1 Exampromax - Stuvia US 2025/2026
Discounted Cash Flow Questions with Detailed
Verified Answers (100% Correct Answers)
Already Graded A+
What's the basic concept behind a Discounted Cash Flow analysis?
Ans: The concept is that you value a company based on the present value
of its Free Cash Flows far into the future.
You divide the future into a "near future" period of 5-10 years and then
calculate, project, discount, and add up those Free Cash Flows; and then
©, 2025 All rights reserved®
there's also a "far future" period for everything beyond that, which you can't
estimate as precisely, but which you can approximate using different
approaches.
Exampromax - Stuvia US
You need to discount everything back to its present value because money
today is worth more than money tomorrow.
Walk me through a DCF.
Ans: "A DCF values a company based on the Present Value of its Cash
Flows and the Present Value of its Terminal Value.
First, you project a company's financials using assumptions for revenue
growth, margins, and the Change in Operating Assets and Liabilities; then
you calculate Free Cash Flow for each year, which you discount and sum
up to get to the Net Present Value. The Discount Rate is usually the
Weighted Average Cost of Capital.
Once you have the present value of the Free Cash Flows, you determine the
company's Terminal Value, using either the Multiples Method or the
Gordon Growth Method, and then you discount that back to its Net Present
Value using the Discount Rate.
Finally, you add the two together to determine the company's Enterprise
Value."
, 2 Exampromax - Stuvia US 2025/2026
Walk me through how you get from Revenue to Free Cash Flow in the
projections.
Ans: First, confirm that they are asking for Unlevered Free Cash Flow
(Free Cash Flow to Firm). If so:
Subtract COGS and Operating Expenses from Revenue to get to Operating
Income (EBIT) - or just use the EBIT margin you've assumed.
Then, multiply by (1 - Tax Rate), add back Depreciation, Amortization, and
other non-cash charges, and factor in the Change in Operating Assets and
Liabilities. If Assets increase by more than Liabilities, this is a negative;
otherwise it's positive.
©, 2025 All rights reserved®
Finally, subtract Capital Expenditures to calculate Unlevered Free Cash
Exampromax - Stuvia US
Flow.
Levered Free Cash Flow (FCFE) is similar, but you must also subtract the
Net Interest Expense before multiplying by (1 - Tax Rate), and you must
also subtract Mandatory Debt Repayments at the end.
What's the point of Free Cash Flow, anyway? What are you trying to do?
Ans: The idea is that you're replicating the Cash Flow Statement, but only
including recurring, predictable items. And in the case of Unlevered Free
Cash Flow, you also exclude the impact of Debt entirely.
That's why everything in Cash Flow from Investing except for CapEx is
excluded, and why the entire Cash Flow from Financing section is excluded
(the only exception being Mandatory Debt Repayments for Levered FCF).
Why do you use 5 or 10 years for the "near future" DCF projections?
Ans: That's about as far as you can reasonably predict for most companies.
Less than 5 years would be too short to be useful, and more than 10 years is
too difficult to project for most companies.
Is there a valid reason why we might sometimes project 10 years or more
anyway?
, 3 Exampromax - Stuvia US 2025/2026
Ans: You might sometimes do this if it's a cyclical industry, such as
chemicals, because it may be important to show the entire cycle from low to
high.
What do you usually use for the Discount Rate?
Ans: In a Unlevered DCF analysis, you use WACC (Weighted Average
Cost of Capital), which reflects the "Cost" of Equity, Debt, and Preferred
Stock. In a Levered DCF analysis, you use Cost of Equity instead.
If I'm working with a public company in a DCF, how do I move from
Enterprise Value to its Implied per Share Value?
Ans: Once you get to Enterprise Value, ADD Cash and then SUBTRACT
©, 2025 All rights reserved®
Debt, Preferred Stock, and Noncontrolling Interests (and any other debt-like
items) to get to Equity Value.
Exampromax - Stuvia US
Then you divide by the company's share count (factoring in all dilutive
securities) to determine the implied per-share price.
Let's say we do this and find that the Implied per Share Value is $10.00.
