Discounted Cash Flow

What is Discounted Cash Flow

It is the fundamental method of valuation of a company in which the future cash flows of the company are discounted by the expected return to arrive at the present value of the company

Three things are important for DCF calculation

• Cash flows of the Company
• Expected rate of the analysts
• Timeline of the cash Flows

These factors affect the valuation by DCF method in the following ways

• Cash Flows- More the better
• Expected return of the analyst- Less the better because we discount the cash flows by this rate
• Timeline of the cash flows- Sooner the better

How to do valuation using DFC?

Most Common Free Cash Flow Definition:

Free Cash Flow to Equity = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment

Free cash flow= EBIT(1-t) + Gross depreciation- Capex- Change in Working Capital

Calculating Cost of Capital

Cost of equity= rf+ (rm-rf)* beta

rf= risk free rate

Cost of Capital= wd*rd*(1-t)+ we*re

rd= cost of debt

re= cost of equity

wd= relative proportion of weight in the value of firm

we= relative proportion of equity in the value of firm

Beta can be calculated by un-levering the beta of the comparable company and then re-levering the beta for the subject company using its debt equity ratio. In our case Facebook has very minimum debt in its book and this is the same case with the majority of the social networking and internet giants, so we can directly take the average of the comparables to calculate the beta for Facebook.

In our LinkedIn model we have used DCF to calculate the present of the firm. The free cash to the equity has been discounted by the cost of equity to arrive at the value of firm

See the image below. In the formula you can see how the free cash flow to equity has been discounted to arrive at the value of the firm

You can download and see the complete e-book to understand DCF better. EduPristine’s extensive Financial Modeling course covers this aspect in detail. To know more, quickly write an email to helpdesk@edupristine.com .

You can also make different stages of DCF on excel. See the model below, you can also download the model.

I am greatly impressed by the quality of your training. In fact it is the reason I am going to take the exam this time as I had previously decided not to take it because the quality of the training I had purchased was not what I had expected. All the best to you and everyone at Edupristine.
I am very pleased to have found these courses offered by a recognized, reputable training firm at a great value! Thank you!
##### Disclaimer

Global Association of Risk Professionals, Inc. (GARP®) does not endorse, promote, review or warrant the accuracy of the products or services offered by Edu for FRM® related information, nor does it endorse any pass rates claimed by the provider. Further, GARP is not responsible for any fees or costs paid by the user to Edu nor is GARP responsible for any fees or costs of any person or entity providing any services to Edu Study Program. FRM®, GARP® and Global Association of Risk Professionals®, are trademarks owned by the Global Association of Risk Professionals, Inc

CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by EduPristine. CFA Institute, CFA®, Claritas®, and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Utmost care has been taken to ensure that there is no copyright violation or infringement in any of our content. Still, in case you feel that there is any copyright violation of any kind please send a mail to legal@edupristine.com and we will rectify it.

Popular Blogs: Whatsapp Revenue Model | CFA vs CPA | CMA vs CPA | ACCA vs CPA | CFA vs FRM