Principles of Managerial Finance

332 PART 2 Important Financial Concepts

TABLE 7.5 Calculation of the Value of the

Entire Company for Dewhurst Inc.

Present value of FCFt

FCFt PVIF9%,t [(1)(2)]

Year (t) (1) (2) (3)

2004 $ 400,000 0.917 $ 366,800

2005 450,000 0.842 378,900

2006 520,000 0.772 401,440

2007 560,000 0.708 396,480

2008 10,900,000a 0.650  (^7) , (^0)  (^8)  (^5) , (^0)  (^0)  (^0) 
Value of entire company, VC$

8

,

6

2

8

,

6

2

0

aThis amount is the sum of the FCF 2008 of $600,000 from Table 7.4 and the
$10,300,000 value of the FCF (^2009) ∞calculated in Step 1.
Note that to calculate the FCF in 2009, we had to increase the 2008 FCF
value of $600,000 by the 3% FCF growth rate, gFCF.
Step 2 Add the present value of the FCF from 2009 to infinity, which is measured
at the end of 2008, to the 2008 FCF value to get the total FCF in 2008.
Total FCF 2008 $600,000$10,300,000$10,900,000
Step 3 Find the sum of the present values of the FCFs for 2004 through 2008
to determine the value of the entire company,VC.This calculation is
shown in Table 7.5, using present value interest factors, PVIFs, from
Appendix Table A–2.
Step 4 Calculate the value of the common stock using Equation 7.8. Substitut-
ing the value of the entire company, VC,calculated in Step 3, and the
market values of debt, VD,and preferred stock, VP, given in Table 7.4,
yields the value of the common stock, VS:
VS$8,628,620$3,100,000$800,000$

4

,

7

2

8

,

6

2

0

The value of Dewhurst’s common stock is therefore estimated to be
$4,728,620. By dividing this total by the 300,000 shares of common
stock that the firm has outstanding, we get a common stock value of
$15.76 per share($4,728,620300,000).
It should now be clear that the free cash flow valuation model is consistent
with the dividend valuation models presented earlier. The appeal of this
approach is its focus on the free cash flow estimates rather than on forecast divi-
dends, which are far more difficult to estimate, given that they are paid at the dis-
cretion of the firm’s board. The more general nature of the free cash flow model
is responsible for its growing popularity, particularly with CFOs and other finan-
cial managers.