consistent Methods of Valuing Companies By Dcf: Methods and Assumptions (August 2006). Available at SSRN: https://ssrn.com/abstract=925186 or http://dx.doi.org/10.2139/ssrn.925186

Ian Anthony Cooper (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 171 262 5050 (Phone)

Kjell G. Nyborg

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 (0)44 634 2980 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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