DCF & Other basic valuations Flashcards
What are the main advantages of using unlevered free cash flow over the other types of free cash flow?
- Consistency - UFCF does not depend on the company’s capital structure, you will get the same results even if the company issues debt or equity, repays debt etc
- Ease of projecting - You do not need to project items such as debt, cash and the interest rates on debt and cash because you ignore the net interest expense in the analysis
What are the most basic line items needed for UFCF?
Revenue
Cogs and operating expenses
Taxes
Depreciation and amortisation
Increases in NWC
Capital Expenditures
What line income statement line items are needed to calculate NOPAT?
Revenue
COGS
Operating expenses
Taxes
For a DCF, why do we only add back D&A from non-cash expenses, rather than additional non-cash expenses?
Most of the other non-cash adjustments are non-recurring. When you project free cash flow, you want to ignore these non-recurring items in future periods
In a DCF, why do we not add back stock-based compensation, the other common item on the cash flow statement in non-cash expenses section?
It is not a real non-cash expense, as it creates additional shares and dilutes the existing investors. Therefore, If you add it back as a non-cash expense, you are getting a “free lunch” because you are not reflecting the existing shareholders’ reduced ownership in the company
If you have a sufficient amount of time, how would you build out projections for revenues?
Look at the underlying drivers of the business; does the business need additional Capex to grow, such as a steel producer will need additional plants to increase production which increases revenue
Or, for an exploration O&G company, you would likely use barrel capacity and the price of oil
You could also look at a market share * market size metric
What is the difference between how you would forecast maintenance Capex and growth Capex?
Maintenance Capex is likely to be as a % of revenue / what is driving revenue i.e. asset base
Growth Capex is likely to be discretionary, and will depend on how you are planning to grow the business over the long term
Which version of Capex should you use in a DCF?
Total Capex, because it is often the growth Capex which is driving the revenue expansion
From a cash flow perspective, would you prefer a greater proportion of your Capex to be maintenance or growth?
Preferably growth, as it is considered more discretionary than maintenance. This is particularly important in the case of an LBO
For a growing company, should Capex be higher than D&A?
Yes, Capex as a % of revenue should be above D&A as a % of revenue. They should not be equal by the end, unless you assume that the cash flows stagnate or decline
By the end of the forecast period, where should the growth rates for revenue, EBIT, UFCF and EBITDA be?
Approaching low, single digit percentages for mature companies, else the transition to the terminal period will be too abrupt
What is the concept behind how an investors views a discount rate?
Represents the opportunity cost for the investor: it is what they could earn each year by investing in other, similar companies
What are the different securities that you can use to invest in a company?
Not just by buying shares - can also be through buying bonds, preferred stock, or purchasing other securities that it issues
If you invested proportionally in all parts of a companies capital structure, what return could you expect to make?
WACC!
What is the best measure for the current cost of debt?
Using yield to maturity, as it factors in the current market value of the debt
