RTD approach

The F low- T o e quity approach is one of the discounted cash flow method of valuation.

overview

The purpose of the discounted cash flow method consists in an exact (quantitative) determination of the tax advantage from a proportionate external financing. Now the amount of the tax benefit depends on the company's financing policy. In many cases, only a corporate tax (e.g. corporation tax or trade tax ) is assumed, the taxation of shareholders is neglected.

If it continues to be assumed that the company operates a so-called market- value- oriented financing (in the case of market- value- oriented financing, the future debt capital ratio for the entire future is already specified today , deviations or other uncertainties are excluded), then the use of the FTE approach ( Flow to Equity). The use of the FTE approach is tied to the requirement of market value-oriented financing - if the company is financed differently than market value-oriented, then the correct company value will not match the FTE value.

In addition to the FTE approach, the TCF approach or the WACC approach can also be used. All three procedures lead to the same company value. Which of the three methods you use depends on what information the evaluator has. The FTE assumes that the valuer knows the expected cash flows to shareholders in the future as well as the cost of equity of the indebted company. Both the WACC and TCF processes make different assumptions about this information.

equation

${\displaystyle E=\sum _{t=1}^{T}{\frac {E[FCF_{t}^{l}-Z_{t}-T_{t}]}{(1+k_{0}^{E})\cdots (1+k_{t-1}^{E})}}}$

With:

• ${\displaystyle E}$ Market value of the equity of the indebted company
• ${\displaystyle k_{t}^{E}}$ Equity costs of the indebted company at time t
• ${\displaystyle E[X]}$ Expected value of the quantity X
• ${\displaystyle FCF_{t}^{l}}$ total cash flow of the indebted company at time t
• ${\displaystyle Z_{t}}$ Interest payments by the indebted company at time t
• ${\displaystyle T_{t}}$ expected repayments of the indebted company at time t