DCF and NOLs

Can someone please explain how to include NOLs in a DCF if a company has had negative pre-tax income, and how to include deferred tax assets as a result as well. Also, if I know from the 10k that their NOLs are set to begin expiring in 2027, how does this affect the projection. Thanks

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Based on the most helpful WSO content, here's how to include NOLs in a DCF and account for deferred tax assets:

Including NOLs in a DCF:

  1. Projecting Taxable Income:

    • Start by projecting the company's taxable income over the forecast period.
    • Use the NOLs to offset taxable income until the NOLs are exhausted or expire.
  2. Calculating Tax Savings:

    • For each year, reduce the taxable income by the available NOL balance.
    • Calculate the tax savings by multiplying the reduced taxable income by the tax rate.
  3. Discounting Tax Savings:

    • Discount the tax savings to their present value (PV). The discount rate can vary, but you could argue for using the Cost of Equity since the NOL savings flow directly to equity holders.

Including Deferred Tax Assets (DTA):

  1. Initial Recognition:

    • When the company incurs a loss, recognize a DTA on the balance sheet. The DTA is calculated as the NOL balance multiplied by the tax rate.
  2. Adjusting for NOL Utilization:

    • As NOLs are used to offset taxable income, reduce the DTA accordingly.
    • The reduction in DTA will affect the cash flow statement and balance sheet.

Impact of NOL Expiration:

  1. Projection Adjustments:

    • If NOLs are set to begin expiring in 2027, ensure that your projections account for this.
    • After 2027, any remaining NOLs that expire should no longer be used to offset taxable income.
  2. Revising Tax Savings:

    • Adjust the tax savings calculations to reflect the expiration of NOLs.
    • Ensure that the DTA is also adjusted to reflect the expiration of NOLs.

Example:

  • Balance Sheet Impact:

    • If the company has a $200 NOL and a tax rate of 40%, the DTA would be $80.
    • As the NOL is used, the DTA decreases, impacting the balance sheet.
  • Cash Flow Statement Impact:

    • Net income is adjusted for changes in DTA.
    • For instance, if net income is -$120 and the DTA changes by -$80, the cash flow impact is -$200.

By following these steps, you can accurately incorporate NOLs and DTAs into your DCF model, ensuring that your projections and valuations are precise and reflective of the company's tax position.

I'm sorry, but it looks like this may be out of my ability to answer... maybe some of the links below might help?

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