DISCOUNTED CASH FLOW VALUATION\MODELING
WITH QUESTIONS AND WELL VERIFIED ANSWERS
[ALREADY GRADED A+] 2025
All else equal, should the WACC be higher for a company with $100 million of market cap or a
company with $100 billion of market cap? - ANS✔✔---If the capital structures are the same, then
the larger company should be less risky and therefore have a lower WACC.
-However, if the larger company has a lot of high-interest debt, it could have a higher WACC.
All else equal, should the cost of equity be higher for a company with $100 million of market cap or
a company with $100 billion of market cap? - ANS✔✔--Typically a smaller company is more risky
therefore would have a higher cost of equity
How do you calculate Free Cash Flow? - ANS✔✔--𝐸𝐵𝐼𝑇(1 − 𝑇) + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 & 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 −
∆𝑁𝑊𝐶 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒
Free cash flow is the cash that flows through a company in the course year once all cash expenses
have been expensed
Why do you project out free cash flows for the DCF model? - ANS✔✔--The reason you project
FCF for the DCF is because FCF is the amount of actual cash that could hypothetically be paid out to
debt holders and equity holders from the earnings of a company.
When would you not want to use a DCF? - ANS✔✔---If you have a company that has very
unpredictable cash flows
-In this situation, you will most likely want to use a multiples or precedent transactions analysis.
What is Net Working Capital? - ANS✔✔--𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡
𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
-An increase in net working capital is a use of cash.
-A decrease in net working capital is a source of cash.
Current Assets - ANS✔✔---Inventory
-Accounts receivable
-Other short-term assets.
Current Liabilities - ANS✔✔---Accounts payable
-Other short term liabilities.
, What happens to Free Cash Flow if Net Working Capital increases? - ANS✔✔---You subtract the
change in Net Working Capital when you calculate Free Cash Flow, so if Net Working Capital
increases, your Free Cash Flow decreases and vice versa.
When would a company collect cash from a customer and not show it as revenue? If it isn't
revenue, what is it? - ANS✔✔---When a customer pays for a good or service to be delivered in
the future.
-Some examples would be annual magazine subscriptions, annual contracts on cell phone service
-The revenue is not recognized until the good or service is delivered to the customer.
-Until it is delivered, it is recorded as deferred revenue (liability) on the Balance Sheet.
Walk me through a Discounted Cash Flow model. - ANS✔✔--First, you project out a company's
financials using assumptions for revenue growth, expenses and Working Capital; then you get down
to Free Cash Flow for each year,
-Project free cash flows for five to ten years.
- Predict cash flow for over 5 years using perpetuity method
-Once future cash flows have been projected, calculate the present value of those cash flows.
-To find the present values of the cash flows (which is equal to the company's Enterprise Value), we
discount them with the WACC, as follows. CF1/ (1+WAAC)^1
-The final cash flow (CFn) in the analysis will be the sum of the terminal value calculation and the 5
years present cash flow
How do you calculate a firm's terminal value? - ANS✔✔---Terminal multiple method. Usually the
Ebitda cash flow times the ebitda multiple.
-The second method is the perpetuity growth method where you choose a modest growth rate,
usually just a bit higher than the inflation rate or GDP growth rate, and assume that the company
can grow at this rate infinitely. You then multiply the FCF from the final year by 1 plus (the growth
rate), and divide that number by (WACC) minus the assumed growth rate.
What is WACC and how do you calculate it? - ANS✔✔--WACC is the acronym for Weighted
Average Cost of Capital. It is used as the discount rate in a
discounted cash flow analysis to calculate the present value of a company's cash flows and terminal
value. It reflects the overall cost of a company's raising new capital, which is also a representation
of the riskiness of investing in the company. Mathematically, WACC is the percentage of equity in
the capital structure times the cost of equity (calculated by the Capital Assets Pricing Model) plus
percentage of debt in the capital structure times one minus the corporate tax rate times the cost of
debt—current yield on outstanding debt—plus percentage of preferred stock in the capital
structure times the cost of preferred stock if there is any preferred stock outstanding.
Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 - Tax Rate) + Cost of Preferred * (%
Preferred).
What is the difference between accounts receivable and deferred revenue? - ANS✔✔---Accounts
receivable is money a company has earned from delivery of goods or services but has not collected
yet.
-Deferred revenue is the opposite, money that has not yet been recorded as revenue because it was
collected for goods or services not yet delivered.
