Discounted Cash Flow Analysis

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gordon growth number

Hi for the gordon growth number g say using global GDP growth rate of 2%, 1. has this already included inflation? 2. if yes, then you just add the global inflation rate? 3. If you were to include inflation, then does that mean you need to adjust your whole model (projection of 3 financial stat... Read More

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by Elvina J.

added 6 years ago

Re: gordon growth number

1) Yes, because your model explicitly implicitly includes the impact of inflation (see your other post), the growth rate used for Gordon Growth should be compared against GDP NOMINAL 2) Not sure "if yes, add inflation". If yes, that would be double counting inflation, no? 3) Yes, per previous ... Read More

by WST Expert 1.

added 6 years ago

DCF - can you project with a change in capital structure

Hi When pitching a stock for long/short funds: 1. Say the company has debt repayment schedule, in addition to using trading comps, I thought of using DCF as a sanity check or to extrapolate a few data points for valuation. Say the management announced debt repayment schedule in the next few yea... Hi

When pitching a stock for long/short funds:
1. Say the company has debt repayment schedule, in addition to using trading comps, I thought of using DCF as a sanity check or to extrapolate a few data points for valuation. Say the management announced debt repayment schedule in the next few years of your 5 years projection. I understand that DCF keeps the capital structure constant (which is also it's flaw in valuation method), is it recommended to project such debt repayment and any other planned equity changes during the projection?

2. Follow up question to the above, assuming there is a change in the capital structure during the projection, then for diluted share outstanding for your valuation, I assume you would include the exercisable options or securities at that terminal year using implied share price as exercise price (which is ok even though there is circular) right?

3. If you recommend changing the capital structure through the projection as above, if I were to pitch the stock to a fund, and I assume the fund take minority stake, does it mean projecting FCFE is more relevant than FCFF in the DCF? (since you are an equity investor hence you get whatever that is paid to you after debt holders are paid off). Is that right?

4. If you keep capital structure constant through the projection, you should yield the same implied share price whether you use FCFF or FCFE in DCF right (hence you can use this method as a way to check errors in your projection if you dont get the same implied share price using both methods)?

5. What if you project a capital structure that is not constant through DCF, would DCF using FCFF vs FCFE yield a different implied share price?

6. If you were to project a different capital structure in the DCF, does that render DCF method useless meaning is it better to use other valuation methods e.g. trading comps like 1-year forward or 2-3 year forward multiple?

7. Practical application of DCF: I understand that some hedge fund folks have the impression that DCF is useless due to too many theoritical assumptions that could impact on the valuation greatly, although in some case I think it can be used if there is a lack of trading peer comps, am I right? Just wanted to get your opinion on the limitation. For pitching stocks, are there any methods that you think are less useful? (e.g. residual income, liquidation value is also less useful unless the company is in distress or you are projecting the share price to go to 0)

8. Is it realistic to project the share price to go to 0 e.g. Blue Apron for example? From what I know (correct me if I'm wrong), troubled companies hardly reach 0 share price (maybe Bear Stearns?). Share price tends to go to very depressed price and stay there for a long time before they decide to privatize it. Read More

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by Elvina J.

added 6 years ago

Re: DCF - can you project with a change in capital structure

1) Yes and no. DCF does not assume capital structure constant. You are using latest available capital structure for DCF because DCF is as of a specific point in time since you are discounting both the FCFF and TV to today. Hence, you use latest available figures. 2) By virtual of debt repayments ... Read More

by WST Expert 1.

added 6 years ago

DCF Analysis: Using Tax-Effected EBIT as Perpetuity in the Perpetuity Growth Method (PGM) to calculate Terminal Value

I have recently purchased Packages 3, 4, 5, 6, Private Company Valuation, and Super-Complex M&A LBO Modeling self-study courses to refresh my skill-sets. FYI, I have been an M&A investment banker and senior Corporate Development professional for many years. In my experience with DCF Analysis, t... Read More

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by Peter C.

added 7 years ago

Re: DCF Analysis: Using Tax-Effected EBIT as Perpetuity in the Perpetuity Growth Method (PGM) to calculate Terminal Value

