Discounted Cash Flows UPDATED Actual
Exam Questions and CORRECT Answers
A DCF values a company based on: - CORRECT ANSWER✔✔- The present value of its
cash flows and the present value of its terminal value.
Walk me through a DCF - CORRECT ANSWER✔✔- First, you project out the company's
financials using assumptions for revenue growth, expenses and working capital. Then you get
FCF for each year which you sum up and discount to a NPV based on your discount rate,
usually the WACC. Then you determine the company's terminal value using either the
multiples method or the Gordon Growth Method and dicount that back to NPV using WACC.
Add the two together to get the estimated EV.
How do you get from revenue to FCF? - CORRECT 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).
What is an alternate way to calculate FCF aside from taking NI, adding DEP and subtracting
CAPEX? - CORRECT ANSWER✔✔- Take CF from operations and subtract CAPEX to get
levered CF. To get unlevered you need to add back the tax adjusted interest expense and
subtract tax adjusted interest income.
Why do you use 5 or 10 years for a DCF? - CORRECT ANSWER✔✔- Anything beyond 10
years is too difficult to predict for most companies.
What do you usually use for the discount rate? - CORRECT ANSWER✔✔- WACC, although
you could use Cost of Equity.
How do you calculate WACC? - CORRECT 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 calculate cost of equity - CORRECT ANSWER✔✔- Use the Capital Asset
Pricing Model = Risk free rate +beta *Equity risk premium
, What is the Risk free rate - CORRECT ANSWER✔✔- Typically the yield on 10 or 20 year T-
bond
What is risk premiuim - CORRECT ANSWER✔✔- The % by which stocks are expected to
out-perform risk-less assets
How do you get Beta in the Cost of Equity calculation? - CORRECT 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)
Why do you have to un-lever and re-lever beta? - CORRECT ANSWER✔✔- Levered beta
reflects the debt already assumed by each company but since each company's capital structure
is different and if we want to see how risky the company is regardless of debt structure then
we must un-lever the beta. In the end beta will be re-levered because we want the cost of
equity to reflect the true risk
Which would you expect to have a higher beta a tech company or a manufacturing company?
- CORRECT ANSWER✔✔- A technology company because the technology industry is seen
as riskier then the manufacturing industry
What is the effect of using levered cash flow vs unlevered cash flow in your DCF? -
CORRECT ANSWER✔✔- Levered cash flow gives you equity value rather than enterprise
value since the cash flow is only available to equity investors (debt investors have already
been paid with interest payments)
If you use levered FCF what should you use as the discount rate? - CORRECT
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
How do you calculate terminal value? - CORRECT 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
Gordon Growth Method equation: - CORRECT ANSWER✔✔- Terminal value= year 5
FCF*(1+growth rate)/(discount rate- growth rate)
Exam Questions and CORRECT Answers
A DCF values a company based on: - CORRECT ANSWER✔✔- The present value of its
cash flows and the present value of its terminal value.
Walk me through a DCF - CORRECT ANSWER✔✔- First, you project out the company's
financials using assumptions for revenue growth, expenses and working capital. Then you get
FCF for each year which you sum up and discount to a NPV based on your discount rate,
usually the WACC. Then you determine the company's terminal value using either the
multiples method or the Gordon Growth Method and dicount that back to NPV using WACC.
Add the two together to get the estimated EV.
How do you get from revenue to FCF? - CORRECT 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).
What is an alternate way to calculate FCF aside from taking NI, adding DEP and subtracting
CAPEX? - CORRECT ANSWER✔✔- Take CF from operations and subtract CAPEX to get
levered CF. To get unlevered you need to add back the tax adjusted interest expense and
subtract tax adjusted interest income.
Why do you use 5 or 10 years for a DCF? - CORRECT ANSWER✔✔- Anything beyond 10
years is too difficult to predict for most companies.
What do you usually use for the discount rate? - CORRECT ANSWER✔✔- WACC, although
you could use Cost of Equity.
How do you calculate WACC? - CORRECT 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 calculate cost of equity - CORRECT ANSWER✔✔- Use the Capital Asset
Pricing Model = Risk free rate +beta *Equity risk premium
, What is the Risk free rate - CORRECT ANSWER✔✔- Typically the yield on 10 or 20 year T-
bond
What is risk premiuim - CORRECT ANSWER✔✔- The % by which stocks are expected to
out-perform risk-less assets
How do you get Beta in the Cost of Equity calculation? - CORRECT 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)
Why do you have to un-lever and re-lever beta? - CORRECT ANSWER✔✔- Levered beta
reflects the debt already assumed by each company but since each company's capital structure
is different and if we want to see how risky the company is regardless of debt structure then
we must un-lever the beta. In the end beta will be re-levered because we want the cost of
equity to reflect the true risk
Which would you expect to have a higher beta a tech company or a manufacturing company?
- CORRECT ANSWER✔✔- A technology company because the technology industry is seen
as riskier then the manufacturing industry
What is the effect of using levered cash flow vs unlevered cash flow in your DCF? -
CORRECT ANSWER✔✔- Levered cash flow gives you equity value rather than enterprise
value since the cash flow is only available to equity investors (debt investors have already
been paid with interest payments)
If you use levered FCF what should you use as the discount rate? - CORRECT
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
How do you calculate terminal value? - CORRECT 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
Gordon Growth Method equation: - CORRECT ANSWER✔✔- Terminal value= year 5
FCF*(1+growth rate)/(discount rate- growth rate)
