Walk through + Factors Flashcards
Why do you build a DCF?
- valuation isn’t as straightforward as the formula cash flow / (DR - CFGR)
- b/c DR and CFGR do not stay the same
- Therefore DCF which divides valuation into 2 periods: one where assumptions change (explicit forecast period) and one where they stay the same (Terminal) makes it theoretically very accurate
What is a company worth?
PV of expected cash flows
Walk me through a DCF
- DCF values co based on PV of cash flows in explicit forecast period + PV of TV
- Project FCF over next 5-10 years by making assumotions for rev growth, margins, WC, capex
- Discount CF using Discount Rate (WACC)
- Find TV - co value aft first 5-10 years into perpetuity
- estimate using Mults or GG
- Discount TV to PV using DR
add everything up
compare implied value to current value
calculate implied share price, compare to current share price
How to calc TV in DCF?
- mults, gordon growth
mults
- apply terminal mult to co’s EBITDA, EBIT, in final year of forecast period
GG
- assign “Terminal Growth Rate” to the company’s Free Cash Flows in the Terminal Period and assume they’ll grow at that rate forever.
Which method of calc TV is best?
- GG better from a theoretical perspective because growth always
slows down over time - Multiples Method, it’s easy to pick a multiple that makes no logical sense because it implies a growth rate that’s too high.
Signs that DCF assumptions are incorrect?
- PV of TV too high- should be at least 50% but not super high
- Implied Terminal Growth Rates/ Terminal mults that don’t make sense- eg. TGR of 8% higher than GDP
- Double counting items- if expense deducted in FCF, should not subtract corr liability in TEV -> EqV bridge
- mismatched FCF GR and TGR- TGR should be close
If DCF is wrong, how to fix?
- extend explicit forecast period
- FCF is higher % of implied value -> time for FCF growth to slow down and approach TGR
- Pick lower TGR or Terminal Mult -> reduce TV
How do you interpret results of DCF?
- compare implied TEV, implied EqV or implied share price to current values of these
- over/ undervalued
- do this over a range b/c investing is probabilistic
why do we want to get a range from the valuation methods?
- valuation is probabilisic
Does DCG make sense w co w -ve cash flow?
Maybe: DCF is based on co’s expected FCF
- if co has plan to make -ve CF +ve
- if not: can’t
Which assumptions make the biggest impact on DCF?
- DR: affects PV of everything
- TV: PV of TV affects 50%+ implied value
Should COE or WACC be higher for a co with larger or smaller EqVal?
- assuming that both cos have same capstr %
- COE higher for smaller EqVal co
- small cos have higher risk and higher return -> increase COE
- higher chance of defaulting on debt -> cost of debt is higher
- therefore WACC is higher as well
Which makes more impact on DCF- increase rev growth or DR, both from 9 to 10%?
- DR increase b/c affects everything
- increasing rev from 9 to 10% will barely affect FCF
Two companies produce identical total Free Cash Flows over 10 years, but Company A generates 90% of its Free Cash Flow in the first year and 10% over the remaining 9 years.
Company B generates the same amount of Free Cash Flow every year.
Which company will have the higher Implied Value in a DCF?
- B- b/c TV will be higher b/c higher FCF in Y10
How does low tax rate affect the Cost of Equity, Cost of Debt, WACC, and the Implied Value from a DCF?
- COD higher, WACC higher
- implied value higher b/c lower tax rate will increase FCF and TV
