DCF Flashcards
Step 1 of DCF
Get these 8 pieces of information from the past:
1. Financial Statements
2. Cash Flow Projections
3. Discount Rate
4. Terminal Value Calculation
5. Capital Expenditures
6. Working Capital Changes
7. Tax Rate
8. Assumptions
Step 2 of DCF
Forecast Cash Flows: Estimate the future cash flows the investment is expected to generate. This could include revenues, expenses, and investments over a certain period.
Step 3 of DCF
Determine Discount Rate: Decide on an appropriate discount rate, typically the weighted average cost of capital (WACC), which represents the required rate of return for the investment.
Step 4 of DCF
Calculate Present Value of Cash Flows: Discount each future cash flow back to its present value using the discount rate. This is typically done using the NPV (Net Present Value) function in Excel.
Step 5 of DCF
Sum Up Present Values: Sum up the present values of all cash flows to get the total present value.
Step 6 of DCF
Add Terminal Value: If applicable, calculate the terminal value of the investment at the end of the forecast period and discount it back to present value. Add this value to the sum of present values.
Step 7 of DCF
Compare to Initial Investment: Compare the total present value to the initial investment to determine if the investment is attractive.
Give the definition of Cash Flows
Cash Flows: The expected future cash inflows and outflows generated by an investment or project, typically measured on a yearly basis.
Give the definition of Discount Rate
Discount Rate: Also known as the discount rate or required rate of return, it represents the rate at which future cash flows are discounted back to their present value. It accounts for the time value of money and the risk associated with the investment.
Give the definition of Terminal Value
Terminal Value: The value of an investment or project at the end of the projection period. It is often estimated using a terminal multiple (such as EBITDA multiple) or a perpetuity growth rate applied to the final year’s cash flow.
Give the definition of Projection Period
Projection Period: The timeframe over which future cash flows are forecasted. It typically ranges from five to ten years, although it can vary depending on the nature of the investment or project.
Give the definition of Initial Investment
Initial Investment: The upfront cost required to initiate the investment or project, including capital expenditures and any other initial expenses.
Give the definition of assumptions
Assumptions: The underlying factors and variables used to forecast future cash flows, including revenue growth rates, operating expenses, tax rates, inflation rates, and any other relevant factors.
Give the definition of Financial Statements
Financial Statements: Historical records of a company’s financial performance, including the income statement, balance sheet, and cash flow statement. These statements provide insights into past performance and help inform projections for the DCF analysis.
Give the definition of Capital Expenditures
Capital Expenditures (CapEx): The funds used by a company to acquire, upgrade, or maintain physical assets such as property, plants, and equipment. CapEx is crucial for projecting future cash flows, as it represents investments necessary for the ongoing operation and growth of the business.
Give the definition of Working Capital Changes
Working Capital Changes: Changes in a company’s working capital, which is calculated as current assets minus current liabilities. Changes in working capital affect cash flow and must be accounted for in the DCF analysis, as they reflect the investment required to support ongoing operations.
Give the definition of Tax Rate
Tax Rate: The rate at which taxable income is taxed by the government. It is essential to determine the after-tax cash flows used in the DCF analysis, as taxes directly impact the net cash flows generated by an investment or project.
Give the formula for Forecasted Cash Flows
FCF = (Revenue - Operating Expenses - Taxes) - (Capital Expenditures + Change in Working Capital)
Give the formula for Discount Rate
Weighted Average Cost of Capital (WACC) = (E/V * Cost of Equity) + (D/V * Cost of Debt) * (1 - Tax Rate)
E = Market value of equity
V = Market value of equity + Market value of debt
D = Market value of debt
Cost of Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Debt = Interest Expense / Market value of debt
Give the formula for Present Value of Cash Flows (PV)
PV = FCF / (1 + Discount Rate)^n
n = time period
Give the formula for Terminal Value
TV = (FCF * (1 + Growth Rate)) / (Discount Rate - Growth Rate)
Growth Rate = Estimated perpetual growth rate
Give the formula for Discounted Terminal Value
Discounted Terminal Value = TV / (1 + Discount Rate)^n
n = time period
Give the formula for Total Present Value
Total Present Value = Σ(PV) + Discounted Terminal Value
Σ(PV) = Sum of present values of cash flows
Give the formula for Net Present Value (NPV)
NPV = Total Present Value - Initial Investment
