One final aspect of the model bears repeating. In FCFE
models,weareimplicitlyassumingthatcashflowstoequity
willbewithdrawnfromthefirmeachyear.Thus,therewill
benocashbuildupinthefirmandwedonotneedtokeep
trackoffuturecashbalances.Acommonmistakein FCFE
modelsisdoublecounting,whereanalystsestimatethevalue
oftheequitybydiscountingFCFEtothefirmandthenalso
keeptrackofthecashbuildupinthefirmbecausethefirmis
paying out less than its FCFE as dividends.
10
Limitations of the Model
Whilefreecashflowstoequitymodelsrelaxtheconstraints
on measuring cash flows to equity placed by dividend
discountmodels,thereisacost.Analystshavetoestimatenet
capitalexpendituresandnoncashworkingcapitalneedseach
yeartogettocashflows.Whilethismaybestraightforward,
analystsalsohavetoestimatehowmuchcashthefirmwill
raisefromnewdebtissuesandhowmuchitwillusetorepay
olddebt.This exerciseisfairlystraightforwardwhenfirms
maintain stable debt ratios but becomes increasingly
complicatedasdebtratiosareexpectedtochangeovertime.
Intheformercase,wecanusetheshortcutforfreecashflows
to equity:
Inthelattercase,wehavetousetheexpandedversionofthe
model: