DCF with Negative Free Cash Flow

Guys, a quick question. I am doing a DCF for a utility power company and right now it has positive EBITDA but negative FCF due to very high Capex. Obviously I am assuming that it will generate positive FCF in the future( in line with equity research reports I read on the firm). My question is that when calculating EV, do I have to sum all the discounted FCFs( as in the negative ones too?) or just consider the positive cash flow? I would appreciate if someone could explain the logic.
I am assuming we do not have to take the negative FCFs into account bcoz all we are saying is that the firms value is the sum of positive cash flows it generates. Please correct me if I am wrong.
Thanks!

Discounted Cash Flow Model with Negative FCF

If your valuation model has negative cash flow at any point during the projection window, it does need to be included in the sum of the discounted cash flows. Having a few years of negative cash flow will not necessarily result in a negative enterprise value as seen in the image below; if so there is no issue using a DCF to value the business. However, if you are getting a negative share price or enterprise value you should consider using a different valuation method or altering your assumptions if you think that your capex assumptions are too aggressive.

Review of Free Cash Flow

Read more about free cash flow on the WSO finance dictionary.

Read more about the levered vs. unlevered free cash flow on the WSO.

Dividend Discount Model

If your DCF is resulting in a negative share price, you should consider using a different valuation method. The OP should consider using the dividend discount model to value the business. Since regulated utilities often offer a very large dividend this valuation method is appropriate.

You could also consider using the multiples method to value the business.

Preparing for Investment Banking Interviews?

The WSO investment banking interview course is designed by countless professionals with real world experience, tailored to people aspiring to break into the industry. This guide will help you learn how to answer these questions and many, many more.

Investment Banking Interview Course Here

WSO Elite Modeling Package

  • 6 courses to mastery: Excel, Financial Statement, LBO, M&A, Valuation and DCF
  • Elite instructors from top BB investment banks and private equity megafunds
  • Includes Company DB + Video Library Access (1 year)

Comments (8)

Oct 26, 2011 - 5:10pm

The whole purpose of calculating a FCF (whether +ve or -ve) is to value them by discounting back to today and arriving at a value of the business.

Hence, if you ignore the -ve FCF you effectively overvalue the business, ignoring the fact that you are paying for cash flows (which you will never get).

Oct 26, 2011 - 5:36pm

If the PV of the total cash flows is ~0 or negative, you may want to question the accuracy of your DCF. Do you want the entire valuation to be derived from the terminal value?

I'm not particularly familiar with utility companies, but I would imagine a P / BV or P / TBV multiple measure would be a more accurate indicator of value. Assuming this is a regulated utility?

Learn More

300+ video lessons across 6 modeling courses taught by elite practitioners at the top investment banks and private equity funds -- Excel Modeling -- Financial Statement Modeling -- M&A Modeling -- LBO Modeling -- DCF and Valuation Modeling -- ALL INCLUDED + 2 Huge Bonuses.

Learn more
Oct 27, 2011 - 11:00am
Start Discussion

Total Avg Compensation

June 2021 Investment Banking

  • Director/MD (9) $911
  • Vice President (35) $364
  • Associates (202) $234
  • 2nd Year Analyst (115) $151
  • Intern/Summer Associate (97) $145
  • 3rd+ Year Analyst (27) $145
  • 1st Year Analyst (420) $131
  • Intern/Summer Analyst (338) $82