:DISCOUNTED CASH FLOW MODEL
EXAM WALL STREET PREP 2024
DISTINCTION GUARANTEED
1. What is the Discounted Cash Flow (DCF) model?
Answer: The DCF model is a valuation method used to estimate the value of an
investment or company based on the present value of its projected future cash
flows. The formula is: DCF=CF1(1+r)1+CF2(1+r)2+⋯+CFn(1+r)n\text{DCF} = \
frac{CF_1}{(1 + r)^1} + \frac{CF_2}{(1 + r)^2} + \cdots + \frac{CF_n}{(1 +
r)^n}DCF=(1+r)1CF1+(1+r)2CF2+⋯+(1+r)nCFn where CFCFCF represents the
cash flow at each period, and rrr is the discount rate.
2. How do you determine the discount rate in a DCF model?
Answer: The discount rate is typically the Weighted Average Cost of Capital (WACC)
for a company. It accounts for the cost of equity and the cost of debt, weighted
according to their proportions in the company’s capital structure. The WACC is
calculated as: WACC=(EE+D×re)+(DE+D×rd×(1−T))\text{WACC} = \left(\frac{E}
{E + D} \times r_e\right) + \left(\frac{D}{E + D} \times r_d \times (1 - T)\
right)WACC=(E+DE×re)+(E+DD×rd×(1−T)) where EEE is the market value of
equity, DDD is the market value of debt, rer_ere is the cost of equity, rdr_drd is the
cost of debt, and TTT is the tax rate.
EXAM WALL STREET PREP 2024
DISTINCTION GUARANTEED
1. What is the Discounted Cash Flow (DCF) model?
Answer: The DCF model is a valuation method used to estimate the value of an
investment or company based on the present value of its projected future cash
flows. The formula is: DCF=CF1(1+r)1+CF2(1+r)2+⋯+CFn(1+r)n\text{DCF} = \
frac{CF_1}{(1 + r)^1} + \frac{CF_2}{(1 + r)^2} + \cdots + \frac{CF_n}{(1 +
r)^n}DCF=(1+r)1CF1+(1+r)2CF2+⋯+(1+r)nCFn where CFCFCF represents the
cash flow at each period, and rrr is the discount rate.
2. How do you determine the discount rate in a DCF model?
Answer: The discount rate is typically the Weighted Average Cost of Capital (WACC)
for a company. It accounts for the cost of equity and the cost of debt, weighted
according to their proportions in the company’s capital structure. The WACC is
calculated as: WACC=(EE+D×re)+(DE+D×rd×(1−T))\text{WACC} = \left(\frac{E}
{E + D} \times r_e\right) + \left(\frac{D}{E + D} \times r_d \times (1 - T)\
right)WACC=(E+DE×re)+(E+DD×rd×(1−T)) where EEE is the market value of
equity, DDD is the market value of debt, rer_ere is the cost of equity, rdr_drd is the
cost of debt, and TTT is the tax rate.
