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* Continuing value =
2013
2014
2015
$1,450
$1,020
$ 430
1,576
1,124
452
1,718
1,200
518
1.21
374
1.331
389
1.10
391
$1,154
8,979
6,746
$7,900 million
759
$7,141 million
518 1.04
1.10 1.04
8,989
430
1.10 1.05
= $8,600 million
E4.3. Valuation with Negative Free Cash Flows
Calculate free cash flow from the forecasts of cash flow from operations and cash investments.
Your will see that free cash flow is negative in all years except 2013:
2013
Cash flow from operations
Cash investments
Free cash flow
730
673
57
2014
2015
932
1,023
( 91)
1,234
1,352
( 118)
2016
1,592
1,745
( 153)
If you calculate the present value of these free cash flows (with any discount rate), youll get a
negative price. Prices cant be negative (with limited liability). The continuing value must be
greater than 100% of the price, but we have no way to calculate it. The free cash flows are
increasingly negative because, while cash flow from operations are positive and increasing, the
firm is investing more.
E4.4. Calculate Free Cash Flow from a Cash Flow Statement
Cash flow from operations reported
Interest payments
Interest receipts
Net interest payments
Tax at 35%
Cash flow from operations
$5,270
$1,342
876
466
163
303
5,573
2,203
3,370
E4.7. Calculating Cash Flow from Operations and Cash Investment for Coca-Cola
Cash flow from operations:
Reported cash flow from operations
Interest paid
$405
Interest received
236
Net interest paid
169
Tax deduction (at 36%)
61
Cash from operations
$7,150
108
$7,258 million
Cash investment:
Reported cash investment
Sale of investments
Purchase of investments
$6,719
$ 448
(99)
349
$7,068
5,929
618
5,311
6,421
1,496
4,925
5,969
2,258
3,711
7,258
7,068
190
Though positive, the free cash flows are declining over the four years. If cash flows from
operations and cash investments were declining at about the same rate, we might conclude that
the firm indeed was in a state of decline: declining cash flows from the business lead to declining
investments. However, cash flows from operations are increasing and cash investment is
increasing at a faster rate: Coke is investing heavily. While free cash flow is declining over these
years, one would thus expect it to increase in future years as cash from the rising investment here
comes in. These cash flow are not a good indication of future free cash flows (and nor is the
$190 million of free cash flow in 2007 a good base to calculate a continuing value.)
If you were valuing Coke at the beginning of 2004 based on these subsequent cash flows, you
would have a big problem: you would have to forecast the cash flows after 2007 that the new
investment from 2005-2007 would produce. That is a difficult task, and it would extend the
forecast horizon to a point where outcomes are more uncertain.
The exercise is a good example of why free cash flow does not work, in principle: Investment
(which is made to generate cash flows actually decreases free cash flow, so rising investment
relative to cash flow from operations (lower free cash flow) typically means higher free cash
flow later.
2006
2,014
300
1,714
1.09
1,572
2007
2,057
380
1,677
1.1881
1,411
2008
2009
2,095
2,107
442
470
1,653
1,637
1.2950
1.4116
1,276
1,160
1,637
18,189
0.09
CV (no growth) =
18,189
12,885
1.4116
PV of CV =
CV
1,637 1.03
$28,102
1.09 1.03
5,419
28,102
19,908
25,327
18,189
Net debt
Equity value
6,192
19,135