DCF Analysis **Urgent Help**
I am currently an Investment Analyst for a REIT. Everyday I underwrite properties by performing DCF analysis that consists of the acquisition cost, NOI over a 5 year period and disposition price. I have an investment banking interview tomorrow and was wondering if a DCF analysis in investment banking requires an acquisition cost in the beginning? I am signed up for courses by breaking into Wall Street and he does not include the cost of the acquisition. He only includes the unlevered free cash flow over a 10 year period and the terminal value. Do you need an acquisition cost in an investment banking DCF? What do you analyze at the end - the sum of the discounted unlevered free cash flow over a 10 year period and the terminal value?
No no, let me explain.
Let's say you project out 5 years of Unlevered Free Cash Flows (UFCF). Using your discount rate, you'll discount those values to the present, so we have our PV of UFCF. Then we need to find our terminal value, which is basically a simulated sale at the end of the projections.
In order to do this, we'll either use the Gordon Growth Method or the Multiples Method. If using GGM, we will apply a (normally 3%) growth rate to the final year's cash flow. The formula looks like this: (FCF * (1+Growth rate)/WACC - Growth Rate). That will be your Terminal Value there.
Now, you will discount this Terminal Value using your discount rate back to the present. Now you have your PV of UFCF, and PV of TV. You then add your UFCF and TV, which brings you to the Enterprise Value. So to answer your question, you need both the PV of projected free cash flows added with the PV of the terminal value to derive an enterprise value for the company.
If using the multiples method, then you will apply either the industry average EV/EBITDA multiple that its peer companies are trading at; or if the company is public, you will apply its own EV/EBITDA multiple to the final year EBITDA, NOT UFCF. Then you will discount that terminal value back to the present as well using WACC, and will have your PV of the terminal value. Similarly, you will again here add together your PV of UFCF + PV of TV and that will obtain your Enterprise Value.
If you were to use Levered Free Cash Flow instead of UFCF, the only difference is that the value you derive is the equity value, and NOT the enterprise value.
Make sense?
It depends on the context and what are you trying to achieve.
Let's say you are on a buy-side and your client tells you: "We want to acquire Intralinks. Our goal is to grow EBITDA from $115m to $200m in five years. We do not want to engage in acquisitions but we believe that we can cut costs and introduce this new initiative which lets bankers translate documents from any language to English extremely well".
No acquisition costs in this example. You wills imply run a DCF and come up with an estimate of a price.
Let's say then the client changes its mind and says: "Hey, actually having talked to consultants, this new initiative is quite cool but it's not unique so won't attract as many clients as we would have hoped. So we will acquire a smaller player to consolidate and become an unreachable #1 datasite provider for bankers".
Here you will need to include acquisition cost of paying for the acquisition of a smaller player in your DCF.
Let's consider another example:
Verizon calls your MD and says that it wants to start building a FttP network on west coast in areas where FttP penetration is low. They are not willing to proceed with the project alone so they want a partner because they want this project off balance sheet. MD comes to you on a Friday evening before you leave and asks to do a quick DCF because he has a call with Verizon on a Sat morning.
The project will have a huge upfront capex for building the network which you will need to include in your DCF.
Let's then say that you did the DCF, sent it to your MD and went on a date. Next morning, he calls you at 10am so instead of staying in bed with a chick from yesterday's night, he asks you to come in to the office and do another DCF. The client decided not to build the network itself but heard that an existing FttP network operator on the west coast is seeking a partner to accelerate expansion.
In this case, there is no upfront capex and you are just doing a standard DCF to determine purchase price range which then you will need to refine as the project advances.
Hope this clarifies things somewhat