IB 400 (Discounted Cash Flow - Basic)

Question 1

Walk me through a DCF.

Answer 1

A DCF values a company based on the Present Value of its Cash Flows and the Present Value of its Terminal Value.

First, you project out a company’s financials using assumptions for revenue growth, expenses and Working Capital; then you get down to Free Cash Flow for each year, which you then sum up and discount to a Net Present Value, based on your discount rate - usually the Weighted Average Cost of Capital.

Once you have the present value of the cash Flows, you determine the company’s Terminal Value, using either the Multiples Method or the Gordon Growth Method, and then also discount that back to its Net Present Value using WACC.

Finally, you add the two together to determine the company’s Enterprise Value.

Question 2

Walk me through how you get from Revenue to Free Cash Flow in the projections.

Answer 2

Subtract COGS and Operating Expenses to get to Operating Income (EBIT). Then, multiply by (1 – Tax Rate), add back Depreciation and other non-cash charges, and subtract Capital Expenditures and the change in Working Capital.

Note: This gets you to Unlevered Free Cash Flow since you went off EBIT rather than EBT. You should confirm that this is what the interviewer is asking for.