1. Types of Free Cash Flows
So the intrinsic value of an asset or business is based on its
future profits. This kind of cash flow analysis is the most common and
practical form of intrinsic valuation. This is the most detailed approach
to business valuation and involves forecasting future cash flows,
discounting them using the appropriate cost of capital of the business,
and arriving at the present value of the business today.
The two most common types of discounted cash flow calculations are the Unlevered
Free Cash Flow method, also known as Free Cash Flow to the Firm,
and the Levered Free Cash Flow method, also known as Free Cash Flow
to Equity. Unlevered Free Cash Flow is the cash the business generates before
paying its debt obligations. Levered Free Cash Flow is the amount of cash
a business generates after it has met its debt obligations.
Both have their pluses and minuses, but the Unlevered Free Cash Flow methodology
is way more common in practice.
2. Let's practice!