Background Note | HBS Case Collection | October 1987 (Revised January 2013)

Note on Free Cash Flow Valuation Models

by William A. Sahlman

Abstract

Explores some of the issues involved in valuing cash flow streams. A simple model is presented that reveals the effect on value of changing assumptions about the appropriate discount rate, the level of profitability, the growth rate of sales, the asset intensity ratio, and the leverage ratio. Helps students address some of the following issues: 1) What is the definition of cash flow? 2) What effects do changes in the discount rate have on valuation? 3) How sensitive is value to changes in assumptions about the underlying characteristics of the cash flow stream? 4) How does growth affect value? 5) How does the use of leverage affect value? 6) What are price-to-earnings ratios? and 7) What factors affect price-to-earnings ratios?

Keywords: Cash Flow; Valuation;

Citation:

Sahlman, William A. "Note on Free Cash Flow Valuation Models." Harvard Business School Background Note 288-023, October 1987. (Revised January 2013.)