Cash Flow Multiples, Growth Rates, and Discount Rates
Topic 57 explores the fundamental determinants of free cash flow multiples and introduces the approach of deriving other valuation multiples from free cash flow multiples.
The reader is encouraged to take the time to read the text in conjunction with the referenced Appendices to gain the appropriate level of understanding of the subject matter discussed in the narrative. Appendices are either presented at the end of this and each remaining Topic or are available for review and download on this book's companion Web site (see the About the Web Site page for login information).
LAGGING FREE CASH FLOW MULTIPLES, END-OF-YEAR BASIS, NO GROWTH
- In its simplest form, free cash flow multiples (FCFM) (applied to lagging, most recent actual period free cash flow [FCF] to derive enterprise values), on an end-of-year discount rate basis, where there is no growth expected are equal to the reciprocal of the weighted average cost of capital, C* (see Equation 57.1).
- This concept is easily demonstrated by the fact that the reciprocal of a C* of 12.5% is equal to a multiple of 8.0 on an end-of-year discount rate basis as presented in Illustration 57.1.
ILLUSTRATION 57.1 LAGGING FCF BASIS, END-OF-YEAR RATE BASIS, NO GROWTH
A company with lagging FCF of $1 million with a C* of 12.5% and zero growth expectations would normally ...