Free Cash Flow Models

Abstract

Cash flow models include not only the dividend discount model but also free cash flow models, in which free cash flows are discounted at the expected rate of return instead of dividends. Free cash flows are the operating cash flows generated by the company less the net capital expenditures that are required for its operating activities. They can be determined either after payment of the debt provider claims (free cash flows to equity) or before these claims are paid (free cash flows to firm). The advantage of these valuation models is that they are conceptually sound and suitable for most equity valuation applications. The free cash flow to equity model and the free cash flow to firm model are presented in this chapter. The adjusted present value model, which is a further development of the free cash flow to firm model, is also described.