DCF Guide Flashcards
Two companies are exactly the same, but one has Debt and one does not – which one will have the higher WACC?
The company without debt will generally have a higher WACC, due to the following: - Interest is tax deductibe - Debt commands a lower cost than equity, due to having higher seniority, covenents, security, etc
What discount period numbers would you use for the mid-year convention if you had a stub period – e.g. Q4 of Year 1 – in a DCF?
.125 You divide the period by 2. e.g. (.25/2)
The Free Cash Flows in the projection period of a DCF analysis increase by 10% each year. How much will the company’s Enterprise Value increase by?
A % less than 10% due to discounting and uncertain affect on cash flows. *Make sure to ask questions and clarify assumptions
Which tax rate should you use when calculating Free Cash Flow – statutory or effective?
Effective rate of target company You want to capture what the company is actually paying out in taxes.
Let’s take a look at companies during the financial crisis (or really, just any type of crisis or economic downturn). Does WACC increase or decrease?
Cost of Equity: - Rf would decrease as governments lower cost of borrowing to spur growth - Beta would increase as overall volatility increases - Equity risk premium would increase as investors expect higher returns to take on that type of risk Cost of Debt - Increase as companies have more difficulty raising money D/E Ratio - Equity value expected to fall, thus constituting a smaller share - Rd increases Thus, overall WACC increases
If you’re using levered FCFs to derive equity value, what type of terminal multiple would you use?
Multiple of NI since I am deriving equity value. I would not do a multiple of EBITDA, since that would give me enterprise value (both debt and equity) when I only want equity value
Can you explain the Gordon Growth formula in more detail? I don’t need a full derivation, but what’s the intuition behind it?
You are willing to pay more if your FCF is expected to grow at a certain % each year
So if you’re using Levered FCF to value a company, is the company better off paying off Debt quickly or repaying the bare minimum required?
Bare minimum because that will increase your cash flow thus increasing the value of your company
We’re creating a DCF for a company that is planning to buy a factory for $100 in Cash in Year 4. Currently the net present value of this company, according to the DCF, is $200. How would we change the DCF to account for the factory purchase, and what would the new Enterprise Value be?
Subtract $100/(1+WACC)^4 from $200 (enterprise value)
What would have a greater impact to a valuation- a 1% change in revenues or a 1% change in WACC?
1% change in WACC.
What’s the relationship between Debt and Cost of Equity?
As debt increases, beta increases, thus increasing cost of equity
How do you factor in one-time events such as raising Debt, completing acquisitions, and so on in a DCF?
You would ignore those types of events, because DCFs are supposed to value predictable and recurring events.
What’s the flaw with basing the Terminal Multiple on public comps?
1) Target or comparable company may significantly outperform competition 2) Multiples may drastically change over a period of 5-10 years or into perpetuity. Is the current multiple truly indicative of the long term multiple?
