2. Discounted Cash Flow Analysis 2
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3. Discounted Cash Flow Analysis
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3
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Intro to Valuation
8. Discounted Cash Flow Analysis
What is a Discounted Cash Flow Analysis?
8
Discounted Cash Flow (DCF) Analysis yields a
theoretical valuation of a firm.
The concept behind a DCF analysis is that the
value of a company is based on the present value
of the unlevered free cash flows that it can
generate in the future.
A DCF has three main components:
• A discount rate (WACC)
• Forecasting Cash Flows (or unlevered Free
Cash Flows
• Terminal Value of the Company
9. Discounted Cash Flow Analysis
Lets Break it Down
9
Forecasting Free
Cash Flow
Estimating Cost
of Capital
Estimating
Terminal Value
Calculating and
Interpreting Results
Identify components
of Free Cash Flow
Develop historical
perspective
Determine forecast
assumptions and
scenarios
Decide forecast
horizon
Prepare the forecast
Develop target
capital structure
Equity cost of equity
Estimate cost of
non-equity sources
of capital
Determine the
relationship
between terminal
value and cash flow
Estimate terminal
value
Discount to the
present
Develop results
Perform sensitivity
analyses
Interpret results
within decision
context
10. Discounted Cash Flow Analysis
Its all about the cash flow
10
EBITDA
Depreciation & Amortization
EBIT
Taxes
Tax-Effected EBIT
Depreciation & Amortization
Capital Expenditures
Changes in Net Working Capital
Don’t
forget
the Tax
Shield!
Free cash flow is the cash that flows through a company in
the course of a quarter or a year once all cash expenses
have been taken out.
Loosely translated, it is the cash flow after taxes are
paid, capital expenditure requirements are met, and
working capital needs are deducted.
What exactly are Unlevered Free Cash Flows?
How do I calculate it?
UFCF is a good
indication of how
the company is using
assets to generate
cash and it’s
relativity to debt
It is also the money
the company has
left to grow the
business and thus
important to project
its value
It represents the
amount of cash left
from operations
that can be used to
enhance
shareholder value
Why use these Cash Flows for valuations and why is it important?
Who Uses FCF?
The Investment
Banking Analyst The Investor
Corporate
Finance
11. Discounted Cash Flow Analysis
Capital Structure
11
Why is Capital Structure important for a DCF?
Let’s consider the NPV formula:
-C0 = Initial Investment
C = Cash Flow
r = Discount Rate
T = Time
• It helps determine your cost of capital
• Depending on the structure and future
changes, it can have a profound impact on
your NPV
• This impact can greatly affect your overall
target price and thus your investment
decision
12. Discounted Cash Flow Analysis
No, Not “Whack”
12
Weighted Average
Cost of Capital
(WACC)
Weighted Cost of
Debt
After tax cost of
debt
Cost of Debt
1 – Tax Rate
Percentage of
debt
Weighted Cost of
Equity
Percentage of
Equity
Cost of Equity
Risk free rate RFr
Beta β
Market risk
premium (MRP)
How do you calculate it? Where:
Re= Cost of Equity
Rd= Cost of Debt
Tc = Corporate Tax Rate
E= Market Value of Equity
D= Market Value of Debt
V = E + D (Total MV)
E/V= % finance that’s equity
D/V= % finance that’s debt
Weighted Average Cost of Capital
Measures a company's cost to borrow money
given the proportional amounts of debt and
equity a company has taken on
Where
• RFr : typically the yield
on the 10-year US
government Bond
• β : measures the
volatility of a stock
price compared to the
overall market
• MRP : the rate of
return in the market
minus the risk free rate
Importance of WACC
• Used to evaluate corporate projects
• Used as a Discount Rate in Net
Present Value Calculations
• Calculate Economic Value Added
• Valuation of a Company
Why use WACC?
• WACC captures the risk of future
cash flows and is a holistic reflection
of the cost of capital.
13. Discounted Cash Flow Analysis
Steady As She Goes
13
Free Cash Flows:
Discount Rate:
Terminal Value:
Status Update: The “Terminal Value” represents the present value of the sum of the
additional cash flows beyond the forecasted period.
Terminal Value: FCFn x (1 + g)
(r – g)
• Perpetuity Growth Rate Method
• Terminal Multiple Method
Perpetuity Growth Rate Method
Assumes that the company’s free cash flows will
grow at a moderate, constant rate indefinitely.
FCF= normalized free cash flow in period n
g= nominal perpetual growth rate
r= discount rate or WACC
Where Two Main Methods
The nominal perpetual growth rate (g) is the company’s sustainable long-run growth rate. This
rate can be higher than inflation but should not exceed the growth rate of the overall economy.
Rates vary by situation and company, but the typical range is 2% to 5%.
14. Discounted Cash Flow Analysis
SHOW ME THE MONEY
14
Getting to a per share value:
PV of
Free Cash
Flows
PV of
Terminal
Value
Enterprise
Value Net
Debt
Equity
Value
1
2
Equity
Value
Total
Outstandi
ng Shares
Equity
Value
Per
Share
Enterprise Value
The present value of unlevered free cash
flows plus the present value of the terminal
value
• Also calculated as “Market Cap”
plus debt minus total cash
Net Debt
Refers to all interest-bearing liabilities, plus
preferred stock and minority interest
less all cash and cash equivalents
Equity Value
Equity Value or “Fair Value” of a company;
the equity value equals the Enterprise Value
less Net Debt and is the total intrinsic value
of a company.
15. Discounted Cash Flow Analysis 15
Net Present Value Present Value Weighted Average Cost
of Capital (WACC)
Free Cash Flow
(Unlevered)
The difference between
the present value of cash
inflows and the present
value of cash outflows.
The current worth of a
future sum of money or
stream of cash
flows given a
specified rate of return.
The rate that a company
is expected to pay
on average to all its
security holders to
finance growth.
A company's cash flow
before interest payments
are taken into account.
Terminal Value Enterprise Value Equity Value EBITDA
The value of an asset at a
specified, future
valuation date, assuming
a stable growth rate.
A measure of a
company's total value;
calculated as the market
capitalization
plus debt, minus total
cash.
The value of a company
available to owners or
shareholders; the
enterprise value plus all
cash, investments, and
less all debt
Essentially net
income with interest,
taxes, depreciation, and
amortization added back
to it, and can be used to
analyze and compare
profitability between
companies and industries
because it eliminates the
effects of financing and
accounting decisions.
Considerations:
• EBITDA vs FCF : EBITDA does not take into account ∆WC
17. Discounted Cash Flow Analysis
Any Questions?
This model was derived from the Wall Street Prep Financial Statement
Modeling Course. You can watch step by step videos of everything you missed.
17Financial Statement Modeling Pt. 2 -
