400 IB BIWS QUESTIONS - DCF BASIC
EXAM 2025 QUESTIONS AND ANSWERS
100% CORRECT.
What is the basic concept behind a Discounted Cash Flow Analysis? - ANSWERThe
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 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.
You need to discount everything back to its present value b/c money today is worth
more than money tomorrow.
Walk me through a DCF. - ANSWERA 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 FCF for
each year, which you discount and sum up to get to the NPV. The Discount Rate is
usually the WACC.
Once you have the present value of the FCFs, 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 NPV using the Discount Rate.
Finally, you add the two together to determine the company's Enterprise Value.
Walk me through how you get from Revenue to Free Cash Flow in the projections. -
ANSWERFirst, confirm that they are asking for Unlevered FCF (FCF 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 D&A and other non-cash charges, and factor
in the Change in Operating Assets and Liabilities. If Assets increase by more than
Liabilities, this is negative; otherwise, it's positive.
Finally, subtract CapEx to calculate Unlevered FCF.
Levered FCF is similar, but you must also subtract the Net Interest Expense before
multiplying by the (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? - ANSWERThe
idea is that you're replicating the SCF but only including recurring, predictable items.
And in the case of Unlevered FCF, you also exclude the impact of Debt entirely.
That's why everything in CFI except for CapEx is excluded, and why the entire CFF is
excluded (the only exception being Mandatory Debt Repayments for Levered FCF).
, Why do use 5 or 10 years for the "near future" DCF projections? - ANSWERThat'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? -
ANSWERYou might sometimes do this if it's a cyclical industry, such as chemicals, b/c it
may be important to show the entire cycle from low to high.
What do you usually use for the Discount Rate? - ANSWERIn an Unlevered DCF
analysis, you use WACC, 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
Implied per Share Value? - ANSWEROnce you get to Enterprise Value, ADD Cash and
then SUBTRACT Debt, Preferred Stock, and Noncontrolling Interests (and any other
debt-like items) to get to Equity Value.
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 [move from Enterprise Value to Implied per Share Value for a public
company] and find that the Implied per Share Value is $10. The company's current
share price is $5. What does this mean? - ANSWERBy 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?)
- ANSWERThe 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 FCF - instead, you stop at NI and assume
that Dividends Issued are a percentage of NI, 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.
Finally, a Dividend Discount Model gets you the company's Equity Value rather than its
Enterprise Value since you're using metrics that include interest income and expense.
Is it always correct to leave out most of the Cash Flow from Investing section and all of
the Cash Flow from Financing section? - ANSWERMost of the time, yes, because all
EXAM 2025 QUESTIONS AND ANSWERS
100% CORRECT.
What is the basic concept behind a Discounted Cash Flow Analysis? - ANSWERThe
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 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.
You need to discount everything back to its present value b/c money today is worth
more than money tomorrow.
Walk me through a DCF. - ANSWERA 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 FCF for
each year, which you discount and sum up to get to the NPV. The Discount Rate is
usually the WACC.
Once you have the present value of the FCFs, 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 NPV using the Discount Rate.
Finally, you add the two together to determine the company's Enterprise Value.
Walk me through how you get from Revenue to Free Cash Flow in the projections. -
ANSWERFirst, confirm that they are asking for Unlevered FCF (FCF 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 D&A and other non-cash charges, and factor
in the Change in Operating Assets and Liabilities. If Assets increase by more than
Liabilities, this is negative; otherwise, it's positive.
Finally, subtract CapEx to calculate Unlevered FCF.
Levered FCF is similar, but you must also subtract the Net Interest Expense before
multiplying by the (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? - ANSWERThe
idea is that you're replicating the SCF but only including recurring, predictable items.
And in the case of Unlevered FCF, you also exclude the impact of Debt entirely.
That's why everything in CFI except for CapEx is excluded, and why the entire CFF is
excluded (the only exception being Mandatory Debt Repayments for Levered FCF).
, Why do use 5 or 10 years for the "near future" DCF projections? - ANSWERThat'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? -
ANSWERYou might sometimes do this if it's a cyclical industry, such as chemicals, b/c it
may be important to show the entire cycle from low to high.
What do you usually use for the Discount Rate? - ANSWERIn an Unlevered DCF
analysis, you use WACC, 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
Implied per Share Value? - ANSWEROnce you get to Enterprise Value, ADD Cash and
then SUBTRACT Debt, Preferred Stock, and Noncontrolling Interests (and any other
debt-like items) to get to Equity Value.
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 [move from Enterprise Value to Implied per Share Value for a public
company] and find that the Implied per Share Value is $10. The company's current
share price is $5. What does this mean? - ANSWERBy 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?)
- ANSWERThe 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 FCF - instead, you stop at NI and assume
that Dividends Issued are a percentage of NI, 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.
Finally, a Dividend Discount Model gets you the company's Equity Value rather than its
Enterprise Value since you're using metrics that include interest income and expense.
Is it always correct to leave out most of the Cash Flow from Investing section and all of
the Cash Flow from Financing section? - ANSWERMost of the time, yes, because all
