Chapter 3, Discounted Cash Flow
Analysis Study Questions and Correct
Answers
Discounted Cash Flow Analysis ✅the value of a company can be derived from the PV
of its projected FCF (free cash flow)
What kind of value is DCF? (intrinsic value or market value) ✅Intrinsic Value, as
opposed to market-values such as Company Comparables or Precedent Transactions
Projection Period Length ✅5 years
Terminal Value ✅- used to capture the remaining value of the target beyond the
projection period
-used to quantify the remaining value of the target after the projection period
Weighted Average Cost of Capital (WACC) ✅- The projected FCF and the terminal
value are discounted at the target's WACC
- rate used to discount the target's projected FCF and terminal value to the present. It
reflects the target's business and financial risks
Enterprise Value ✅FCF + TV = EV
Sensitivity Analysis ✅impact of the key assumptions on valuation is tested using
sensitivity analysis
Market-based Valuation techniques ✅Company Comporables and Precedent
Transactions
Steps in a DCF Analysis ✅1) Study the Target and Determine Key Performance
Drivers
2) Project FCF
3) Calculate WACC
4) Determine Terminal Value
5) Calculate PV and Determine Valuation
Step I. ✅Study the Target and Determine Key Performance Drivers
Step II. ✅Project Free Cash Flow
, Free Cash Flow ✅the cash generated by a company after paying all cash operating
expenses and taxes, capex and working capital, but prior to the payment of any interest
expense
Assumptions for Free Cash Flow ✅Sales growth rates, profit margins, capex, and
working capital requirements
Step III. ✅Calculate Weighted Average Cost of Capital (WACC)
Step IV. Determine the Terminal Value ✅
The 2 methods to calculate a company's terminal value ✅1) Exit multiple method
(EMM)
2) Perpetuity growth method (PGM)
Exit Multiple Method (EMM) ✅calculates the remaining value of the target after the
projection period on the basis of a multiple of the target's terminal year EBITDA (or
EBIT)
Perpetuity Growth Method (PGM) ✅calculates the terminal value by treating the
target's terminal year FCF as a perpetuity growing at an assumed rate
Step V. ✅Calculate Present Value and Determine Valuation
Discount Factor ✅represents the PV of one dollar received at a given future date
assuming a given discount rate
What are some key drivers of a company's performance? ✅sales growth, profitability,
and FCF generation
How to calculate FCF? ✅(EBIT - Taxes) + D&A - CapEx + Net Working Capital
What's a good proxy for projecting future financial performance? ✅Typically prior
three-year period
Why five-year projection period? ✅five-year projection typically spans at least one
business cycle and allows sufficient time to realize planned initiatives
Sales Projections ✅- depends on the type of business (cyclical or not)
Sanity Check ✅- double check sales projections afterwards. Look at the target's
historical growth rates sa well as peer estimates and sector/market outlook
- must ensure that sales projections are consistent with other related assumptions in the
DCF, such as capex and working capital
Analysis Study Questions and Correct
Answers
Discounted Cash Flow Analysis ✅the value of a company can be derived from the PV
of its projected FCF (free cash flow)
What kind of value is DCF? (intrinsic value or market value) ✅Intrinsic Value, as
opposed to market-values such as Company Comparables or Precedent Transactions
Projection Period Length ✅5 years
Terminal Value ✅- used to capture the remaining value of the target beyond the
projection period
-used to quantify the remaining value of the target after the projection period
Weighted Average Cost of Capital (WACC) ✅- The projected FCF and the terminal
value are discounted at the target's WACC
- rate used to discount the target's projected FCF and terminal value to the present. It
reflects the target's business and financial risks
Enterprise Value ✅FCF + TV = EV
Sensitivity Analysis ✅impact of the key assumptions on valuation is tested using
sensitivity analysis
Market-based Valuation techniques ✅Company Comporables and Precedent
Transactions
Steps in a DCF Analysis ✅1) Study the Target and Determine Key Performance
Drivers
2) Project FCF
3) Calculate WACC
4) Determine Terminal Value
5) Calculate PV and Determine Valuation
Step I. ✅Study the Target and Determine Key Performance Drivers
Step II. ✅Project Free Cash Flow
, Free Cash Flow ✅the cash generated by a company after paying all cash operating
expenses and taxes, capex and working capital, but prior to the payment of any interest
expense
Assumptions for Free Cash Flow ✅Sales growth rates, profit margins, capex, and
working capital requirements
Step III. ✅Calculate Weighted Average Cost of Capital (WACC)
Step IV. Determine the Terminal Value ✅
The 2 methods to calculate a company's terminal value ✅1) Exit multiple method
(EMM)
2) Perpetuity growth method (PGM)
Exit Multiple Method (EMM) ✅calculates the remaining value of the target after the
projection period on the basis of a multiple of the target's terminal year EBITDA (or
EBIT)
Perpetuity Growth Method (PGM) ✅calculates the terminal value by treating the
target's terminal year FCF as a perpetuity growing at an assumed rate
Step V. ✅Calculate Present Value and Determine Valuation
Discount Factor ✅represents the PV of one dollar received at a given future date
assuming a given discount rate
What are some key drivers of a company's performance? ✅sales growth, profitability,
and FCF generation
How to calculate FCF? ✅(EBIT - Taxes) + D&A - CapEx + Net Working Capital
What's a good proxy for projecting future financial performance? ✅Typically prior
three-year period
Why five-year projection period? ✅five-year projection typically spans at least one
business cycle and allows sufficient time to realize planned initiatives
Sales Projections ✅- depends on the type of business (cyclical or not)
Sanity Check ✅- double check sales projections afterwards. Look at the target's
historical growth rates sa well as peer estimates and sector/market outlook
- must ensure that sales projections are consistent with other related assumptions in the
DCF, such as capex and working capital
