There are several reasons why valuing a company based on Operating Cash Flow (OCF) is an

effective method:
● Reflects cash generation ability: OCF (Operating Cash Flow) directly reflects a
company's ability to generate cash from its core business activities. This cash flow is not
affected by accounting factors such as depreciation or taxes, helping investors accurately
assess the profit potential of the company.

● Assess financial health: A high OCF indicates that a company can sustain its operations,
repay debts, and reinvest without relying heavily on external sources of capital. This
demonstrates strong financial health and reduces risk for investors.

● Comparison between companies: OCF facilitates the comparison of operational

efficiency between companies in the same industry, regardless of different accounting
methods or capital structures. Comparing based on OCF eliminates the end influence of
non-operational factors, ensuring accuracy and objectivity.

● Predict future growth potential: A high OCF suggests that a company has growth
potential in the future. Abundant cash flow enables the company to reinvest, expand
operations, and increase profitability.

● Complementing other methods: OCF effectively complements other valuation methods

such as Discounted Cash Flow (DCF) to provide a comprehensive assessment of the
company's value. Using multiple methods enhances confidence in valuation results.

Limitations:
● OCF does not reflect the value of non-operating assets or long-term investments.
● OCF can be manipulated by tax or accounting management activities.
● OCF does not predict market risk or fluctuations.

Conclusion:
Valuing a company based on OCF is an effective method to cash generation ability, financial
health, and growth potential. However, investors should combine OCF with other methods for a
comprehensive and accurate assessment of the company's value.
Additionally:
- OCF is used to calculate the value of a business using the Discounted Cash Flow (DCF)
method.
- OCF is an important metric used by investors and analysts to evaluate companies.

FORMULA FOR CALCULATING OCF VALUE

1. General Formula at Any Given Time
- Why Use WACC?
In this model, we calculate the value of the company by discounting the Operating Cash Flow
(OCF) before paying interest to the debt holders and BEFORE deducting the funds needed to
maintain the company's asset base (capital expenditures). Furthermore, as we are discounting the
total firm’s operating free cash flow, we will use the Weighted Average Cost of Capital (WACC)
as the discount rate. And we have the general formula:

WACC formula:
WACC (Weighted Average Cost of Capital): is calculated by the average cost with the
proportion taken according to the types of capital used by the business.
 WACC = ( E+ED ) x k + ( E+DD ) x k x ( 1 – T )
e d c

E (%) = the proportion of the firm’s equity

D (%) = the proportion of the firm’s debt
Ke (%) = cost of the firm’s equity
Kd (%)= before-tax cost of the firm’s debt
Tc (%)= corporate tax rate

Or

WACC = (Wi x ri) + (Wp x rp) + (WS x rS) + (Wr x rr) + (Wn x rn)
W (%) : the proportion of :
R (%) : cost of:
i: debt (loan & bond) – long-term debt
p: preferred stock
s: common stock
r: retained earnings
n: issuing new stock
❑
∑
❑
W =100% (capital structure)

EXAMPLE: Over five years, a firm’s sales revenue equals $50 000, production costs equal $30
000, depreciation expense for tax purposes equals $8000, corporate tax rate is 20%. Besides, the
capital structure is 40% on debt and 60% on equity. The risk-free rate is 8% and the stock market
return is 10%, beta is 1.5, and the firm is charged 12% on cost of debt. Calculate the value of the
firm at the present.

Sales revenue $50 000

Costs ($30 000)

Depreciation ($8 000)

EBIT $12 000

Tax ($12 000 x 0.34 = $4 080)

Net income $7 920

OCF = EBIT + Depreciation - Taxes

= 12 000 + 8 000 - 4 080 = 15 920

WACC = kd ( 1 - Tc) x %D + ke x %E

= 12% x ( 1 - 20% ) x 40% + ( 8% + 1.5 ( 10% - 8% ) ) x 60%

= 10.44%
5
=> PV =∑ ❑ ¿=59677.0444
i=1

2. Assumption of Infinite Period: Simplifies the calculation process and enhances our
understanding of the present value of a series of future cash flows.
- Considers the impact of future cash flows: Business projects often extend over a long
period, and it's challenging to precisely determine the exact end time. Assuming an
infinite period helps eliminate the complexity of pinpointing this exact moment.
- Convenient for calculations.
- Flexibility in estimating value: Creates a more flexible calculation environment when
estimating the present value of cash flows. Supports assessing the impact of variability
and uncertainty in the future.
*** This assumption may not accurately reflect reality, so it should be applied with caution to
avoid deviations in evaluating the actual value of cash flows.

Why Make the Assumption of an Infinite Period Instead of Extending the Estimate of
Operating Cash Flow?
Because it offers a minor benefit - small variations in volatility. If there is significant volatility,
reconsideration and recalculation are necessary.
 - Simplification: helps simplify the process of calculating the company's value. Estimating
OCF for a long period can be complex and time-consuming.
- Focus on long-term value: focuses on the long-term value of the company, rather than
short-term cash flow fluctuations.
- Suitable for certain business models: Some business models have relatively stable cash
flows over the long term, such as large companies like Microsoft, Apple, Samsung,...
- Reflects investor expectations: Some investors are concerned about the long-term value
of the company and are willing to invest in companies that can generate stable cash flows
in the future.

However, the assumption of infinite periods also has some limitations:

- Does not reflect future cash flow fluctuations.
- May lead to inaccurate valuation results for companies with fluctuating cash flows or in
growth phases.

Therefore, using the assumption of infinite periods requires careful consideration and should be
combined with other valuation methods to provide a comprehensive assessment of the company's
value.

