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Free cash flow to the firm

The cash flow the DCF discounts, and how each forecast year is built.

Free cash flow to the firm (FCFF) is the cash left after taxes and after reinvesting to support growth, before any payments to lenders or shareholders. Because it is before financing, it belongs to all capital providers and is discounted at the weighted cost of all capital (WACC), which gives enterprise value.

FCFFt=EBITt (1−τt)⏟NOPATt−Reinvestmentt\text{FCFF}_t = \underbrace{\text{EBIT}_t\,(1 - \tau_t)}_{\text{NOPAT}_t} - \text{Reinvestment}_t

Each forecast year the engine builds the income statement from three drivers:

Revenuet=Revenuet−1 (1+gt)EBITt=mt⋅RevenuetNOPATt=EBITt (1−τt)\text{Revenue}_t = \text{Revenue}_{t-1}\,(1 + g_t) \qquad \text{EBIT}_t = m_t \cdot \text{Revenue}_t \qquad \text{NOPAT}_t = \text{EBIT}_t\,(1-\tau_t)

where gtg_t is revenue growth, mtm_t is the operating margin and τt\tau_t is the tax rate in year tt. NOPAT, net operating profit after tax, is what the business earns for its capital providers before reinvestment. Each year's cash flow is then discounted at WACC:

PVt=FCFFt(1+WACC)t\text{PV}_t = \frac{\text{FCFF}_t}{(1 + \text{WACC})^{t}}
Worked exampleRevenue last year $1,000, growth 10%, margin 20%, tax 25%, sales-to-capital 2.0. Revenue becomes $1,100, EBIT $220, NOPAT $165. Reinvestment is the $100 of new revenue divided by 2.0, so $50. FCFF is $115. At a 9% WACC its present value one year out is $105.5.
In the appThe per-year table under the value shows revenue, EBIT, NOPAT, reinvestment, FCFF and PV for each forecast year, so you can trace every number in this section.

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