DCF VALUATION METHODOLOFY EXAMINED
DCF Explained.
The DCF (Discounted Cash Flow) values a company (business or division)
based on the sum of the Present Value of its Forecasted Free Cash Flows
(FFCFs) and the Present Value of its Terminal Value. The assumed value
derived from a DCF is known as the intrinsic value and differs from other
valuation methodologies such as “Comps” and Precedent Transactions
which are public/market-based valuation methodologies.
1st , you project out a company’s financials using assumptions for revenue
growth, expenses and Working Capital and then get down to Free Cash
Flow for each year. Next, discount each of those cash flows to their
respective Present Values based on the derived discount rate – usually the
WACC (Weighted Average Cost of Capital).
Once you have the present value of the Free Cash Flows, you then proceed
to calculate the company’s Terminal Value using either the Multiples
Method or the Gordon Growth Method. Since a company’s FFCFs
(Forecasted Free Cash Flows) are usually projected for a 5-yr. period in a
DCF; the terminal value serves to capture/quantify the remaining value of
the target beyond the projection period. Note that the discount rate or
WACC is used to discount the TV to the present. Finally, sum the PV of the
FFCFs and the total to the PV of Terminal Value to determine the
Enterprise Value.”
Lastly, and importantly, the DCF is used to produce a valuation range as
opposed to a single value. This is due mainly to key assumptions –
particularly the WACC and terminal value – which are highly subject to
judgement and potential for manipulation.
Steps in DCF
1. Identify components of Free Cash Flow
DCF Explained.
The DCF (Discounted Cash Flow) values a company (business or division)
based on the sum of the Present Value of its Forecasted Free Cash Flows
(FFCFs) and the Present Value of its Terminal Value. The assumed value
derived from a DCF is known as the intrinsic value and differs from other
valuation methodologies such as “Comps” and Precedent Transactions
which are public/market-based valuation methodologies.
1st , you project out a company’s financials using assumptions for revenue
growth, expenses and Working Capital and then get down to Free Cash
Flow for each year. Next, discount each of those cash flows to their
respective Present Values based on the derived discount rate – usually the
WACC (Weighted Average Cost of Capital).
Once you have the present value of the Free Cash Flows, you then proceed
to calculate the company’s Terminal Value using either the Multiples
Method or the Gordon Growth Method. Since a company’s FFCFs
(Forecasted Free Cash Flows) are usually projected for a 5-yr. period in a
DCF; the terminal value serves to capture/quantify the remaining value of
the target beyond the projection period. Note that the discount rate or
WACC is used to discount the TV to the present. Finally, sum the PV of the
FFCFs and the total to the PV of Terminal Value to determine the
Enterprise Value.”
Lastly, and importantly, the DCF is used to produce a valuation range as
opposed to a single value. This is due mainly to key assumptions –
particularly the WACC and terminal value – which are highly subject to
judgement and potential for manipulation.
Steps in DCF
1. Identify components of Free Cash Flow
