Steps in Building a Free Cash Flow Valuation Spreadsheet

1. Cash flow Forecast a. Get historical income statements and balance sheets to: b. Calculate relevant reference ratios c. Project sales figures for several years out (the number depends on how far out you can see) In the short term, these sales projections may be actual dollar figures, or they may be projected by means of indicating the forecast year-to-year growth rates. The second group of years is the intermediate term, and this will rely on information that is less clear. Project sales growth rates first to get sales. Finally, pick a period of several years to have revenue growth rates decline to a long-term reasonable growth rate- something like 4%. d. Project the ratios or other methods you will make to forecast, each year, each of the elements that will need to go into the cash flow construction. Going with Damodarans definition of FCFF (FCFF = EBIT(1-t) + depreciation capital expenditures change in working capital), you will need to forecast the income statement down to EBIT, changes in net working capital, and expenditures for plant and equipment. For FCFE (=FCFF Interest Expense Principal repayments new debt issues new preferred dividends), you will need to forecast these additional items as well something its very hard to do for most cases. e. Use the results to calculate FCFF and FCFE f. It will be important to make some checks that for your last year of forecast, the FCFF and FCFE numbers grow at the same rate that you are forecasting for the long-term growth of sales. This will insure that the dynamics have settled down by the time you get to your last year and everything is growing at the same rate. 2. Valuation a. Gather information necessary to estimate the cost of equity (to discount FCFE and WACC (to discount FCFF). i. Market values of equity and debt are preferred; ii. Cost of debt inferred from bonds outstanding or possibly from footnotes in the annual report. iii. Cost of equity might use the CAPM, in which case you need estimates for the stocks beta, the risk free rate, and the market risk premium. b. Use the appropriate cost of capital to discount the cash flows i. Calculate terminal value using the constant growth model (TVn = CFn/(k-g). Then discount TV for n periods to get the PV ii. Discount the individual year-by-year cash flows. iii. Add the two for the present value of the business operations (FCFF) or PV of equity (FCFE) c. Add cash d. For FCFF, subtract the value of debt e. Divide by the number of shares outstanding to get price per share. f. Compare to current market price.