188  Frameworks for Valuation
EXHIBIT 10.11  GlobalCo: Continuing Value
$ million
Key inputs1
Projected NOPAT in final forecast year
74.0
Continuing valuet =
NOPATt+1
1 –
WACC – g
g
RONIC




NOPAT growth rate in perpetuity (g)
2.2%
Return on new invested capital (RONIC)
19.8%
Weighted average cost of capital (WACC)
7.8%
= 1,176.21
1 $1,176.2 is calculated from unrounded data. Rounded inputs calculate to $1,174.6 million.
rate from Exhibit 10.9 of 2.2 percent, the continuing value is estimated at 
$1,176.2 million. The valuation model presented in Exhibit 10.4 discounts this 
value into today’s dollars and adds it to the value from the explicit forecast 
period to determine GlobalCo’s operating value.
Alternative methods and additional details for estimating continuing 
value are provided in Chapter 14.
Discounting Free Cash Flow at the Weighted Average Cost of Capital  In 
an enterprise valuation, free cash flows are available to all investors. Conse-
quently, the discount factor for free cash flow must represent the risk faced by 
all investors. The WACC blends the rates of return required by debt holders 
(kd) and equity holders (ke). For a company financed solely with debt and eq-
uity, the WACC is defined as follows:
WACC =
+
−
(
) +
+
D
D
E k
T
E
D
E k
d
m
e
1
where debt (D) and equity (E) are measured using market values. Note how 
the cost of debt has been reduced by the marginal tax rate (Tm). The reason for 
doing this is that the tax shield attributable to interest has been excluded from 
free cash flow. Since the interest tax shield (ITS) has value to the shareholder, 
it must be incorporated in the valuation. Enterprise DCF values the tax shield 
by reducing the weighted average cost of capital.
Why move interest tax shields from free cash flow to the cost of capital? 
By calculating free cash flow as if the company were financed entirely with 
equity, one can compare operating performance across companies and over 
time without regard to capital structure. By focusing solely on operations, it is 
possible to develop a clearer picture of historical performance, and this leads 
to better performance measurement and forecasting.
Although applying the WACC is intuitive and relatively straightforward, 
it has some drawbacks. If you discount all future cash flows with a constant 
cost of capital, as most analysts do, you are implicitly assuming the company 
keeps its capital structure constant at a target ratio of debt to equity. But if 
a company plans, say, to increase (or decrease) its debt-to-value ratio, the 

Enterprise Discounted Cash Flow Model  189
EXHIBIT 10.12  GlobalCo: Weighted Average Cost of Capital
%
Source of 
capital
Proportion 
of total 
capital
Cost of 
capital
Marginal 
tax rate
After-tax 
cost of 
capital
Contribution 
to weighted 
average
Debt
25.0
4.0
20.0
3.2
0.8
Equity
75.0
9.3
9.3
7.0
WACC
100.0
7.8
current cost of capital will understate (or overstate) the expected tax shields. 
The WACC can be adjusted to accommodate a changing capital structure. 
However, the process is complicated, and in these situations, we recommend 
an alternative method such as adjusted present value (APV).
The weighted average cost of capital for GlobalCo is presented in 
Exhibit 10.12. GlobalCo’s 7.8 percent WACC is based on a cost of equity of 
9.3 percent, pretax cost of debt of 4.0 percent, and a debt-to-value ratio of 25 
percent.
Identifying and Valuing Nonoperating Assets
Many companies own assets that have value but whose cash flows are not 
included in accounting revenue or operating profit. As a result, the cash gener-
ated by these assets is not part of free cash flow and must be valued separately.
For example, consider equity investments, known outside the United 
States as nonconsolidated subsidiaries. When a company owns a minority 
stake in another company, it will not record the company’s revenue or costs 
as part of its own. Instead, the company will record only its proportion of the 
other company’s net income as a separate line item.9 Including net income 
from nonconsolidated subsidiaries as part of the parent’s operating profit will 
distort margins, since only the subsidiaries’ profit is recognized and not the 
corresponding revenues. Consequently, nonconsolidated subsidiaries are best 
analyzed and valued separately.
Other nonoperating assets include excess cash, tradable securities, and 
customer-financing business units. A detailed process for identifying and 
valuing nonoperating assets appears in Chapter 16.
Identifying and Valuing Debt and Other Nonequity Claims
To convert enterprise value into equity value, subtract debt and other non-
equity claims, such as unfunded retirement liabilities, capitalized operat-
9 For stakes between 20 percent and 50 percent, the parent company will recognize its proportion of 
the subsidiary’s income. A parent that owns less than a 20 percent stake in another company records 
only dividends paid as part of its own income. This makes valuation of stakes of less than 20 percent in 
privately held companies extremely challenging.