Calculating Present Value of Free Cash Flows

Easy Equity Valuation Applications Free Cash Flow Valuation

Lisa is conducting a valuation for a mature company that has generated stable but modest Free Cash Flows (FCF) over the past few years. She considers using the Free Cash Flow to Firm (FCFF) model to estimate the company's intrinsic value. As part of her analysis, she needs to project the growth rate of the company's free cash flows for the next five years. Given the company's historical performance and expected market conditions, she estimates that FCF will grow at 3% annually during this period before stabilizing to a long-term growth rate of 2%.
Additionally, she plans to discount the estimated future cash flows using a Weighted Average Cost of Capital (WACC) of 8%. Which of the following represents the correct approach to calculate the present value of the projected FCF for the first five years?

Discount each projected FCF individually for the first five years and sum them up.

Calculate the terminal value at the end of year five and discount it back to present value.

Project the FCF for five years, then apply the long-term growth rate as if it's effective immediately.

Hint

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