The second way is to just value the equity stake in the
business,andthisiscalledequityvaluation.(SeeFigure1.3.)
Thecashflowsafterdebtpaymentsand reinvestmentneeds
arecalledfreecashflowstoequity,andthediscountratethat
reflects just the cost of equity financing is thecost of equity.
FIGURE 1.3Equity Valuation
Notealsothatwecanalwaysgetfromtheformer(firmvalue)
to the latter(equity value) bynetting out thevalue of all
nonequityclaimsfrom firmvalue.Doneright,thevalueof
equityshouldbethesamewhetheritisvalueddirectly(by
discounting cash flows to equity at thecost of equity) or
indirectly(byvaluingthefirmandsubtractingoutthevalue
of all nonequity claims). We will return to discuss this
proposition in far more detail in Chapter 6.
Variations on Discounted Cash Flow Models
The model that we have presented in this section, where
expectedcash flowsarediscounted backata risk-adjusted
discountrate,isthemostcommonlyusedDCFapproach,but
therearetwowidelyusedvariants.Inthefirst,weseparate
thecashflowsintoexcessreturncashflowsandnormalreturn