Lesson 8 of 11 · All lessons in this module
- Present value models: DDM and FCFEVideo lesson
- Choosing the cash flow: dividends or FCFE
- FCFF, EBITDA and residual income
- Preferred stock and the Gordon growth modelVideo lesson
- Multistage dividend discount modelsVideo lesson
- Growth assumptions for any cash flow: constant, implied and two-stage
- The DCF process: discount rates, terminal values and ranges
- Integrated cases: negative growth and reconciling FCFE with FCFF
- Integrated cases: two-stage FCFF with debt, and the effect of the debt ratio
- Shortcomings of constant and multistage growth models
- Preferred shares: required return and contingency features
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Lesson 8 of 11 · 16 min
Integrated cases: negative growth and reconciling FCFE with FCFF
A declining cash flow still has a constant-growth value (the denominator becomes r plus the decline), a value range comes from a range of g, and an FCFE value converts into an FCFF model by adding debt and solving for the implied growth rate.
In short
- Constant growth with a negative g: V = CF₀(1 + g)/(r − g); with g = −4% the denominator is r + 4%, not r − 4%.
- Show a range: hold r fixed and vary g (for example −1%, −4%, −6%); the value falls as the decline steepens.
- To reconcile FCFE and FCFF: equity value → add market debt → firm value → solve g = WACC − FCFF₁/V.
- WACC weights from a ratio: a debt:equity ratio of 2:3 means debt 2/5 and equity 3/5 of capital.
- A rise in the risk-free rate lifts both r_e and r_d; value falls by more than the rate move because r − g is small.
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