Discounted Cash Flows

5 - answer-Many investors typically use a __________ year holding period in their DCF analysis. 5 - answer-Step 1: Selecting a holding period for the investment (typically _______ years) A company has a high debt load and is paying off a significant portion of its principle each year, how would we account for that in a DCF. - answer-We would not because paying off debt shows up in CF from Financing but we only go down to CF from operations and then subtract CAPEX to get FCF. A DCF values a company based on: - answer-The present value of its cash flows and the present value of its terminal value. Add - answer-Step 5: _________ the present value of future benefits to the reversion amount. Added - answer-The anticipated net income of an investment is discounted to present value and _________________ to the discounted value of the investment at the end of the ownership period. Bank Discount Yield - answer-Discount/Face Value x 360/Days to Maturity Bond Equivalent Yield - answer- Cash Flow - answer-Step 2: Forecast future _______________ (income and expenses) by developing annual operating statements. Choosing NPV vs IRR rules - answer-For independent projects the rules produce the same decision. For mutually exclusive projects choose the project with higher NPV as long as it is positive. Cost of Equity tells us: - answer-What kind of return an investor can expect Differences between money- and time-weighted rates of return - answer-If funds are added to a portfolio just before a period of poor performance, the money-weighted return will be lower than the time-weighted return. Time-weighted return is the preferred measure of an ability to select investments. If the manager controls the money flows in and out, the money-weighted return is the more appropriate performance measure. Discount - answer-Step 3: Convert future cash flows into present value by discounting each annual amount by an appropriate _____________ factor. Discount Rate - answer-_________________ is the rate that is applied to the annual cash flows in order to convert them to present value. Discounted - answer-A future benefit is ________________ to present value by calculating the amount that, if invested today, would grow with compound interest at a satisfactory rate to equal the future payments. Discounted Cash Flow - answer-______________________ is two or more years of net income are discounted back to present value to arrive at a value of the investment Discounted to Present Value - answer-The anticipated net income of an investment is ________________________ and added to the discounted value of the investment at the end of the ownership period. Discounting - answer-______________ is the benefits received in the future are worth less that the same benefits received today because of opportunity cost. Effective Annual Yield - answer- Gordon Growth Method equation: - answer-Terminal value= year 5 FCF*(1+growth rate)/(discount rate- growth rate) Holding Period - answer-______________ is the length of time in years that the investment is expected to be owned. Holding Period - answer-Reversion is the value of the investment at the end of the __________________. Holding Period Yield (HPY) - answer-Total return of holding an investment over a period of time How can we calculate the cost of equity without CAPM - answer-Alternatively we could use the formula COE=(dividends per share/share price)+growth rate of dividends. This is typically used in companies where dividends are more important or when you lack information on beta How do you calculate cost of equity - answer-Use the Capital Asset Pricing Model = Risk free rate +beta *Equity risk premium How do you calculate terminal value? - answer-You can either use the multiples method in which you apply an exit multiple to the company's year 5 EBITDA, EBIT or FCF or you can use the Gordon Growth method to estimate its value based on its growth rate into perpetuity How do you calculate WACC for private companies? - answer-This is tough because you do not have beta or a market cap. You would typically try to use comparable public companies or work done by auditors. How do you calculate WACC? - answer-Cost of Equity *% of capital structure composed of equity+ cost of debt* % of capital structure composed of debt*(1-tax rate) + cost of preferred*% of capital structure composed of preferred How do you get Beta in the Cost of Equity calculation? - answer-Unlevered beta= levered beta/(1+(1-tax rate)*(total debt/total equity) Levered Beta= unlevered beta*(1+(1-Tax rate)*(total debt/total equity) How do you get from revenue to FCF? - answer-Revenue-COGS-Operating Expenses to get to EBIT. Then multiply by (1-Tax Rate), add back Depreciation and other non-cash charges and subtract CAPEX and the change in Working Capital. (This is unlevered FCF since we went off of EBIT rather than EBT). How do you know if your DCF is too dependent on future assumptions? - answer-If significantly more than 50% of your company EV comes from its terminal value then it is probably too dependent. In reality most all DCF's are too dependent on future assumptions and it is rare to find one in which terminal value is less than 50% of EV. When it gets to be 80-90% however, you may need to rethink some assumptions. How do you select appropriate exit multiples when calculating Terminal Value? - answer-Normally you look at comparable companies and pick the median of the set. You would want to select a range of exit multiples and show what the TV looks like over that range. For example if the median EBITDA multiple is 8x you would want to show all TV from 6x to 10x HPR in terms of the Bank Discount Yield - answer- HPR in terms of the money market yield - answer- HPY in terms of bank discount yield - answer- HPY in terms of EAY - answer- If you use levered FCF what should you use as the discount rate? - answer-You would use the cost of equity rather than the WACC since we are not concerned with the debt or preferred stock in this case