The relevance of using cash flows and economic profit-based methods in capital budgeting: a focus on techniques – FCFF, FCFE and EVA

The purpose of this paper is to examine consequences of choice: cash flow or economic value-added method on the net present value of investment project, further on company value.Design/methodology/approach: The article introduces three main methods to measure the net present value of investment project: free cash flow to firm, free cash flow to equity, and economical value added.Paper examines the challenge of using these three-methods in determining what constitutes cash flow and what is the source of the investment value.Findings: The cost of capital should be calculated in different ways to ensure the validity of the calculation.Estimation should be explored by other influencing factors, such as expected rate of return, market value of cost, rather than accounting/historical value.Implementing these factors is necessary to evaluate business value.According to the presented approach the use of the FCFF technique creates fewer risks of acting against the interests of the owners than the use of the FCFE or EVA techniques.Practical implications: As one of the main implications in business, valuation is cost of capital.According to the financing priority theory, when a firm needs financing, the first consideration is internal financing, while equity financing is secondary.Both types of financing sources determine the financing structure and ultimately affect the value of the company.Originality/value: The paper provided and insight in the different investment project valuation methods that are used in the nowadays practice.This was done in an attempt to answer the question: What method should not be used in the assessment of investment projects?The paper provides evidence that most appropriate method in estimating NPV value of investment project is FCFF.