CASH = CASH ?      CASH = KING?     WHERE?    WHEN?
Discounted cash-flow methods use different implicit cash-definitions. Under the banner ¨cash = king¨ this leads to convincing but entirely different valuation results. This might be applied dependent upon where and when. We illustrate this hereunder(1)

Let us assume a company with an everlasting fixed profit after tax of 100, financed totally with 1000 equity and a WACC after tax of 10%. Keeping things simple requires zero investments and zero depreciation. In all financial markets this company would be valued at 1000, being the perpetuity of 100 discounted at 10%. Also free cash-flow theory would valuate this company at 1000. 

Let us now change our example into the same company with everlasting profits after tax of 100 but now totally financed with 1000 loans at 10% before tax. Free cash-flow would be calculated at 100 + 0.65(2)% of 100 interest, thus 165.. Free cash-flow valuation at a WACC of 10% after tax would value this company at 1650 minus 1000 debt=650 (3)) . With a ten year horizon, the calculation would be the sum of net present values of: 

+ 10 years 165 at 10%  =  + 1,013.85 
+ continuing value end year 10 of 1650  =  +    636.15
- debt  =   -  1,000.
Thus, free cash-flow valuation would result in =   +    650
Standard cash-flow valuation however would continue to valuate at 1000. Everybody considers this company to be the equivalent of a perpetuity bond of 10% discounted at 10%. 

What happens to a buyer financing this deal bought at 650 with a WACC of 10% after tax and selling end year 10 at 1000. 
This is shown with the following buyer's cash-in/cash-out survey: 
This is shown with the following buyer's cash-in/cash-out survey(4)

- buyers cash-out of buying price start year 1  =   -    650
- 10 year WACC charges of 10% after tax on 650  =    -    650
+ 10 years net profits of 100 at 10% after tax =    + 1.000 
+ sales proceeds end year 10 of 1000  =   + 1.000
Of course, buyer's handsome net (cash) profit is +          700 in year 10.
This simple cash-in/cash-out survey demonstrates that informed buyers should be inclined valuing with the free cash-flow method. There are however more reasons why free cash-flow valuation tends -except in Germany-, to result systematically in lower valuations compared to standard discounted cash-flow methodsr(5)

Sellers should prefer standard discounted cash-flow methods rather than free cash-flow. Valuators and analysts using EVA or CFROI, should be aware of these phenomena of applying what, where, when. 

A more academic approach of these phenomena might be found by clicking here. 

By clicking here to find this site's home-page, valuation software (free demo) can be downloaded with a survey of all cash-flow methods including free cash-flow.

A solution of the confounding problem of what, where and when may be found in the  help-file of this valuation software by using properly the most classic discounted cash-flow valuation techniques, using pay-back methods. 

NOTE 1. Corneel B.A. Spil, manager Finiconsult B.V., Netherlands, e-mail:

NOTE 2. Supposing 35% is the marginal tax rate

NOTE 3. Make not the mistake to calculate present values of each line; interest was already taken care of in line 2 with 10%.

NOTE  4. Sometimes net Ebit is used in free cash-flow valuation. In this case Ebit would be 200, thus net Ebit would be (1-0,35)* 200=130.  This is clearly wrong while this does not take into account the tax-deductibility of interest payments.

NOTE  5. But not in Germany where the specific tax structure of ' anrechenbare Körperschaftsteuer' reverses all previous effects in most circumstances. See  free-cash-flow-german.htm