In addition to the assumption of infinite periods, there are other methods to extend the
estimation of OCF:
- Growth models: Use growth models to estimate the growth rate of OCF in the future.
- Discounted Cash Flow (DCF) model: Use the DCF model to estimate the present value
of OCF over a certain period.

The choice of method depends on various factors, including:

- The company's business model
- The volatility of cash flows
- Investor expectations
Growth index and formula proof: (The growth rate coefficient can be positive or negative:
used for forecasting and prediction based on historical data; analysis and forecasting of
future expectations)

Assumptions (based on DDM assumptions):

- Operating cash flow grows at a constant rate.
- The constant growth rate will continue for an infinite period.
 - The Weighted Average Cost of Capital (WACC) is greater than the infinite growth rate
(the growth rate is higher than the cost of capital, leading to an unreasonable future value
expectation resulting in a lower value than forecasted).
There are several reasons explaining why the growth rate must be lower than the cost of
capital (WACC):
- Profitability Concerns: When the growth rate is higher than WACC, it means the
company is using capital to invest in projects with a lower return than the cost of capital.
This leads to reduced profitability and decreased value for shareholders.
- Maintaining Payment Capability: The company needs sufficient cash flow to cover
expenses, including the cost of capital. If the growth rate is higher than WACC, the
company may struggle to cover these expenses, leading to high financial risk.
- Enhancing Investor Confidence: When the growth rate is lower than WACC, investors
may lose confidence in the company's profitability, resulting in a decrease in stock prices.
- Efficient Capital Allocation: The company needs to efficiently allocate capital to projects
with a return higher than WACC to maximize profit and increase shareholder value.
**** Exceptions:
- In cases where the company is in an investment phase and has not generated profits, the
growth rate may be higher than WACC in the short term.
- A company pursuing a fast growth strategy by leveraging debt may have a growth rate
higher than WACC in the short term but potentially lower in the long term.

When the growth rate fluctuates downwards, calculating the present value of cash flows in the
infinite period becomes more complex compared to the case with a constant growth rate.
However, there are still several methods to perform this calculation:
- Sum-of-the-parts method (segmentation): Divide the cash flows into smaller groups, each
with a different growth rate. Then, calculate the present value of each group and sum
them to obtain the present value of the entire cash flow.
- Using mathematical formulas: Mathematical formulas can be used to calculate the
present value of cash flows with a growth rate that changes over time. These formulas
often rely on the Gompertz growth model or the Logistic growth model.
- Using financial software: Financial software assists in calculating the present value of
cash flows with a growth rate that changes over time. These software applications
typically employ advanced calculation methods and may provide more accurate results
compared to manual methods.
*** Example: Suppose you have projected cash flows that will grow by 5% for the first 5 years,
then gradually decrease to 2% over the next 10 years, and finally to 1% over the following 15
years. The discount rate is 10%.

● Using the sum-of-the-parts method:

- Group 1: First 5 years, growth rate 5%, present value = 100 / (1 + 0.1)^1 + 100 / (1 +
0.1)^2 + ... + 100 / (1 + 0.1)^5 = 476.19
- Group 2: Next 10 years, growth rate 2%, present value = 100 / (1 + 0.02)^6 + 100 / (1
+ 0.02)^7 + ... + 100 / (1 + 0.02)^15 = 322.97
- Group 3: Following 15 years, growth rate 1%, present value = 100 / (1 + 0.01)^16 +
100 / (1 + 0.01)^17 + ... + 100 / (1 + 0.01)^30 = 214.43
⇨ The total present value of cash flows = 1013.59

● Using mathematical formula:

The following formula can be used to calculate the present value of cash flows with a growth
coefficient that changes over time:
PV = Σ (OCFt / (1 + r)^t) * (1 - (1 + g)^(-n)) / (r - g)
−n
OCF t (1− (1+ g ) )
( Ghi lại ): PV = Σ x
(1+r )
t
r −g

In which:
PV: Present Value
OCFt: Expected cash flow in year t
r: Discount rate
g: Growth rate
n: Number of years

⇨ Present value of the cash flow to be 1013.59, similar to the result obtained using the
multiplication summation method.
● Using Software:
Financial software such as Microsoft Excel, Financial Calculators, or other specialized software
can be utilized to calculate the present value of the cash flow with a changing growth rate over
time.

3. Combining Changing and Infinite Growth Stages:

Below are the steps to value a stock using the OCF method:
1. Calculate OCF:
Direct method: Obtain the cash flow from operating activities in the cash flow statement.
Indirect method:
● Start with earnings before taxes (EBT).
● Add non-cash expenses (such as depreciation, amortization of intangible assets, provision
for inventory impairment).
● Subtract non-cash revenues (such as gains from the sale of fixed assets).
● Adjust for changes in working capital (such as inventory, accounts receivable, accounts
payable).
2. Project OCF:
Forecast OCF in the future based on the company's growth rate, business plans, and market
analysis.
3. Choose the discount rate:
● The discount rate (WACC) is the investor's required rate of return.
● WACC is calculated based on the cost of equity and the cost of debt, along with the
company's capital structure.
4. Calculate the Net Present Value (NPV) of OCF:
NPV = Σ (OCFt / (1 + WACC)^t)
where t is the number of projected years.
5. Calculate the stock value:
Stock value = NPV / Number of shares outstanding.

NOTES:
- The OCF method may not be suitable for companies with high investment levels or significant
changes in working capital.
- Use other valuation methods to compare and verify the reliability of the results.

ADVANTAGES AND DISADVANTAGES WHEN USING VALUATION WITH OCF:

ADVANTAGES DISADVANTAGES

- Focus on the company's ability to - Future OCF predictions may not be

generate cash flow. accurate. (It is difficult to predict
- Easy to use and understand. future OCF).
- Provide useful information for - The discount rate can significantly
investors affect the results