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Discounted Cash Flow (Dcf) Analysis

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Discounted Cash Flow (Dcf) Analysis
DCF Modeling
Copyright 2008 © by Wall Street Prep, Inc.

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Table of contents
SECTION 1: OVERVIEW DCF in theory and in practice Unlevered vs. levered DCF SECTION 2: MODELING THE DCF Modeling unlevered free cash flows Discounting to reflect stub year and mid-year adjustment Terminal value using growth in perpetuity approach Terminal value using exit multiple approach Calculating net debt Shares outstanding using the treasury stock method Modeling the weighted average cost of capital (WACC) Sensitivity analysis using data tables Modeling synergies

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DCF in theory and in practice
DCF in theory • The DCF valuation approach is based upon the theory that the value of a business is the sum of its expected future free cash flows, discounted at an appropriate rate. • Discounted cash flow (DCF) analysis is one of the most fundamental, commonly-used valuation methodologies. It is a valuation method developed and supported in academia and also widely used in applied business practices. DCF in practice • There is no consensus on implementation – controversies predominantly over the estimation of the cost of equity. • Extremely sensitive to changes in operating, exit and discount rate assumptions. • That said, there are general rules of thumb that guide implementation. Two-stage DCF model is prevalent form • • • • The prevalent form of the DCF model in practice is the two-stage DCF model. Stage 1 is an explicit projection of free cash flows generally for 5-10 years. Stage 2 is a lump-sum estimate of the cash flows beyond the explicit forecast period. In addition to the two-stage DCF, there are multi-stage manifestations of the DCF model (3-stage, high-low models, etc.) designed to more clearly identify cash flows generated at different phases in a firm’s life cycle.

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