Common stockholders are entitled to various privileges and legal rights. They include voting power, ownership rights, right to sue, dividend as reward, and right to transfer ownership. With regards to voting power, stockholders have the right to vote on major issues which range from electing directors and making fundamental changes like liquidation, mergers, and acquisition.
FCF are surplus cash flows available to be distributed among stakeholders of a company and can comprise of cash from capital expenditures and operations. Elsewhere, Weighted Average Cost of Capital, WACC, is the rate of return that investors require frm an investment.WACC is an importanti parameter in evaluating project and value of an investment. To get the present value of FCF to a firm, WACC is used as a discpunting factor. On the other hand, when evaluating new projects, WACC is used as a tool to make deciosn on whther an invesmsnt is worthy or not. During the analysis and it is foud that WACC is less than internal rate of return (IRR), then the project is deemed viable and should be invested in.
Free cash flow valuation model is where a firm’s cash flow is used to value it. Future projections are used in the calculation of free cash flows from expenditure and income. Also, WACC can be used in the discounting of future free cash flows to arrive at a present value of FCF. The fair value of the firm is therefore obtained through the sum of all the present values of FCF.
Common stock = 5 * 2 = 10
Free cash flow = 24
Growth rate = 5%
Marketable securities = 100
Debt = 200
Preferred stock = 50
Value of the firm= free cash flow / (discount rate-growth rate)
= 24 / (0.11-0.05)
Discount rate is WACC 11%
Residual equity is calculated by subtracting the claims of bondholders and preferred shareholders from the company’s total Value.
Present Value of expected FCF when discounted at WACC is given by the free cash flow expected in year = 0*(1+g)/(WACC-g)=
Therefore: Free cash flow expected in year = 1/(WACC-g)
Dell’Acqua, A. (2018). Corporate debt management.
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