What are the most common errors in FCFE/FCFF model valuation?
In cash flow valuation models, the assumptions about net capital expenditures and growth are linked strongly. When one changes, so should the other. In general, there are two types of errors that show up in these valuations. In the first, high growth firms with high net capital expenditures are assumed to keep reinvesting at current rates, even as growth drops off. Not surprisingly, these firms are not valued very highly in these models. In the second, the net capital expenditures are reduced to zero in stable growth, even as the firm is assumed to grow at some rate forever. Here, the valuations tend to be too high. To avoid both errors, make the assumptions about reinvestment a function of the growth and the return on capital. As growth changes, the reinvestment rate will also change. • How do you value a firm that is losing money? There are a number of reasons why a firm might have negative earnings, and the response will vary depending upon the reason: – If the earnings of a cyclica
