How do the FCFE, corporate FCF valuation, and compressed APV models differ? How are they similar?

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How do the FCFE, corporate FCF valuation, and compressed APV models differ? How are they similar?

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How do the FCFE, corporate FCF valuation, and compressed APV models differ? How are they similar?

Explanation & AnswerSolution by a verified expert

Explanation

The corporate free cash flow (FCF), the free cash flow to equity (FCFE), and the compressed adjusted present value (CAPV) model use different cash flows that are to be discounted, which are free cash flows (FCF), free cash flows to equity (FCFE) and free cash flows (FCF) with interest tax savings respectively.
 
The corporate FCF model discounts the cash flows at the weighted average cost of capital (WACC), whereas the FCFE and CAPV model discounts the cash flows at the levered cost of equity and unlevered cost of equity respectively. The FCF model results in the calculation of the value of the operations of the entity. The FCFE model calculates the present values of cash flows available to equity holders with the assistance of levered cost of equity. While, the CAPV calculates the value of unlevered operations and the value of the tax shield.
 
However, the three models assume that the growth rate and capital structure after the horizon period are constant with perpetual cash flows. The growth rate during the forecast period may not be constant. The common assumptions also include non presence of both non-operating assets and  preferred stocks.

Verified Answer

The corporate free cash flow (FCF), the free cash flow to equity (FCFE), and the compressed adjusted present value (CAPV) model, considers different cash flows that can be discounted, use different rates to discount these cash flows, which eventually lead to different present values of cash flows after discounting.
 
However, the three models assume that the growth rate and capital structure after the horizon period is constant with perpetual cash flows. The common assumptions also include no non-operating assets and no preferred stock.

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