The company's current share price is $5.00. What does this mean?
Ans: By itself, this does not mean much - you have to look at a range of
outputs from a DCF rather than just a single number. So you would see
what the Implied per Share Value is under different assumptions for the
Discount Rate, revenue growth, margins, and so on.
If you consistently find that it's greater than the company's current share
price, then the analysis might tell you that the company is undervalued; it
might be overvalued if it's consistently less than the current share price
across all ranges.
An alternative to the DCF is the Dividend Discount Model (DDM). How
is it different in the general case (i.e. for a normal company, not a
commercial bank or insurance firm?)
, 4 Exampromax - Stuvia US 2025/2026
Ans: The setup is similar: you still project revenue and expenses over a 5-
10 year period, and you still calculate Terminal Value.
The difference is that you do not calculate Free Cash Flow - instead, you
stop at Net Income and assume that Dividends Issued are a percentage of
Net Income, and then you discount those Dividends back to their present
value using the Cost of Equity.
Then, you add those up and add them to the present value of the Terminal
Value, which you might base on a P / E multiple instead.
©, 2025 All rights reserved®
Finally, a Dividend Discount Model gets you the company's Equity Value
rather than its Enterprise Value since you're using metrics that include
Exampromax - Stuvia US
interest income and expense.
Let's talk more about how you calculate Free Cash Flow. Is it always
correct to leave out most of the Cash Flow from Investing section and all of
the Cash Flow from Financing section?
Ans: Most of the time, yes, because all items other than CapEx are
generally non- recurring, or at least do not recur in a predictable way.
If you have advance knowledge that a company is going to sell or buy a
certain amount of securities, issue a certain amount of stock, or repurchase
a certain number of shares every year, then sure, you can factor those in.
But it's extremely rare to do that.
Why do you add back non-cash charges when calculating Free Cash Flow?
Ans: For the same reason you add them back on the Cash Flow Statement:
you want to reflect the fact that they save the company on taxes, but that the
company does not actually pay the expense in cash.
What's an alternate method for calculating Unlevered Free Cash Flow
(Free Cash Flow to Firm)?
Discounted Cash Flow Questions with Detailed
Verified Answers (100% Correct Answers)
Already Graded A+
What's the basic concept behind a Discounted Cash Flow analysis?
Ans: The concept is that you value a company based on the present value
of its Free Cash Flows far into the future.
You divide the future into a "near future" period of 5-10 years and then
calculate, project, discount, and add up those Free Cash Flows; and then
©, 2025 All rights reserved®
there's also a "far future" period for everything beyond that, which you can't
estimate as precisely, but which you can approximate using different
approaches.
Exampromax - Stuvia US
You need to discount everything back to its present value because money
today is worth more than money tomorrow.
Walk me through a DCF.
Ans: "A DCF values a company based on the Present Value of its Cash
Flows and the Present Value of its Terminal Value.
First, you project a company's financials using assumptions for revenue
growth, margins, and the Change in Operating Assets and Liabilities; then
you calculate Free Cash Flow for each year, which you discount and sum
up to get to the Net Present Value. The Discount Rate is usually the
Weighted Average Cost of Capital.
Once you have the present value of the Free Cash Flows, you determine the
company's Terminal Value, using either the Multiples Method or the
Gordon Growth Method, and then you discount that back to its Net Present
Value using the Discount Rate.
Finally, you add the two together to determine the company's Enterprise
Value."
, 2 Exampromax - Stuvia US 2025/2026
Walk me through how you get from Revenue to Free Cash Flow in the
projections.
Ans: First, confirm that they are asking for Unlevered Free Cash Flow
(Free Cash Flow to Firm). If so:
Subtract COGS and Operating Expenses from Revenue to get to Operating
Income (EBIT) - or just use the EBIT margin you've assumed.
Then, multiply by (1 - Tax Rate), add back Depreciation, Amortization, and
other non-cash charges, and factor in the Change in Operating Assets and
Liabilities. If Assets increase by more than Liabilities, this is a negative;
otherwise it's positive.
©, 2025 All rights reserved®
Finally, subtract Capital Expenditures to calculate Unlevered Free Cash
Exampromax - Stuvia US
Flow.
