Key Rule #2 to #4

Question 1

What is the first step of a DCF?

Answer 1

Project co cash flows in explicit forecast period

Question 2

What is the explicit forecast period?

Answer 2

time taken for co to mature- when cash flow growth low single digit percentage

Question 3

How long till co gets to maturity?

Answer 3

5-10 years, dep on industry, 1 biz cycle, enough time to realize new initiatives

Question 4

What FCF rendition do you use to project cash flow?

Answer 4

UFCF

Question 5

Why use UFCF?

Answer 5

Doesn’t depend on cap structure -> get same results even if co issues debt/ equity/ repays debt

Question 6

What is the key rule to calculating UFCF?

Answer 6

only recurring items that are related to core biz and avail to all investor groups

Question 7

What is the rationale behind UFCF’s key rule?

Answer 7

corresponds to TEV which represents value of core biz available to all investor groups

Question 8

How does change in WC affect FCF?

Answer 8

could increase or decrease FCF,
but rarely major value driver b/c quite small for most companies

Question 9

What does change in WC tell you about biz model?

Answer 9

• tells you when co pays for things and when they are paid
• retailer biz model- -ve Change in WC b/c pay for inventory before delivering goods
• subscription based software co- +ve change in WC b/c collect cash from long term subscription upfront and recognize as rev over time

Question 10

How does change in WC relate to retailer biz model?

Answer 10

-ve Change in WC b/c pay for inventory before delivering goods

Question 11

How does change in WC relate to subscription based software co?

Answer 11

+ve change in WC b/c collect cash from long term subscription upfront and recognize as rev over time

Question 12

What’s the proper tax rate to use when calculating FCF?

Answer 12

cash taxes. Doesn’t matter which rate you use as long as cash taxes are right.

Question 13

Include inflation in the FCF projections?

Answer 13

No. Too uncertain, too many assumptions otherwise

Question 14

How should CapEx and Depreciation change within the explicit forecast period?

Answer 14

• companies spend less on capex as they move from growing to mature
• Capex and dep as % of rev should decrease

Question 15

If capstr about to change, how to reflect in FCF?

Answer 15

• reflect it directly in levered dcf b/c net interest expense and debt principal will change
• change cost of equity to reflect this
• unlevered DCF- DR will show the change b/c WACC will change

Question 16

What’s the relationship between subtracting an expense in the FCF projections and the
Implied Equity Value calculation at the end of the DCF?

Answer 16

If subtract a certain expense in FCF, then you should ignore the corresponding Liability when moving from Implied Enterprise Value to Implied Equity Value at the end.

Question 17

Should you ever include items such as asset sales, impairments, or acquisitions in FCF?

Answer 17

• no, non-recurring

Question 18

NOLs in FCF?

Answer 18

• add as NOA in the Implied Enterprise Value -> Implied Equity Value

Question 19

How many years out should you project a DCF?

Answer 19

No defined answer- until cash flows reach steady state growth.

Question 20

Do deferred taxes affect DCF?

Answer 20

• affect NOPAT when calculating FCF
• Raise or lower co’s effective tax rate to reflect DTL or DTA.