DCF Modeling Flashcards
3 Required Inputs for Model
Expected future cash flows, discount rate, terminal value
Premise
That the value of a company, division, business, or a collection of assets can be derived from the present value of its projected free cash flow (FCF).
Strengths
The use of defensible assumptions regarding financial projections, WACC, and terminal value helps shield the target’s valuation from market distortions that occur periodically. In addition, DCF provides the flexibility to analyze the target’s valuation under different scenarios by changing the underlying inputs and examining the resulting impacts.
Weaknesses
A DCF is only as strong as its assumptions. Hence, assumptions that fail to adequately capture the realistic set of opportunities and risk facing the target will also fail to produce a meaningful valuation.
Unlevered Free Cash Flow (FCF)
The cash generated by a company after paying all cash operating expenses and taxes, as well as the funding of capex and working capital, but prior to the payment of any interest expense.
Key Drivers of Company Performance
Sales growth, profitability, and FCF generation.
Internal Revenue Drivers
Opening new facilities, developing new products, new business/contracts, improving operational and/or working capital efficiency.
External Revenue Drivers
Acquisitions, end market trends, consumer buying patterns, macroeconomic factors, legislative/regulatory changes.
Weighted Average Cost of Capital (WACC)
The discount rate to calculate the present value of a company’s projected FCF and terminal value. The weighted average of the required return on the invested capital (debt + equity) in a given company. Dependent on company’s capital structure.
How to Calculate WACC
(aftertax cost of debt * % debt in cap structure) + (cost of equity * % equity in cap structure)