Levered Free Cash Flow (FCFE) is similar, but you must also subtract the
Net Interest Expense before multiplying by (1 - Tax Rate), and you must
also subtract Mandatory Debt Repayments at the end.
What's the point of Free Cash Flow, anyway? What are you trying to do?
Ans: The idea is that you're replicating the Cash Flow Statement, but only
including recurring, predictable items. And in the case of Unlevered Free
Cash Flow, you also exclude the impact of Debt entirely.
That's why everything in Cash Flow from Investing except for CapEx is
excluded, and why the entire Cash Flow from Financing section is excluded
(the only exception being Mandatory Debt Repayments for Levered FCF).
Why do you use 5 or 10 years for the "near future" DCF projections?
Ans: That's about as far as you can reasonably predict for most companies.
Less than 5 years would be too short to be useful, and more than 10 years is
too difficult to project for most companies.
Is there a valid reason why we might sometimes project 10 years or more
anyway?
, 3 Exampromax - Stuvia US 2025/2026
Ans: You might sometimes do this if it's a cyclical industry, such as
chemicals, because it may be important to show the entire cycle from low to
high.
What do you usually use for the Discount Rate?
Ans: In a Unlevered DCF analysis, you use WACC (Weighted Average
Cost of Capital), which reflects the "Cost" of Equity, Debt, and Preferred
Stock. In a Levered DCF analysis, you use Cost of Equity instead.
If I'm working with a public company in a DCF, how do I move from
Enterprise Value to its Implied per Share Value?
Ans: Once you get to Enterprise Value, ADD Cash and then SUBTRACT
©, 2025 All rights reserved®
Debt, Preferred Stock, and Noncontrolling Interests (and any other debt-like
items) to get to Equity Value.
Exampromax - Stuvia US
Then you divide by the company's share count (factoring in all dilutive
securities) to determine the implied per-share price.
Let's say we do this and find that the Implied per Share Value is $10.00.
The company's current share price is $5.00. What does this mean?
Ans: By itself, this does not mean much - you have to look at a range of
outputs from a DCF rather than just a single number. So you would see
what the Implied per Share Value is under different assumptions for the
Discount Rate, revenue growth, margins, and so on.
If you consistently find that it's greater than the company's current share
price, then the analysis might tell you that the company is undervalued; it
might be overvalued if it's consistently less than the current share price
across all ranges.
An alternative to the DCF is the Dividend Discount Model (DDM). How
is it different in the general case (i.e. for a normal company, not a
commercial bank or insurance firm?)
, 4 Exampromax - Stuvia US 2025/2026
Ans: The setup is similar: you still project revenue and expenses over a 5-
10 year period, and you still calculate Terminal Value.
The difference is that you do not calculate Free Cash Flow - instead, you
stop at Net Income and assume that Dividends Issued are a percentage of
Net Income, and then you discount those Dividends back to their present
value using the Cost of Equity.
Then, you add those up and add them to the present value of the Terminal
Value, which you might base on a P / E multiple instead.
©, 2025 All rights reserved®
Finally, a Dividend Discount Model gets you the company's Equity Value
rather than its Enterprise Value since you're using metrics that include
Exampromax - Stuvia US
interest income and expense.
Let's talk more about how you calculate Free Cash Flow. Is it always
correct to leave out most of the Cash Flow from Investing section and all of
the Cash Flow from Financing section?
Ans: Most of the time, yes, because all items other than CapEx are
generally non- recurring, or at least do not recur in a predictable way.
If you have advance knowledge that a company is going to sell or buy a
certain amount of securities, issue a certain amount of stock, or repurchase
a certain number of shares every year, then sure, you can factor those in.
But it's extremely rare to do that.
Why do you add back non-cash charges when calculating Free Cash Flow?
Ans: For the same reason you add them back on the Cash Flow Statement:
you want to reflect the fact that they save the company on taxes, but that the
company does not actually pay the expense in cash.
What's an alternate method for calculating Unlevered Free Cash Flow
(Free Cash Flow to Firm)?
