Final answer:
The corporate valuation model uses the Weighted Average Cost of Capital (WACC) and Free Cash Flow (FCF) for business valuation. The future free cash flows are projected and discounted back to the present using WACC. However, this approach has issues with estimating future cash flows and changes in the cost of capital or the company's risk profile.
Step-by-step explanation:
Valuation of a Business Using WACC and FCF
Valuing a business using the corporate valuation model involves the use of the Weighted Average Cost of Capital (WACC) and the Free Cash Flow (FCF). WACC represents the average rate that a company is expected to pay to all its security holders to finance its assets. It is critical for discounting future cash flows to their present value. Free Cash Flow (FCF) is the cash that a company generates after accounting for cash outflows to support operations and maintain its capital assets. In other words, it's the cash available to all investors, including stockholders and debt holders, after necessary capital expenditures.
The approach to valuation using WACC and FCF is based on projecting the company's free cash flows into the future and then discounting them back to the present using the company's weighted average cost of capital. This approach assumes that the value of a business is the present value of its future free cash flows.
However, the use of WACC and FCF for valuation comes with certain problems. Estimating future free cash flows can be highly uncertain, especially for new or rapidly changing industries. The weighted average cost of capital can also be difficult to calculate accurately because it requires estimates of the cost of equity and debt, which can fluctuate over time. Additionally, the assumption that a company's risk profile and capital structure remain constant may not hold true, leading to valuation inaccuracies.