DCF Analysis Flashcards
(14 cards)
What is a DCF?
It assumes that a company is worth the present value of its future cash flows
What are the steps of a DCF?
1) Estimate a companies free cash flows over a 5-10 year period
2) Calculate the companies discount rate (usually WACC)
3) Dicsount and sum the companies free cash flow
4) Calculate the terminal value of the company
5) Discount the terminal value
6) Sum the two numbers together
How to calculate unlevered FCF
1) Project the company’s revenue growth
2) Assume an operating margin (to calculate EBIT/Operating Income)
3) Calculate it’s net Operating Profit After Tax (NOPAT)
4) Move to cash flow statement and project a) non-cash charges b) changes in operating assets and liabilities and c) CapEx
5) Add back the non-cash charges (i.e., depreciation and ammortiziation, and stock based compensation)
6) Decide if you add or subtract Operating Assets and Liabilities (if the operating assets increase more than operating liabilities, you subtract)
On this point: if assets go up, cash goes down
if liabilities go up, cash goes up
7) Subtract CapEx
How to calculate WACC
Cost of Equity * % Equity + Cost of Debt % Debt(1-Tax Rate) + Cost of Preferred Stock*% Preferred Stock
Why do you multiple debt by the tax rate in WACC?
Interest payments are tax-deductible so debt is almost always less costly than equity or preffered stock
What is the discount rate with unlevered FCF?
It is the WACC
What is the discount rate with levered FCF?
It is the cost of equity because you only care about equity investors here
What are some implications of WACC?
1) Debt will almost always push down the WACC
2) Preferred Stock is generally cheaper than equity
3) Equity will likely drive the WACC up
Hohw to estimate terminal value?
1) Assume the company sale for a certain multiple
2) Use the Gordon Growth Model and assume it operates indefinitely with cash flow
You can calculate this by doing Final Year Cash Flow * (1+Terminal FCF Growth Rate) / (Discount Rate - Terminal Growth Rate)
What has the biggest impact on the DCF?
Overall, the discount rate and the terminal value will have the biggest impact
Cost of Equity Rules of Thumb
1) Smaller companies generally have higher cost of Equity than larger companies because expected returns are higher
2) Companies in emerging and fast-growing geographies will have higher cost of equity
3) Additional debt raises the cost of equity (makes the company riskier)
4) Historical vs. Calculated Betas don’t have predictable impact
Rules of thumb for WACC
1) WACC is higher for smaller companies and emerging markets
2) Additional debt reduces WACC because debt is less expensive than equity
3) Preferred stock will generally reduce WACC
4) Higher interest rates will increase WACC because it increases the cost of debt
