Glossary

Direct Capitalization Method

The direct capitalization method values an income-producing real estate asset by dividing its stabilised net operating income by a market capitalization rate. It is a simpler, single-period alternative to a full multi-year discounted cash flow, useful as a fast cross-check but not a substitute for a full DCF where lease rollover, re-leasing costs, or near-term capital needs make a single stabilised year unrepresentative of the asset's cash flow profile over a typical holding period.

Discount Rate

The discount rate is the rate used to convert a future cash flow into its equivalent value today, reflecting both the time value of money and the risk associated with actually receiving that cash flow. In a discounted cash flow valuation, the discount rate is not a single, universal figure — it must match the cash flow being discounted. Unlevered free cash flow (FCFF), which is available to all capital providers, is discounted at the weighted average cost of capital (WACC), producing enterprise value. Levered free cash flow (FCFE), which is available only to equity holders after debt service, is discounted at the cost of equity, producing equity value directly. Selecting the wrong discount rate for a given cash flow is one of the most consequential and common errors in DCF valuation, since a mismatch corrupts both the theoretical basis and the resulting figure.

Distribution Lock-Up

A distribution lock-up is a contractual test applied at each cash waterfall period that blocks a distribution to equity when a defined condition is not met, most commonly a minimum DSCR or LLCR threshold, or full funding of reserve accounts, even where nominal cash is available after debt service in that period. The lock-up threshold is frequently set higher than the minimum DSCR covenant itself, providing an early warning buffer, and a lock-up event is distinct from a covenant breach or default, since it retains cash within the project structure rather than triggering a contractual remedy.

Dividend Discount Model (DDM)

The Dividend Discount Model (DDM) is a special case of discounted cash flow valuation that values a company's equity directly as the present value of its expected future dividend payments, discounted at the cost of equity. DDM shares its underlying logic with a standard FCFE-based DCF — both discount a cash flow available to equity holders at the cost of equity to arrive at equity value directly — but DDM uses actual or projected dividends rather than levered free cash flow as the cash flow being discounted. DDM is most commonly applied to banks, insurers, and other financial institutions, where regulatory capital requirements and the nature of the balance sheet make a conventional FCFE build difficult to construct, and where dividends are a closely regulated, relatively predictable and disclosed cash flow to shareholders.

Dividend Policy

Dividend policy is the framework a company follows to decide how much cash to distribute to shareholders as dividends, and how consistently. The two archetypal approaches are a residual dividend policy, in which dividends are whatever cash remains after funding all positive-NPV investment opportunities, and a stable or smoothed dividend policy, in which a company targets a consistent or gradually growing dividend regardless of short-term earnings fluctuations. Because markets tend to read dividend changes as a signal of management's view of future prospects — a phenomenon known as the signalling effect — dividend policy carries a reputational and market-reaction dimension beyond its direct cash impact, making it a comparatively rigid, hard-to-reverse commitment relative to a share buyback.

Downside Case

The downside case in a financial model is a scenario constructed using pessimistic but plausible assumptions to assess the model's projected performance under adverse conditions. It is defined relative to the base case: each assumption in the downside case is set at a level less favourable than the base case, representing conditions that could realistically occur but that the developer does not expect to be the most likely outcome. The downside case is used by lenders and investors to assess whether a project or investment can withstand a realistic adverse scenario while continuing to service debt and meet minimum covenant requirements.

Drawdown Schedule

A drawdown schedule is the period-by-period profile of debt and equity funding actually drawn during a project finance construction phase, distinct from the total sources and uses statement, which shows only the aggregate position. The drawdown schedule determines the cumulative drawn debt balance in each period, which in turn drives the interest during construction calculation, so the sequencing and proportion of debt versus equity drawdown, known as the funding competition, is itself a modelling decision with a direct cost consequence.

Due Diligence

Due diligence is the structured investigation a party to a proposed transaction conducts before committing capital — verifying facts, quantifying risk, and testing the assumptions underlying the deal's price. In an M&A or transaction context it is organized into distinct workstreams (financial, commercial, operational, technical, legal, tax, ESG) and run from one of three postures depending on who commissions it (buy-side, sell-side, or vendor).

Dynamic Arrays

A dynamic array formula is a single Excel formula that returns more than one result, which Excel automatically places ("spills") into the neighbouring cells below and to the right of the formula cell, without the formula needing to be copied down or across manually. Functions such as SORT, FILTER, UNIQUE, and SEQUENCE are dynamic array functions. The spill range is generated and owned by a single formula in the top-left cell; the cells it spills into are not independently editable.

Earn-Out

An earn-out is a contingent, deferred component of purchase price, paid to a seller only if the acquired business achieves specified performance targets — typically revenue or EBITDA thresholds — over a defined period following closing. It is used to bridge a valuation gap between what a buyer is willing to pay based on current performance and what a seller believes the business is worth based on its future potential, but introduces its own structural risks around metric definition, measurement period control, and post-closing operating decisions that could affect the earn-out outcome.

