Question

Divide estimated maintainable free cash flow by the capitalization rate

This estimated maintainable free cash flow amount is then divided by the capitalization rate to determine the value of capitalized cash flows.

The capitalization rate is the measure of the risk (discount rate) and constant growth rate. The capitalization rate that is often used in practice is the weighted average cost of capital (WACC).

a) Multiply estimated free cash flow by the capitalization rate.
b) Divide estimated free cash flow by the capitalization rate.
c) Add estimated free cash flow to the capitalization rate.
d) Subtract estimated free cash flow from the capitalization rate.

Answer 1

To value capitalized cash flows, divide estimated maintainable free cash flow by the capitalization rate, usually represented by the WACC. This derives a present value which reflects the current worth of expected future earnings.

Step-by-step explanation:

To determine the value of capitalized cash flows, you should divide estimated maintainable free cash flow by the capitalization rate. The capitalization rate typically used is the weighted average cost of capital (WACC). The capitalization rate accounts for the risk and constant growth rate associated with the investment.

Applying a present value calculation to this situation, one would first calculate the present discounted value (PDV) of future profits and then divide that value by the number of shares. This process helps determine an appropriate price per share based on expected future earnings and the time value of money.

The formula for valuing a firm's cash flow or share price involves dividing the PDV by the number of shares or the free cash flow by the WACC to forecast the investment's worth in today's terms.