Principles of Finance · free preview
The Discounted Cash Flow Model
The discounted cash flow model values a firm from its free cash flows rather than its dividends, discounting projected flows at the weighted average cost of capital and summing to enterprise value, from which equity value follows by subtracting net debt.
1. Cash flow, not dividends
Cash flow, not dividends
2. Building the projection
Building the projection
3. The bridge to equity value
The bridge to equity value
4. Advantages and limitations
Advantages and limitations
5. The key difference from dividend models
What fundamentally distinguishes the discounted cash flow model from dividend discount models?
6. The discount rate
At what rate does the DCF discount projected free cash flows?
7. The enterprise-to-equity bridge
A DCF produces an enterprise value of 900 million dollars. The firm carries 300 million of debt and holds 100 million of cash. What is the equity value?
8. Terminal value dominance
Why does the terminal value typically account for 70 to 80 percent of a DCF's total?
9. The narrow margin of safety
A DCF values a stock at 52 dollars against a market price of 50 dollars. How should an analyst read the result?
10. The two-approach habit
Why do professionals pair the DCF with multiples rather than relying on either alone?
11. The cash measure valued
What three-word term names operating cash flow minus capital expenditures, the cash the DCF values? Answer in lowercase.
12. The whole-firm value
What two-word term names the value the DCF produces before subtracting net debt? Answer in lowercase.
13. The stable growth assumption
What three-letter abbreviation names the rate at which free cash flow is assumed to grow in perpetuity in the terminal value? Answer with the letter g spelled out.
14. The double-count error
What two-word term names the cash balance that, subtracted alongside gross debt, prevents double counting when bridging to equity value? Answer in lowercase.
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