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To: Jurgis Bekepuris who wrote (43535)	6/15/2001 10:04:54 PM
From: Stock Farmer	Read Replies (1) \| Respond to of 54805

Jurgis: Adjusting cash flow by discount >>They "adjust the cash flow by a discount rate known as the company's weighted average cost of capital". I am not sure why they do this since presumably this already should have been subtracted while obtaining FCF.<< This is called "discounted cash flows". There are three things to do. First is calculate a cash flow projection for the business. Next, you can't just add this string of numbers together and say "this is the pile of cash we shareholders get to divvy up". A dollar in the future isn't worth as much as a dollar today because of the time value of money. So you have to "discount" the future cash flows to present value. In excel notation, the discount factor in year n is simply 1/((1+r)^n) where "r" is the discount rate in %, and "n" is the number of years in the future. What discount rate do you use? Opinions vary, but the most widely accepted is that you should use the weighted average cost of capital (WACC) for the firm. This is because you are buying a share in the company, which theoretically can be freely exchanged to and from treasury at market price. Since the firm is obliged to optimize its use of capital, it should borrow money if it can create a greater return for shareholders, or repurchase shares if it can borrow money more cheaply. This is really all there is to a "valuation" based on future cash flows. To restate: First calculate expected cash flows for the firm. Second, discount each year's cash flow to present value using WACC as the discount rate Third, sum the discounted cash flows to net present value Hope this clears up the confusion. John. P.S. Yes, journalists are worse than economists. Economists know all of the answers to last years questions. Journalists apply these answers to this years questions.