Free Cash Flow (FCF), Economic Value Added (EVATM), and Net Present Value (NPV):

Introduction

• The use of DCF methods for investment decision making and valuation is well entrenched in finance theory and practice.
• The relative new comers with profound conceptual insights are Irving Fisher and Jack Hirshleifer, who provided concise, rigorous utility-theoretic foundations.
• The modern literature has broadened application of DCF techniques from primarily response to compound interest problem to capital budgeting and security valuation problems.
• The last few years have witnessed a tremendous growth in writing on EVA^TM, in the financial press, practitioner publications, and numerous unpublished working papers.
• The primary purpose of this paper is:
• To assist users of DCF methods by clearly setting forth the relationship of free-cash-flow (FCF) and economic value added (EVA^TM) concepts to each other and to the more traditional applications of DCF thinking such as net present value (NPV).
• The article still follows others in demonstrating the equivalence between EVA and NPV. Although the approach is more general in link the problems of security valuation, enterprise valuation, and investment project selection. Additionally, the approach relates more directly to use of standard financial accounting information.
• The paper also briefly summarizes some implications of the analysis for problems encountered in translating the theoretical concepts into practice.

Findings

• Conceptually, free cash flow, economic value added, and net present value approaches to valuation and decision-making are equivalent.
• While that fact appears well known, the paper partially fill a void in the literature by rigorously demonstrating the linkage among problems of security valuation, enterprise valuation, and investment project selection, and by doing so in a manner that relates directly to the use of standard financial accounting nformation.
• Beginning with the cash budget identity, the paper demonstrate how the discoubting of appropriately defined cash flows under the free-cash-flow (FCF) valuation approach is logically equivalent to the discounting of economic profits under EVATM approach.
• The end of the similarities is on the concept of net operating profit after-tax(NOPAT), found by adding after-tax interest payments to net profit after taxes which is central to both approaches.
• Then, the FCF approach focuses on the periodic total cash flows obtained by deducting total net investment and adding net debt issuance to net operating cash flow
• And the EVA^TM approach requires defining the periodic total investment in the firm.
• Each approach necessities as a myriad of adjustments to the accounting information available for most corporations.