WITH QUESTIONS AND WELL VERIFIED ANSWERS
[ALREADY GRADED A+] 2025
All else equal, should the WACC be higher for a company with $100 million of market cap or a
company with $100 billion of market cap? - ANS✔✔---If the capital structures are the same, then
the larger company should be less risky and therefore have a lower WACC.
-However, if the larger company has a lot of high-interest debt, it could have a higher WACC.
All else equal, should the cost of equity be higher for a company with $100 million of market cap or
a company with $100 billion of market cap? - ANS✔✔--Typically a smaller company is more risky
therefore would have a higher cost of equity
How do you calculate Free Cash Flow? - ANS✔✔--𝐸𝐵𝐼𝑇(1 − 𝑇) + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 & 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑡𝑖𝑜𝑛 −
∆𝑁𝑊𝐶 − 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒
Free cash flow is the cash that flows through a company in the course year once all cash expenses
have been expensed
Why do you project out free cash flows for the DCF model? - ANS✔✔--The reason you project
FCF for the DCF is because FCF is the amount of actual cash that could hypothetically be paid out to
debt holders and equity holders from the earnings of a company.
When would you not want to use a DCF? - ANS✔✔---If you have a company that has very
unpredictable cash flows
-In this situation, you will most likely want to use a multiples or precedent transactions analysis.
What is Net Working Capital? - ANS✔✔--𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡
𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
-An increase in net working capital is a use of cash.
-A decrease in net working capital is a source of cash.
Current Assets - ANS✔✔---Inventory
-Accounts receivable
-Other short-term assets.
Current Liabilities - ANS✔✔---Accounts payable
-Other short term liabilities.
, What happens to Free Cash Flow if Net Working Capital increases? - ANS✔✔---You subtract the
change in Net Working Capital when you calculate Free Cash Flow, so if Net Working Capital
increases, your Free Cash Flow decreases and vice versa.
When would a company collect cash from a customer and not show it as revenue? If it isn't
revenue, what is it? - ANS✔✔---When a customer pays for a good or service to be delivered in
the future.
-Some examples would be annual magazine subscriptions, annual contracts on cell phone service
-The revenue is not recognized until the good or service is delivered to the customer.
-Until it is delivered, it is recorded as deferred revenue (liability) on the Balance Sheet.
Walk me through a Discounted Cash Flow model. - ANS✔✔--First, you project out a company's
financials using assumptions for revenue growth, expenses and Working Capital; then you get down
to Free Cash Flow for each year,
-Project free cash flows for five to ten years.
- Predict cash flow for over 5 years using perpetuity method
-Once future cash flows have been projected, calculate the present value of those cash flows.
-To find the present values of the cash flows (which is equal to the company's Enterprise Value), we
discount them with the WACC, as follows. CF1/ (1+WAAC)^1
-The final cash flow (CFn) in the analysis will be the sum of the terminal value calculation and the 5
years present cash flow
How do you calculate a firm's terminal value? - ANS✔✔---Terminal multiple method. Usually the
Ebitda cash flow times the ebitda multiple.
-The second method is the perpetuity growth method where you choose a modest growth rate,
usually just a bit higher than the inflation rate or GDP growth rate, and assume that the company
can grow at this rate infinitely. You then multiply the FCF from the final year by 1 plus (the growth
rate), and divide that number by (WACC) minus the assumed growth rate.
What is WACC and how do you calculate it? - ANS✔✔--WACC is the acronym for Weighted
Average Cost of Capital. It is used as the discount rate in a
discounted cash flow analysis to calculate the present value of a company's cash flows and terminal
value. It reflects the overall cost of a company's raising new capital, which is also a representation
of the riskiness of investing in the company. Mathematically, WACC is the percentage of equity in
the capital structure times the cost of equity (calculated by the Capital Assets Pricing Model) plus
percentage of debt in the capital structure times one minus the corporate tax rate times the cost of
debt—current yield on outstanding debt—plus percentage of preferred stock in the capital
structure times the cost of preferred stock if there is any preferred stock outstanding.
Cost of Equity * (% Equity) + Cost of Debt * (% Debt) * (1 - Tax Rate) + Cost of Preferred * (%
Preferred).
What is the difference between accounts receivable and deferred revenue? - ANS✔✔---Accounts
receivable is money a company has earned from delivery of goods or services but has not collected
yet.
-Deferred revenue is the opposite, money that has not yet been recorded as revenue because it was
collected for goods or services not yet delivered.
