Beginners question DCF
Hi Guys,
Question with regards to following:
"If we assume that the coffee shop is in operation for 5 years and we use a 10% WACC, then its value would be: Value = 31,500 + 31,500/ 1.1 + 31,500/1.1^2 + 31,500/1.1^3 + 31,500/1.1^4 = $131,000"
Questions: 1. Why is there no terminal year value calculated? 2. The 31,500 is an estimate of the market size without growth assumpttions, isn´t this too oversimplified?
Thanks for providing some input...
1) Usually you assume the first cash flow comes in at t=1, but depends on the question. And since you stated the coffee shop is in operation for 5 years, there's no terminal value because that's for calculating the value of a company around for perpetuity (remaining a going concern).
2) If this was the number given to you in the question then use it, but if you assume the coffee shop is running at full capacity already and will not expand, then I would grow the cash flows at by some rate to account for inflation.
Ok, maybe its because english is not my mother tongue but i dont understand the first part...cld you please elaborate a bit upon when you do calculate a terminal year value to add to all calculated PV FCF and when not?
Thx in advance...
If you are going to account for inflation in the cash flow, shouldnt you use real rates for when discounting the cash flows for each yr vs using the nominal rate?
Terminal value accounts for the cashflows beyond year 5, in this case, which assumes a constant growth rate. Since you stated that the shop will only be in business for 5 years, there is no need to calculate anything beyond those 5 years, as the shop will no longer be in business..
shouldn't you include a resale value for the coffee shop as a year 5 cash flow? like, you plan on selling the company/physical location to someone else at the end of the 5 year period?
thanks guys and with regards to a residual value of the shop after 5 years to incorporate as well, I dont know...wouldnt that be indeed something you look in to?
well,if you have a real estate asset (the store), that you plan on selling at the end of the 5 year period, you could probably include the forecast resale value of the store as a year 5 cash flow.
What is the 31,500 number? In any event, the first number should be discounted and the last year should be ^5 not ^4. This would calculate the "price" of the cash flows, but you'd need to factor in the initial investment and eventual return of working capital at the very least if you were going to do some sort of project NPV analysis.
cash flows are calculated in nominal terms (see components ebit, nwc, etc.), therefore use nominal rates.
plus this is a simplified problem for academia, why would you worry about things that are not included in the problem? save urself some work, god knows how many dcfs u will have to do once u get into IB
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