Free Cash Flow and Weighted Average Cost of Capital
According to Noori and Aslani, free cash flow (FCF) is a concept of measuring the cash flow of a business aimed to define the fraction which is available for distribution among the groups of stakeholders of the company such as its stockholders. Essentially, FCF means the fraction of cash flow generated after taking into account the funds aimed at supporting operations and supporting capital assets. If compared to such profitability measures as earnings or net income, FCF is different from them in the way that it excludes the expenses not attributable to cash and includes the financial funds designated for equipment and asset spending and the dynamics of the working capital.
Weighted cost of capital (WACC) is an estimate for the cost of capital faced by a certain company which takes into account the weighted average of its components. The two most typically included components are equity financing and debt financing, which enter the equation according to their fraction in the total amount of a company’s capital. Some of the possible sources of a company’s capital to be included in the calculation are bonds, common equity, long-term debt, and preferred stock. Given that there is no explicitly available estimation of the value of equity, it can be complicated.
The free cash flow valuation model is the method of valuation of companies that focuses on the calculation of the present value of the amount of free cash flow available to a company. This method requires the use of an estimate of the firm’s capital cost and the amounts of future projected cash flows.