1. Free Cash Flow to Firm (FCFF) Model
- Description: Values the business as a whole by discounting the cash flows available to both equity and debt holders (the entire firm).
- Application: Suitable for most company-wide valuations and mergers & acquisitions.
- Method: Calculates unlevered cash flows before debt payments and discounts them using the Weighted Average Cost of Capital (WACC).
2. Free Cash Flow to Equity (FCFE) Model
- Description: Focuses on cash flow directly available to equity shareholders, after accounting for debt payments.
- Application: Ideal for valuing equity in companies, especially when capital structures may change.
- Method: Discounts levered free cash flows at the cost of equity.
3. Dividend Discount Model (DDM)
- Description: Values companies based on expected future dividend payments, discounted to present value.
- Application: Mostly used for stable companies or banks with predictable dividend payouts.
- Method: Projects future dividends; uses appropriate discount rate (often cost of equity).
4. Adjusted Present Value (APV) Model
- Description: Separates the impact of financing from project/business operations.
- Application: Useful when analyzing projects or companies with changing debt levels.
- Method: Values as if all-equity financed and adds the present value of financing benefits (tax shields).
Model Variations Based on Growth
- Single-Stage Model: Assumes a constant growth rate in cash flows forever.
- Two-Stage Model: Forecasts explicit high-growth years, then shifts to a stable, mature growth rate.
- Three-Stage Model: Includes high growth, transitional, and stable phases, useful for startups or changing businesses.
Summary Table
| Model | Cash Flow Type | Discount Rate | Ideal For |
| Free Cash Flow to Firm | Firm-wide (FCFF) | WACC | Business as a whole |
| Free Cash Flow to Equity | To equity only | Cost of Equity | Equity valuation |
| Dividend Discount Model | Dividends | Cost of Equity | Dividend-paying firms |
| Adjusted Present Value | Various | Cost of Capital + tax | Changing debt structures |
Tip: The choice of DCF model depends on your valuation goals and the type of asset or company being analyzed. Multi-stage models capture different phases of business growth and are popular in equity research.
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