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anonymous

  • 5 years ago

Hi. Should I add cash to the output of FCFE model? If yes, why? In book "Investment valuation" it is not added, but in "Damodaran on valuation" it is. I am bit confused.

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  1. anonymous
    • 5 years ago
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    Let's say the company currently has $10 million in annual sales and $1 million in cash, but based on inventory, receivables, payables, current portion of debt, accrued liabilities, observed fluctuations in bank balances from month to month, etc., you estimate that the company needs about $250,000 at current sales levels to maintain a safe level of liquidity. So the company has about $750,000 of "excess" cash which could safely be distributed to shareholders today without affecting the underlying business. So you could then add $750,000 to the FCFE model to arrive at total equity value. BUT, you need to be sure your model indicates the appropriate level of "required" cash in each future period. So if your forecast shows cash being maintained at $1 million over the next five years, while sales grow to $50 million, then your model may not reflect the expected increase in "required" cash balances. Maybe as the company grows, you feel the appropriate level of required cash is $250,000 today, $300,000 in year 2, ..., $1,000,000 in year 5. In this case, first treat the $750,000 cash as being distributed today. Then adjust your model to reflect future borrowing (or paying down debt more slowly) in order to maintain the anticipated cash requirements in each period. (It is possible that the best financing strategy would be to not distribute any cash today, and instead earn very low interest income on the excess cash to avoid having to borrow at higher rates later.) Once you have a balance sheet that reflects an appropriate level of cash in each future period, the cash that should be distributed today should be added to your FCFE result.

  2. anonymous
    • 5 years ago
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    It depends on how you compute your FCFE. If you use the total net income (which includes interest income from cash) and discount back at a cost of equity that is also adjusted for cash (you will have a lower beta), you have already valued cash in your PV and should not add it back. If you take the interest income out of net income and discount back at a cost of equity that reflects only your operating assets, your PV does not include cash and it should be added back.

  3. anonymous
    • 5 years ago
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    Thanks for your answers. I use total net income and value line betas, so I am not sure if it is adjusted. I value stock of company quarterly in period 2001-2011. During that time amount of cash and marketable securities has raised from 9% to 50% of total equity. So the effect on value is also rising with the time (3-15%). I will probably flip a coin :) btw. the weirdest thing is that company has large amount of marketable securities, but its interest income is zero, or close to zero.

  4. anonymous
    • 5 years ago
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    It is incorporated into your value already.. So, don't add it on.

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