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Discounted Cash Flow Analysis
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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