Chapter 10, Problem 1CC

Summary Introduction

Capital Budgeting and Discounted Free Cash Flow Model:

Capital budgeting refers to the process planning which involves determining and evaluating the potential expenses and investments of a business that are large in nature. A discounted free cash flow model refers to a valuation method that helps in estimating the attractiveness of an investment opportunity. It considers the use of future free cash flow projections and discounts them to determine the present value estimate, thereby evaluating the potential for investment.

To identify:

The relation between capital budgeting and discounted free cash flow model.

Explanation of Solution

There is a significant connection between the discounted free cash flow model and capital budgeting, since the free cash flow of a form is equivalent to the sum of the free cash flows from the current and future investments of the firm.

Capital budgeting is primarily done for a project by calculating the net present value (NPV) of all the future cash flows of the project. However, discounted free cash flow model helps in determining the enterprise value by determining the sum of the present values of the existing projects and the net present value of all future new projects.

Hence, it can be said that the discounted free cash flow is nothing but the total of all the individual net present values calculated by capital budgeting for all existing projects as well as future new projects.

Conclusion

Therefore, the relation between capital budgeting and discounted free cash flow model can be summarized by stating that discounted free cash flow is nothing but the total of all the individual net present values calculated by capital budgeting for all existing projects and new projects.