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ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows

When valuing a company using FCFF, which cash flow treatment is correct?

FCFF is measured before interest and other financing flows and is discounted at WACC. Financing costs, including the debt tax benefit, are already reflected in the discount rate, so deducting interest would double count them.

  1. ADeduct interest paid from operating cash flow before discounting at WACC
  2. BAdd back the tax shield on interest and discount at the cost of equity
  3. CUse cash flows before interest and discount at WACC, as financing costs are reflected in the discount rateCorrect
  4. DUse dividends as the cash flow and discount at WACC

Explanation

FCFF is the cash flow available to all capital providers, so it is stated before interest and financing flows. The financing cost is captured in WACC. Deducting interest would double count financing, and dividends are an equity flow matched to the cost of equity.

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