2
$\begingroup$

This is the table I have:

enter image description here

I want to use the $FCFF$ to calculate the stock price, when I did this using the $DDM$ I got $£16$ as the stock price.

I've never used FCFF before but I know there are a few versions of the FCFF formula and picking the right one to use is crucial. There were two FCFF formulas I thought might work:

  1. $FCFF$ = Net income + Non cash charges + (Interest * (1-Tax rate)) - Long term Investments - Investments in working capital

  2. $FCFF$ = Cash flow from operations + (Interest Expense * (1-Tax rate)) - Capital expenditures

I'm not certain either of these are correct and if they are I'm not sure how to apply them.

This is my first time using $FCFF$ so if anyone could offer any support or guidance I would really appreciate it, thanks.

$\endgroup$
2
$\begingroup$

In this case I believe you can break it down into 4 steps:

Step 1: Calculate the WACC

For a lot of questions related to FCFF you'll be using the WACC (Weighted average cost of capital). The formula for it is: $(D/(D+E))*r_d*(1-tax) + (E/(D+E))*r_e$

Where $r_d$ is your cost of debt, $r_e$ is your Rate of Return and $(D/(D+E))$ is your debt to capital ratio. ($E/(E+D)$ is just $1-(D/(D+E))$)

Step 2: Calculate your first FCFF:

This uses quite a simple formula that you can probably derive yourself but here it is anyway: ${FCFF}_1$ = $Current FCFF *(1 +FCFFgrowth)$

Step 3: Calculate current equity value:

$V_{equity} = ({FCFF}_1/(WACC - FCFF growth)) - Debt$

Step 4: Calculate the stock price:

Once you have the equity value you just simply divide by the total number of shares, another simple formula to derive: $V_0 = V_{equity}/NumberOfShares$

FCFF is quite simple once you know what you need to do, this might sound quite obvious but the trick with these types of questions is actually figuring out what process will lead you to your answer, once you've figured that out all you really need to do is remember a few formulae and you're good to go.

Hope this helps

$\endgroup$
1
  • $\begingroup$ This is perfect, thanks. I'll try it out now and let you know if i encounter any problems $\endgroup$
    – Charlie P
    May 28 at 13:26

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.