2.03 Valuation methodology – capitalized cashflow method
The main principle behind the capitalized cashflow method is that the annual free cashflows generated by the enterprise and available to all providers of capital should be capitalized at a rate that reflects a weighted average cost of capital, being a blend of the enterprise’s cost of equity and its cost of debt. The result provides the value of the enterprise, which is funded by providers of both loan capital and equity capital.
The main calculation in the capitalized cashflow method is: Enterprise value = Free cashflow / WACC.
The core calculation in this method provides the enterprise value, being the value of the business that is funded by both lenders and shareholders. Further amounts are added or subtracted to get to the equity value.
An abbreviated example of a simple capitalized cashflow calculation is as follows (refer to the sections on Free cashflow and Capitalization rates for more details on these key components of the capitalized cashflow method) or Contact MVI to discuss.
| Free cashflow | 1,500,000 | A |
| Weighted average cost of capital (weighted average of cost of equity and cost of debt) | 15% | B |
| Enterprise value (A / B) | 10,000,000 | C |
| Tax shield – Present Value of future tax allowances on depreciable assets | 50,000 | D |
| Redundant assets | 450,000 | E |
| Less: Term loans | (3,500,000) | F |
| Equity value (C + D + E – F) | 7,000,000 |
|