Capitalized Cash Flow Method
The capitalized Cash Flow Method is the valuation method used to value the private company which expects to grow in a certain rate. It is also known as the Earning Capitalization method. It will evaluate the company value base on the company’s expected earnings.
Capitalized cash flow will show the potential return from purchasing the company while presenting the risk at the same time. The investors really need both information to balance between risk and reward from their investments. However, this method is only suited for small private companies due to its limitation.
Free Cash Flow to the Firm (FCFF) is the cash available after paying the operation cost such as current assets, non-current assets, operating expenses, and tax. The company will be able to use this cash to pay for investors such as bondholders and shareholders. However, the company also has a choice to keep this cash for reinvesting as well. FCFF is also known as Discretionary Cash Flow.
WACC is the average cost of capital which a company pays to obtain the cash to finance their operational assets. It is the minimum return that the company needs to make.
The growth rate is the rate which we expect the company generates from year to year for ever. It is the sustainable growth in cash inflow that the company will be able to make.
Capitalized Cash Flow Formula
In order to calculate Capitalized Cash Flow, we use the Free Cash Flow to Firm and divided by the WACC minus growth rate.
Enterprise Value = FCFF /(WACC-g)
Capitalized Cash Flow Example
ABC is a private company with the following information below:
|The growth rate in FCFF||5%|
|The required rate of return||8%|
Enterprise Value = $ 10,000,000/(15%-5%) = $ 100,000,000