Analytical solution to the circularity problem in the discounted cash flow valuation framework
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| Format: | Artículo científico |
| Langue: | en |
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Universidad Nacional de Colombia
2011
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| _version_ | 1876479822318796800 |
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| author | Felipe Mejía-Peláez |
| author_facet | Felipe Mejía-Peláez |
| contents | Analytical solution to the circularity problem in the discounted cash flow valuation framework Felipe Mejía-Peláez Ignacio Vélez-Pareja Administración y Contabilidad WACC cash flows circularity Firm valuation free cash flow In this paper we propose an analytical solution to the circularity problem between value and cost of capital. Our solution is derived starting from a central principle of finance thatrelates value today to value, cash flow, and the discount rate for next period. We present a general formulation without circularity for the equity value (E), cost of levered equity (Ke), levered firm value (V), and the weighted average cost of capital (WACC). We furthermore compare the results obtained from these formulas with the results of the application of the Adjusted Present Value approach (no circularity) and the iterative solution of circularity based upon the iteration feature of a spreadsheet, concluding that all methods yield exactly the same answer. The advantage of this solution is that it avoids problems such as using manual methods (i.e., the popular ¿Rolling WACC¿) ignoring the circularity issue, setting a target leverage (usually constant) with the inconsistencies that result from it, the wrong use of book values, or attributing the discrepancies in values to rounding errors. 2011 artículo científico 0121-5051 https://www.redalyc.org/articulo.oa?id=81822807006 en http://www.redalyc.org/revista.oa?id=818 INNOVAR. Revista de Ciencias Administrativas y Sociales application/pdf Universidad Nacional de Colombia INNOVAR. Revista de Ciencias Administrativas y Sociales (Colombia) Num.42 Vol.21 |
| format | Artículo científico |
| id | redalyc_81822807006 |
| institution | Redalyc |
| language | en |
| publishDate | 2011 |
| publisher | Universidad Nacional de Colombia |
| spellingShingle | Analytical solution to the circularity problem in the discounted cash flow valuation framework Felipe Mejía-Peláez Administración y Contabilidad WACC cash flows circularity Firm valuation free cash flow Analytical solution to the circularity problem in the discounted cash flow valuation framework Felipe Mejía-Peláez Ignacio Vélez-Pareja Administración y Contabilidad WACC cash flows circularity Firm valuation free cash flow In this paper we propose an analytical solution to the circularity problem between value and cost of capital. Our solution is derived starting from a central principle of finance thatrelates value today to value, cash flow, and the discount rate for next period. We present a general formulation without circularity for the equity value (E), cost of levered equity (Ke), levered firm value (V), and the weighted average cost of capital (WACC). We furthermore compare the results obtained from these formulas with the results of the application of the Adjusted Present Value approach (no circularity) and the iterative solution of circularity based upon the iteration feature of a spreadsheet, concluding that all methods yield exactly the same answer. The advantage of this solution is that it avoids problems such as using manual methods (i.e., the popular ¿Rolling WACC¿) ignoring the circularity issue, setting a target leverage (usually constant) with the inconsistencies that result from it, the wrong use of book values, or attributing the discrepancies in values to rounding errors. 2011 artículo científico 0121-5051 https://www.redalyc.org/articulo.oa?id=81822807006 en http://www.redalyc.org/revista.oa?id=818 INNOVAR. Revista de Ciencias Administrativas y Sociales application/pdf Universidad Nacional de Colombia INNOVAR. Revista de Ciencias Administrativas y Sociales (Colombia) Num.42 Vol.21 |
| title | Analytical solution to the circularity problem in the discounted cash flow valuation framework |
| topic | Administración y Contabilidad WACC cash flows circularity Firm valuation free cash flow |
| url | https://www.redalyc.org/articulo.oa?id=81822807006 |