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
These factors affect the valuation by DCF method in the following ways
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
Rm= market premium
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 firstname.lastname@example.org .
You can also make different stages of DCF on excel. See the model below, you can also download the model.