week 5 - dcf Flashcards
concept of dcf
The value of an investment asset can be measured by all of its cash flows generated during the holding period.
Can not simply add up all the cash flows generated at different points of time directly as the value of asset because of the time value of money.
Theidea that money available at the present time is worth different than the same amount in the future and the past, due to the compensation for time and risk.
Therefore, cash flows happen in different years can not be used to compare nor put in one calculation directly.
Before we can compare and put cash flows from different years in one calculation, we need to convert them to their equivalent values in one same single year
Convert to one future year-compound;
Convert to one previous year-discount
It is easiest to convert all projected cash flows to their “PV” – start of the investment/development, thus Discounted Cash Flow (DCF)
An investment asset generates two cash flows only: 1 million in year one and -1.2 million in year ten. Is the current value of this asset negative if the discount rate is 5%?
Value= PV1+PV10
= CF1/((1+i)^1)+CF10/((1+i)^10)
=1/((1+5%)^1)+(-1.2)/((1+5%)^10)
=0.26
explain dcf in valuation
Assumes that the value (market/investment value) of an investment-grade property is measured by its capacity of producing income.
Value of an investment-grade property equals to the sum of the present value of all the cash flows (both in and out) generated by the investment-grade property.
Cash flows need to consider: NOI and Expected Reselling Price
dcf in valuation steps
Step 1: Determine the discount rate
Step 2: Projecting property relevant cash flows
Net operating income (NOI) during the holding period
Expected Reselling Price: cash inflow by selling the property at the end of the holding period
Step 3: Discount and add up the projected NOI and Expected Reselling Price to work out the value of the property
name different types of discount rates
Expected rate of return (market value) is the amount one would anticipate receiving on an investment that has various known or expected rates of return. The general level of return of similar asset on the market.
- Market extracted method- comparable’s actual return (IRR-internal rate of return) - Capital Asset Pricing Model (CAPM)
Required rate of return by investor (investment value)- Required Rate of Return in Corporate Finance, ‘Weighted Average Cost Of Capital – WACC
Westfield Group wants to purchase a shopping centre. The expected rate of return for property investment is 7.34%. The current NOI of this shopping centre is $4,800,000 per year, and it is expected to grow by 5% per year in the first 5 years, and then grow by 2% per year after that. The Westfield Group plans to hold the property for 7 years. What is the market value of this shopping centre?
Expected Reselling Price: cash inflow by selling the property at the end of the investment period
Expected Reselling Price
=NOIn*(1+g)/(i-g)=$6,373,648 *(1+2%)/(7.34%-2%)= $121,743,839
The MV of the shopping center should be $104,593,353 by DCF method
The current NOI of an office property is $1,200,000 per year, and it is expected to grow by 6% per year in the first 2 years, and then to grow by 3% per year after that. If this property will be sold after 3 years and the expected rate of return for property investment is 7% . What is the current market value of this office property
gracie boff
- What is the difference between Internal Rate of Return and Required Rate of Return?
IRR is the rate of return which equates the PV of cash outflows with the PV of cash inflows, it is the actual rate of return of the development/investment project.
Whereas the required rate of return is the minimum rate of return for one specific investor/developer.
- What is the difference between Internal Rate of Return and Expected Rate of Return?
IRR is the actual rate of return of the development/investment project. Whereas the expected rate of return is the general level of return of similar asset on the market would produce.
What is the difference between Net Present Value and Market Value?
NPV is the difference between total PV of all cash inflows and total PV of all cash outflows. It is an indicator of how much value the investment adds to the value of the investor (Equity).
Whereas the Market Value is the price of the asset most likely to be transacted at under normal market condition.
. What is the difference between Net Present Value and Investment Value?
NPV indicates how much value the investment adds to the value of the investor (Equity).
Whereas the Investment Value is the price that one particular investor most likely to pay to purchase the asset.
