Constant Leverage Modeling: A Reply to 'a Tutorial on the Mckinsey Model for Valuation of Companies'

Abstract

In this note we analyze the tutorial based on the McKinsey methodology for valuing companies. We have found that the McKinsey methodology has one of the most common mistakes mentioned in Tham and Velez-Pareja (2004a and b): valuing cash flows with a constant cost of capital when the leverage is not constant. We calculate the proper firm andequity values by assuming the free cash flow, FCF calculated in the tutorial, and deriving the cash flow to equity, CFE. We develop the proper calculations of firm and equity values for constant leverage as well. For both calculations we calculate the deviations from the values calculated in the tutorial.