Hello Peter, This is covered in one of the packages that you did not purchase, specifically Package 2, under Basic Financial Modeling, which is the very first spot that we cover DCF Modeling if one were starting from our more basic courses. The short explanation is that in order for perpetuity... Read More

by WST Expert 1.

added 7 years ago

DCF analysis: net debt should be actual not est

Package 3 Advanced Financial Modeling DCF Analysis Regarding the debt & cash calcs, I believe cell A42 footnote (in the excel template) should say 1/31/2006 (= Actual 2005) – if so, is this a typo? Currently, the footnote states 1/31/2005 (= Actual 2004). In the 2005 diluted shares calc,... Read More

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by Guest 1.

added 10 years ago

Re: DCF analysis: net debt should be actual not est

You are correct. the footnote in A42 should say PV as of Jan 31, 2006 which is our "Fiscal 2005". Good catch! We messed that one up (big no-no!) because normally fiscal years are dec 31 year end. so normally we say Dec 31 of and then the first estimated year minus one. which is the same as... Read More

by WST Expert 1.

added 10 years ago

AFM Enhancements: Valuation Question

My name is Jennifer Shi, a colleague of Nadia Sandi. We work in International Finance Corporation of the World Bank. We are currently reviewing the training modules. I have a real life valuation question. Appreciate your guidance. We are using DCF to value an existing equity investment. T... Read More

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by Guest 1.

added 10 years ago

AFM Enhancements: Valuation of negative earnings

What if we must value a company with a 5 year projected cash flows with the first two FCFF being negative?

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by Guest 1.

added 10 years ago

AFM Enhancements: Diluted Shares Oustanding figure

Hi there, Wouldn't be more accurate to calculate the "Implied Price per Share" by using the "Intrinsic value" from our valuation model as an input to the MAX function to calculate the potential dilution through the Treasury Stock method? And if I want to consider our "intrinsic value", how can I ... Read More

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by Guest 1.

added 10 years ago

RE: AFM Enhancements: Diluted Shares Oustanding figure

You are correct that the best way to calculate Implied Price per Share in a DCF analysis is to use the implied price to calculate dilutive options, thus changing the shares outstanding figure. That has the unfortunate effect of creating a circular reference because the newly updated diluted shares o... You are correct that the best way to calculate Implied Price per Share in a DCF analysis is to use the implied price to calculate dilutive options, thus changing the shares outstanding figure. That has the unfortunate effect of creating a circular reference because the newly updated diluted shares outstanding figure is used to recalculate the Implied Price per Share since the DCF analysis provides you with TEV and then Equity Value.

Since we avoid circular references at all costs whenever possible, there is indeed a fairly simple workaround solution. Simple in concept, annoying to implement, but once you have the template set up, it's plug and play. The steps:

1) Input the options strike prices and number of options by tranche of options if available. Recall for DCF analysis, since it is a standalone valuation, it is exerciseable not outstanding. To the right, calculate the cumulative options. For number of options, it's just a cumulative sum. For weighted avg strike price, you have to calculate new weighted average price for each new tranche of options, using sumproduct formula based on the number of options.

2) Once you have the cumulative, weighted average tranche of options (regardless of in the money or not) you will use the MIN formula as following

Fully Diluted Price = minimum of either:

i) Equity Value / Basic or
ii) (Equity Value + Options Out * Strike) / (Basic + Options Out)
Repeat above for each cumulative tranche

The MIN formula cycles through and figures out the lowest Implied Stock Price. The MIN is used b/c if an option tranche is out of the money, it will be anti-dilutive and will not be the smallest stock price.

This achieves the effect of increasing the Equity Value by the total proceeds as if the options were exercised and the exerciser actually paid the strike price. This is then divided by the new number of shares issued (1 for 1). Recall that the treasury method assumes a cash-less convert and issues "fractional shares". This method will achieve the same effect but without needing the end Implied Price as an input, thus avoiding the circular reference. Read More

by WST Expert 1.

added 10 years ago