Thiscalculationcanbecomecomplicatedforfirms thatare
expectedtochangetheirdebtratiosovertime,sincewehave
tocomputenewdebtissuesthatthefirmhastomaketogetits
desired debt ratio.
Applicability of FCFE Models
Clearly, free cash flows to equity models cannot be used
when the inputs needed to compute free cash flows to
equity—capital expenditures, depreciation, working capital,
and net debt cash flows—are difficult or impossible to
estimate. As noted earlier in the discussion of dividend
discountmodels,thisisoftenthecasewithfinancialservices
companies and can sometimes be an issue when there is
incomplete or unreliablefinancial information available on
the company. If this occurs, falling back on the dividend
discount model will yield more reliable estimates of value.
If freecash flowsto equity can be estimated, there is no
reasonwhywecannotusefreecashflowtoequitymodelsto
value all companies. However, the practical problems
associated with estimatingcash flows to equitywhen debt
ratiosareexpectedtochangeovertimecanmakeadifference
inwhetherweuseequityorfirmvaluationmodels.Withfirm
valuation models, changesin the debtratios are easier to
incorporateintothevaluationbecausetheyaffectthediscount
rate(throughtheweights inthecostofcapitalcalculation).
Asweseeinthenextchapter,weshouldarriveatthesame
equityvalueusingeitherapproach,thoughthereareimplicit
assumptions we make in each one that can cause deviations.