Free Cash Flow & Enterprise Value question.
I am writing today seeking help to clear some confusion I have about valuation. It appears that I know the formulas, but I am interpreting the numbers incorrectly, or in fact I cannot explain what is going on or why things are as they are. I would like to start by telling you how I find FCFF and then I want to tell you how I interpret it, how the dictionary interprets it, and why I don't seem to find commonality between the definitions. Alright here I go:
FCF => Profit after tax + Depreciation - Increase in current assets + Increase in current liabilities - Increase in fixed assets at cost + After tax interest on debt - After tax interest on cash and marketable securities
So I do this for a projected 5-10 years, discount them at WACC, and come to find the enterprise value. Now what I was taught at university was that FCF is not profit, this is just the cash available at the end of the projected year for which debt holders or equity holders can put their hand on; ("this is not profit" because there may be accounts receivable which inflated net income but we subtracted any increase in current assets). What I learned in University is that the Enterprise value is basically the PV of all the FCF's. Now let me introduce my confusion:
1) If Enterprise value is the value of the total assets in year 0, and we know FCF does not necessarily represent true profit, why do we construct a valuation model based on cash available at the end of the year which does not embed profit as the final judgement?
2) On most websites, Enterprise value would be defined as (Share price x Outstanding shares) + Net Debt, is this embedding the idea that enterprise value is the present value of total assets in year 0, and total assets are coming from either equity or debt? If so, where did my model take into account discounting my PPE in the future? Yes the formula says "Subtract Increase in fixed assets at cost", but again this seems to be on a cash basis and so the enterprise value does not seem to appear as a valuation figure which takes into account physical assets or non tangible assets, if I were to acquire a firm I would be buying it with its physical assets as well!
3) Since we are discounting CASH figures to get an enterprise value, would it be logical to say enterprise value is the present value of debt and equity of the firm? That link between cash and (debt + equity) is confusing whereas the link between assets and (debt + equity) is easier to understand. It's just that I hear that (debt + equity in DCF = value of operating assets), and then apparently operating assets is proxied by FCF whereas cash is a non operating asset.
4) What's the difference between finding the enterprise value by discounting future FCF's, or doing it as (Market cap + Debt)? I heard it was something like market value vs intrinsic value, but yet still don't understand.
5) Yes I understand the idea that FCF would be the amount left to pay debt holders and equity holders after the year is over, but would discounting those numbers to the present give me a true value of the firm today with all its physical and non tangible assets?
Thanks for making it this far! I know I am in lots of confusion, but I am determined to get a keen understanding of all of this and I thank you all!