Aim/purpose – The aim of this paper is to provide economically justified evidence that the business value calculated by income valuation methods is the same, regardless of the type of cash flow used in the valuation algorithm.
Design/methodology/approach – The evidence was arrived at using free cash flow to equity (FCFE), debt (FCFD) and firm (FCFF). The article draws attention to the FCFF method’s particular popularity in income valuation, based on analysts’ practice. It shows an overview of various approaches to determine the capital structure in the formula for WACC, both in practice and theory. Finally, it examines an empirical example with the authors’ own derivations and postulates.
Findings – The conclusion drawn from the conducted analysis is that the key to the reconciliation process, and thus DCF model coherency, is to apply the appropriate method of capital structure estimation during the calculation of the weighted average cost of capital (WACC). This capital structure will henceforth be referred to as ‘income weights’.
Research implications/limitations – It should be noted that the obtained compliance of valuation results does not imply that the income valuation becomes an objective way of determining business value. It still remains subjective.
Originality/value/contribution – According to the presented approach, the DCF model’s subjectivism is limited to the forecasts. The rest is the algorithm which, based on the principles of mathematics, should be used in the same way in every situation.
Our article was published in Journal of Economics and Management. You can read the whole article here.