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Company Growth Share Value
Although the growth of a company does not have limits, we can depreciate its value in any determined period, due that its current value is diminishing in the measure that we recede in time from the present. The validity of the free cash flow method that values the shares of a company in accordance to its capacity to generate future flows is limited by a correct election of the discount rate to apply. This discount rate must take into account the risk. The discount rate to use when we calculate the value of the company using as base the free cash flow method, is obtained by using the pondered average cost of the debt after taxes and of the capital or pondered average cost of the resources (weighed average cost of capital or WACC). The WACC is calculated by pondering the cost of the debt and the cost of the own resources, in function of the financial structure of the company:
WACC = Eke + Dkd (1 – T)
E + D
Where
D = value of the debt
E = value of the shares
Ke = required yield for own resources
Kd = cost of the debt before taxes
T = tax rate (company tax)
This discount rate is known with the name of capital cost. Once the free cash flows are obtained the corresponding formula is applied to the free cash flow method by using the discount rate of the pondered average cost of the resources (WACC):
n
V = S FCLi
i = 1 (1 + WACC)I
where:
V = value of the company
WACC = pondered average cost of the resources
FCLi = free cash flow of the periodi
Once you know the value of the company you can now obtain the value of a share by dividing the value of the company by the number of shares in the same.
The problem for determining the value of a share by using this method is that not always can you obtain trustworthy previsions of the flows that the company will generate in the future.
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