DCF Questions and Answers
Walk me through a DCF - Answer-A DCF is a discounted cash flow analysis. A DCF values the present
value of all future cash flows and terminal value.
First you project a company's financials using assumptions for rev growth, expenses, and working
capital. Then you work down to the yearly FCF which you sum up and discount to a NPV based on the
discount rate WACC.
Once you have the present value of the CFs you determine the company's terminal value using either
the multiples method or the Gordon Growth Method then discount using WACC.
Finally add the two together to determine the EV.
Walk me how you get from Revenue to FCF in the projections. - Answer-Subtract COGs and Operating
expenses to get Operating income (EBIT). Then multiply by (1-Tax rate), add back depreciation and other
non cash charges and subtract Capex and changes in working capital. Confirm interviewer is asking for
EBIT not EBT.
What's an alternative way to calculate FCF aside from taking Net Income and adding back depreciation,
and subtracting changes in operating assets/liabilities and CapEx. - Answer-Take cash flow from
operations and subtract Capex and mandatory debt payments (LFCF). To get ULFCF you need to add
back the tax adjusted interest expense and subtract the tax adjusted interest income.
, Why do you use 5 or 10 years for DCF projections. - Answer-You do not want to make predictions any
further into the future. Less than 5 years would not be useful.
What do you usually use for the discount rate. - Answer-WACC. Or 10% for standard oil and gas
evaluation.
How do you calculate WACC? - Answer-Cost of equity * % Equity + Cost of debt * % debt*(1-Tax rate) +
Cost of Preferred*(% Preferred).
For cost of equity you can use the Capital asset pricing model. For debt look at comps.
How do you calculate the cost of equity? - Answer-COE= Risk Free Rate + Beta*Equity Risk Premium
RFR= 10 year or 20 year yield
Beta is "riskiness" of comparable companies Equity risk premium is the % by which stocks are expected
to out-perform risk less assets.
You might also add a size or industry premium.
How do you get to Beta in the COE calculation? - Answer-You look up beta for each comparable
company, un lever each one, and take the median of the set. Then lever the unlevered based on the
company's capital structure.
Un-Levered Beta = Lev Beta/(1+((1- Tax Rate)X(Total Debt/Equity)))
Why do you have to un lever and re lever Beta? - Answer-You want to keep things apples to apples. A
company has a higher risk of going BK with high debt. All companies capital structures are different. We
want to look at how risky a company is regardless of % of debt or equity.
Walk me through a DCF - Answer-A DCF is a discounted cash flow analysis. A DCF values the present
value of all future cash flows and terminal value.
First you project a company's financials using assumptions for rev growth, expenses, and working
capital. Then you work down to the yearly FCF which you sum up and discount to a NPV based on the
discount rate WACC.
Once you have the present value of the CFs you determine the company's terminal value using either
the multiples method or the Gordon Growth Method then discount using WACC.
Finally add the two together to determine the EV.
Walk me how you get from Revenue to FCF in the projections. - Answer-Subtract COGs and Operating
expenses to get Operating income (EBIT). Then multiply by (1-Tax rate), add back depreciation and other
non cash charges and subtract Capex and changes in working capital. Confirm interviewer is asking for
EBIT not EBT.
What's an alternative way to calculate FCF aside from taking Net Income and adding back depreciation,
and subtracting changes in operating assets/liabilities and CapEx. - Answer-Take cash flow from
operations and subtract Capex and mandatory debt payments (LFCF). To get ULFCF you need to add
back the tax adjusted interest expense and subtract the tax adjusted interest income.
, Why do you use 5 or 10 years for DCF projections. - Answer-You do not want to make predictions any
further into the future. Less than 5 years would not be useful.
What do you usually use for the discount rate. - Answer-WACC. Or 10% for standard oil and gas
evaluation.
How do you calculate WACC? - Answer-Cost of equity * % Equity + Cost of debt * % debt*(1-Tax rate) +
Cost of Preferred*(% Preferred).
For cost of equity you can use the Capital asset pricing model. For debt look at comps.
How do you calculate the cost of equity? - Answer-COE= Risk Free Rate + Beta*Equity Risk Premium
RFR= 10 year or 20 year yield
Beta is "riskiness" of comparable companies Equity risk premium is the % by which stocks are expected
to out-perform risk less assets.
You might also add a size or industry premium.
How do you get to Beta in the COE calculation? - Answer-You look up beta for each comparable
company, un lever each one, and take the median of the set. Then lever the unlevered based on the
company's capital structure.
Un-Levered Beta = Lev Beta/(1+((1- Tax Rate)X(Total Debt/Equity)))
Why do you have to un lever and re lever Beta? - Answer-You want to keep things apples to apples. A
company has a higher risk of going BK with high debt. All companies capital structures are different. We
want to look at how risky a company is regardless of % of debt or equity.
