Chapter 3, Discounted Cash Flow Analysis Study Questions and Correct Answers
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Course
Discounted Cash Flow
Institution
Discounted Cash Flow
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 L...
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
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