Say we have a company with a Dec FYE
We are purchasing the company on 30 June 2022. We want to do a 10 years DCF
Forecasted FCF at 31 Dec 2022 is $100M which will grow every year by $20M
How do we adjust for a partial year valuation?
Am I right to think we still set out the DCF using December Year End, stub period will be discounted as $100M / (1+WACC)^0.25 and the second year will be $120M / (1+WACC)^1.25?
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^.25 in the first partial year which is six months and ^1 in the second year which is a full 12 months (.25*2 + 0.5). You'd have $50 in FCF in the partial year and then $120 in the first full year.
Discount periods without midyear convention would be 0.5, 1.5, 2.5, 3.5 ... 9.5. When doing mid year convention plus a stub period, it's a little different and not as simple as dividing stub period by 2 and adding 1. You are correct that the first discount factor would be 0.25 as that's halfway for a stub period of 0.5. However, the discount year for the next period would be halfway between 0.5 (end of first calendar year) and 1.5 (end of second calendar year). That would be 1.
Then the discount year for the very next period be halfway be between 1.5 and 2.5, which is 2. So essentially, the discount factors would be 0.25, 1, 2, 3, ... 9. If you're using perpetuity growth method/gordon growth, you would discount the terminal value by (1+WACC)^9. If it's exit multiple method, you discount terminal value by (1+WACC)^9.5. You add 0.5 because exit multiple method uses year end discounting and assumes business is sold at the end of a year.
So in short, it would be (1+WACC)^0.25 discount factor for the stub period, (1+WACC)^1 discount factor for the next year, (1+WACC)^2 discount factor the year after, and so on with the exponent increasing by 1. Best way to figure out the discount period is to first think about what they would be without midyear convention. Then divide the stub period by 2 and subtract 0.5 from every number thereafter (works out because halfway difference of 1 is 0.5).
In terms of the cash flow, it makes sense to do 50% of the first year cash flow since it's 6 months. Stub period cash flow is then $50mm. And then the full year cash flow for the next period would be $120mm.
Hope this helps
Thanks.
I dont quite understand why we half the Dec 22 CF? Don't we get the full cash payout?
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