3.1. CATEGORIZING CASH FLOWS

There are three ways to categorize cash flows. One is to draw a distinction between the equity cash flows and the cash flows to the firm. The cash flows to equity represent cash flows to just the equity investors in the business and are thus after all cash flows associated with debt (interest payments, principal payments, new debt issues). Dividends represent one easily observable measure of these cash flows, but a more expansive definition of cash flows to equity can be computed as follows:

The cash flows to the firm are cash flows generated for all claim holders in the firm and are predebt cash flows.

Note that both of these cash flows are after taxes and after reinvestment needs have been covered, and are thus free (for withdrawal from the firm).

The second way to categorize cash flows is into nominal and real cash flows. Nominal cash flows incorporate expected inflation and consequently have to be in a specific currency—dollars, euros, pesos, or yen, for instance. The expected inflation will vary across currencies, leading to different estimates of cash flows in each. Real cash flows do not have an expected inflation component and thus reflect changes in the number of units sold and real pricing power.

The third way is to differentiate between ...

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