Abstract:
Practitioners and teachers in finance usually treat the most important issues in project appraisal and cash flow valuation is at least light. One is the construction of cash flows; in the other hand is the cost of capital that is intrinsically related to the valuation of the cash flows.
The problem with the cash flows relies on the difficulty of that construction mainly when some real life complexities are present. When this happens the analyst is prone to incur in mistakes because it is very easy to forget some items.
On the other hand, the determination of the cost of capital many times is tackled selecting the discount rate (cost of capital) from the thin air, perhaps adding some percent points to the cost of debt or similar. Some other times a weighted average is calculated using initial book values and keeping that average constant during the period of analysis.
Facing this reality we intend to approach this problem in a very simple and easy but correct way to discount cash flows taking into account the market values to determine the correct discount rate (the weighted average cost of capital WACC). Although we know that the determination of the cost of capital might be biting off more than what one can chew and it is one of the most difficult problems in corporate finance we will try.
In this paper we show a very simple approach to construct the cash flows to value a firm. In particular, we show the Capital Cash Flow, CCF used by Ruback, 2000. We present a simple methodology to determine the cost of capital used to discount the CCF. In order to create a proper context, we present at the very beginning the most common mistakes in cash flow valuation. In the body of the paper we show how to ...