In our jargon terms, we often refer to this reinvestment as CAPEX (Capital Expenditure). Surely, the reinvestment reduces the cash available for the shareholders, but it pays in terms of future growth. Assets: Good companies reinvest a part of the profit to expand and modernize their long-term assets. While FCFF is profit left after tax but before interest and principal payments of debt (OPAT). Profit: In the case of FCFE what is considered profit is the net profit left for the shareholders after payment of taxes and interest expenses (PAT).I’ll briefly describe the components of free cash flow as highlighted in the above image: Components of Free Cash Flow In terms of formula, both are represented as shown below: Now, as we know there are two types of free cash flow: Free Cash Flow to Firm ( FCFF) and Free Cash Flow to Equity ( FCFE). Henceforth, we will refer to it as “current free cash flow.” Even if the board of directors decides against dividend payment or share buyback, we’ll estimate what potential dividend a company can pay to its equity holders/shareholders.Ī study of the last year’s financial reports of a company will give us our potential dividend.
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How to estimate the intrinsic value of a company that neither pays dividends nor practice the philosophy of shares buyback? To include such companies within our ambit, we can use a theory called “potential dividends”. Hence, the current shareholders benefit by the way of price appreciation.īut there is a problem with this concept.
Share Buyback: When companies perform shares buyback, their earnings get less liquidated.Dividend: This is the actual cash that equity holders received from their holding company.For an equity holder, the free cash flow (FCF) is the following: The concept of free cash flow has its roots in the dividends paid to the equity holders. #1.0 Current Cash Flow (Current Free Cash Flow) These two components will help us calculate the future cash flows of our example company ABC.
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