That is a different valuation approach and can be useful when you compare your cash flow valuation and other business valuation methods. The book value is the value of the company’s assets (intangible and fixed assets).

1. Yes you can use the company’s D/E ratio. It is sometimes more correct – it all depends on the situation. If the D/E ratio is reasonable, you should use the company D/E ratio. If the company has too much cash, or to much leverage you should use the industry ratio and adjust for this (otherwise the value of the company will either be too high or too low.). But remember, you need to argue for why you choose either method. Both ways are correct. It is not the financing of the company that is interesting in this part in the DCF valuation, it is what the business itself is worth – not its owners ability to finance the business. A potential acquirer may have a lot of cash which it easily could add to the business…

2. If you have decided to use the mid year discount method (which is correct), the company/owner is in control of the cash evenly troughout the year. Some cash is paid out in January and some in December, to mention one example. To adjust for this you use the mid-year disount period.

But when you calculate the terminal value, you “are in control” of the cash flow at the end of the period (in this DCF model, in the end of 2014). That is why 0.5 is added. 1.5 would be in the middle of 2015…

So for the Terminal value, you get all the cash at the end of the year (2014) and that is why you only add 0.5.

Let me know if you have further questions, good luck!

I have a few questions to ask.

1. Can we use the company D/E ratio itself instead of industry D/E (based on your example, you used the industry D/E)?

2. For the terminal value, why do you add only 0.5 yrs for discount period (4.5 + 0.5), why not 1 yr?

Thank you very much.

I have copied two interesting links on the question you have asked.

- http://www.editgrid.com/user/wikiwealth/FCFF_vs_FCFE_Valuation_Model
- http://www.numeraire.com/value_board/messages/78.html

Let me know if you need further examples to fully understand the difference.

It depends on the project.

If you want to make it more complicated (!), you can check out my “Reverse Engineering NPV” posts on the Treasury Cafe blog.

Essentially what is done there is rearranging the NPV equation to solve for the cash flow requirement instead.

This is sometimes useful as folks have a sense of what comes in and out on a daily basis, wheras some of that gets lost in the investment numbers.