Cash flows in the valuation model

One of the tasks that you'll probably run into if you're trying to build a financial model is the need to value the firm. This is going to start with determining what the cash flows for that firm are going to be. Now, that sounds simple enough, right? We could just look at the statement of cash flows. But the reality is, it's a bit more tricky than you might think. I'm in the 04_02_Begin Excel file. Now, what we've got here is our three-statement financial model, and I focused on the statement of cash flows as well as our various assumptions over time. In order to evaluate the value of this firm, we're going to need to determine the free cash flow for the company. The free cash flow is going to be driven by the cash from operations for the firm, less what the firm thinks it's going to need to spend on capital expenditures. This is one of the assumptions that we'll often have to make in order to build an effective valuation model. So in this case, the firm is projecting cash from operations of 30,215. We've got cap ex of an additional 6,176. We can take this and adjust it across all five years, and that'll give us our free cash flow over that five-year period of time. But, if we really want to understand the value of the firm, we're going to have to go one step beyond this. We're going to have to look at what the present value of these free cash flows is. So, to do that, we're going to use the present value formula in Excel, which is simply =PV open parentheses, then the discount rate that we'll use. We'll add that in just a moment. The number of periods in the future that the cash flows will be received. So in this case, the easiest way to handle that, is going to be to take the year, and then subtract off the current year. PMT, or payment, would be any additional dividends we get. I'll assume it's nothing, and then our future value is going to be our free cash flow. But, for Excel, we're going to have to put a negative in front of that free cash flow, because it would be a cash outflow when it gets paid to us. And then finally, we'll say this is at the end of the year in question. Now, Excel's not going to help us until we add in that discount rate. The discount rate is based on the riskiness of the firm. So I'm going to use a seven percent discount rate here. That will be a reasonable starting point. So now, Excel will go through and help us to determine what the value of this particular set of cash flows is. Now if I've done my job properly, we'll be able to go through and take that discount rate, apply it overtime, and use this same formula with only minimal changes over time. And if we widen out each of our columns, we'll now be able to determine what the present value of all of our future cash flows is based on the year, the discount rate, and the cash flow itself. And this is the first step down the road towards figuring out the valuation of that firm.