Economic Profit

Economic profit, also known as economic value added, measures the value a business creates in a given period above and beyond the cost of the capital employed to generate it. It is calculated as NOPAT minus a capital charge, where the capital charge is invested capital multiplied by the weighted average cost of capital. A business earning a return on invested capital exactly equal to its cost of capital generates zero economic profit in a period, even though it is generating a positive accounting profit — it is merely covering its cost of capital, not creating incremental value for capital providers. Economic profit provides a period-by-period lens on value creation that complements the single, aggregate present-value figure produced by a standard DCF, and underlies the residual income valuation model, which is mathematically reconcilable to DCF under consistent assumptions.

Enterprise Value (EV)

Enterprise value (EV) is the total value of a company's core operating business, independent of its capital structure — it represents what the business as a whole is worth to all capital providers combined, before distinguishing between debt and equity claims. Enterprise value is the direct output of discounting unlevered free cash flow (FCFF) at WACC. To move from enterprise value to the value attributable to equity holders specifically, net debt, minority interests, and other non-operating adjustments must be deducted — the enterprise-to-equity bridge.

Enterprise Value to Equity Value Bridge (Glossary Definition)

The enterprise value to equity value bridge is the defined set of adjustments applied to enterprise value, the output of an FCFF-based DCF, to arrive at equity value, the value attributable specifically to common shareholders. The bridge deducts net debt, minority interests, and preferred stock, and adds back non-operating assets, before the resulting equity value is divided by diluted share count to produce value per share. This glossary entry is a concise definitional companion; the full step-by-step methodology, including sourcing guidance for each bridge component, is set out in the dedicated technical guide.

Equity IRR

Equity IRR (Equity Internal Rate of Return) is the discount rate at which the net present value of all equity cash flows — comprising the initial equity investment as a negative cash flow and subsequent distributions and terminal proceeds as positive cash flows — equals zero. It measures the annualised return earned by equity investors on capital contributed to a project or transaction, calculated on post-debt-service cash flows only. Equity IRR is distinct from Project IRR, which is calculated on total project cash flows before financing. Equity IRR is always higher than Project IRR in a positively leveraged transaction because debt amplifies equity returns. It is lower than Project IRR when leverage is negative — that is, when the cost of debt exceeds the unlevered return of the project.

Equity Risk Premium (ERP)

The equity risk premium (ERP) is the additional return equity investors require, above the risk-free rate, for bearing the risk of holding equities as an asset class rather than a risk-free instrument. ERP is not directly observable and must be estimated, typically from long-run historical average equity returns in excess of government bond yields, from implied ERP models that back the premium out of current market prices, or from surveys of practitioner expectations. ERP is a required input to the Capital Asset Pricing Model (CAPM), where it is multiplied by beta to determine the equity-risk component of cost of equity. Because reasonable ERP estimates can differ materially between sources, the ERP figure used in a valuation should always be disclosed alongside its source and date.

Equity Value

Equity value is the value of a company attributable specifically to its equity holders, as distinct from enterprise value, which represents the value of the whole operating business attributable to all capital providers combined. Equity value is derived from enterprise value by deducting net debt, minority interests, and preferred stock, and adding back non-operating assets. Equity value divided by diluted shares outstanding produces value per share, the figure most directly comparable to a company's quoted share price.

Exit Capitalization Rate

The exit capitalization rate (or reversion cap rate) is the rate applied to terminal-year net operating income to derive a real estate asset's projected value at the end of a discounted cash flow holding period. It is a distinct assumption from the discount rate used to present-value the explicit cash flow forecast, and conflating the two, using one rate for both roles, is a common sector-specific modelling error. The exit cap rate is typically set at a premium to the entry cap rate to reflect asset ageing and uncertainty further into the future.

Exit Multiple Method

The exit multiple method is one of the two standard approaches to estimating terminal value in a DCF valuation. Rather than assuming cash flows grow at a constant rate into perpetuity, the exit multiple method applies an assumed trading or transaction multiple — most commonly EV/EBITDA — to the terminal year's projected financial metric, producing a terminal enterprise value grounded in observed market pricing. The exit multiple is typically sourced from current trading multiples of comparable listed companies or recent precedent transactions. Because the exit multiple method anchors terminal value to market pricing rather than a theoretical growth assumption, it is widely used as a cross-check against the perpetuity growth method, with the two approaches expected to produce an implied growth rate or implied multiple that can be sanity-checked against the other.

FAST Standard

The FAST Standard is a financial modelling standard, published and maintained independently of FMAE, that sets out conventions for how a financial model should be structured, formatted, and documented so that it can be understood, changed, and independently checked by someone other than its original author. It is one of the most widely referenced structural modelling standards in project finance and corporate financial modelling. Following the FAST Standard is a construction discipline; it is not itself a verification step, and a model can follow FAST conventions closely and still contain a calculation error the standard has no mechanism to catch.

FCFE (Levered Free Cash Flow)

FCFE (Free Cash Flow to Equity), also called levered free cash flow, is the cash remaining for equity holders after a business has met its operating needs, capital expenditure, working capital investment, and all debt service obligations — interest and principal repayment (net of new borrowing). Because FCFE already reflects the effect of the company's actual capital structure, it is discounted at the cost of equity rather than WACC, and the resulting present value is equity value directly, with no further enterprise-to-equity bridge required.