DCF Analysis - Calculating Free Cash Flow Flashcards
Why do you calculate Unlevered Free Cash Flow by excluding and including various items on the financial statements?
Unlevered FCF must capture the company’s core, recurring items that are available to ALL investor groups.
Unlevered FCF corresponds to Enterprise Value, which also represents the value of the company’s core business that’s available to all investor groups.
How does the change in Working Capital affect Free Cash Flow, and what does it tell you about a company’s business model?
The Change in Working Capital tells you whether the company generates more cash than expected as it grows, or whether it requires more cash to fuel that growth.
The Change in WC could reduce or increase the company’s Free Cash Flow, but it’s rarely a major value driver because it tends to be fairly small for most companies.S
Should you add back Stock-Based Compensation to calculate Free Cash Flow? It’s a non-cash add-back on the Cash Flow Statement.
No, SBC is not a real non-cash expense in the context of valuation because it creates additional shares and dilutes the existing investors.
The financial statements reflect the true impact of SBC because the company’s diluted share count goes up as a result.
Should you reflect inflation in the FCF projections?
In most cases, no. Clients and investors tend to think in nominal terms, and assumptions for prices and salaries tend to be based on nominal figures.
If you reflect inflation, then you also need to forecast inflation far into the future and adjust all figures in your analysis
How do Net Operating Losses (NOLs) factor into Free Cash Flow?
You could set up an NOL schedule and use them to reduce the company’s cash taxes, also factoring in accruals if the company ever records negative Pre-Tax Income
Should you ever include items such as asset sales, impairments, or acquisitions in FCF?
For the most part, no. You certainly shouldn’t make speculative projections for these items they are all non-recurring, so it’s not correct to forecast them as if they were recurring, predictable items.
If a company has announced plans to sell an asset, make an acquisition, or record a write-down in the near future, then you might factor it into FCF for that year.
What’s the proper tax rate to use when calculating FCF - the effective tax rate, the statutory tax rate, or the cash tax rate?
The company’s Free Cash Flows should reflect the cash taxes it pays.
It’s most common to use the effective tax rate and then adjust for deferred taxes based on historical trends.
How should capex and depreciation change over the explicit forecast period?
CapEx and Depreciation should decline similarly to free cash flow growth rate.
If the company’s FCF is growing, CapEx should always exceed depreciation, but there may be less of a difference by the end.
If the company’s FCF is growing, CapEx should never equal depreciation
If the company’s capital structure is expected to change, how do you reflect it in FCF?
You’ll reflect it directly in a Levered DCF because the company’s Net Interest Expense and Debt Repayments will change over time.
IT won’t show up explicitly in Unlevered FCF, but you will still reflect it in the analysis by changing the discount rate over time
