If you're building a DCF for a company and let's say it operates for one year, then liquidates in the second year for 1x P/B. By including the first year of FCF in the DCF wouldn't you be double counting this cash generated from operations? because it would be counted in the 1st year, then counted again in the terminal value.
Not sure what I'm missing. would appreciate any help.
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I think I understand your point. But theoretically no I don’t think so. If the company is liquidating completely then you are selling off income producing assets less the liabilities (like debt) used to fund the assets / income. If the company is going to continue as a going concern that terminal value is essentially the income producing value of the assets less the liabilities into perpetuity (ie you are selling the capital structure required to produce approximately that level of income going forward).
Thanks for the reply.
My thought:
Company has $10 cash (assume no other assets), and earns $10 FCF in year 1. They liquidate at the end of the year.
So DCF would say: PV Y1 cash flows + $20 (terminal value because now $20 cash on BS at end of year) = ~$30
But doesn't this double count the Y1 cash flows in the forecasted year and in the terminal value?
I think I understand better now. Yes you’re double counting. That year 1 DCF is assumed to be distributable cash (“dividend discount model”). It wouldn’t be in the terminal period balance sheet if you’re “DCF-ing” it. You either count that DCF period and the terminal period has less cash or don’t count the DCF period and terminal period has more cash. The former has a higher present value. Thanks for the example.
So when people run 5 year DCF's (5 year forecasted period + terminal value), i thought it was PV of the 5 year forecasted period FCF, plus the terminal value (ie. some multiple on terminal year earnings/ebitda/book value). But in this case you wouldn't assume the 5 years of FCF is all distributed as a dividend? Thanks for taking the time.
DCFs essentially value companies based on the present value of distributable cash. Theres also a distinction between a balance sheet metric (P/B) and an income statement metric (P/E). In this case, you are using a balance sheet metric at exit but your period 1 is company income based. you cant give the valuation credit for cash that’s been distributed in year 1 for the terminal valuation or Vice versa. If the cash has been distributed it’s not on the balance sheet. A conventional DCF aggregates the value of distributable cash in each period and then assumes a level of distributable cash at exit or into perpetuity typically with an income based (not balance sheet based) exit multiple. Let’s say you applied a P/B multiple after year 5. The balance sheet would not have any of the distributed cash at that time. If it wasnt distributed, then it “accrues” into the terminal multiple. Due to time value of money, it makes sense that cash would be distributed throughout time, unless youre getting better returns on keeping the cash in the business then it’s more prudent not distribute. DCFs are theoretical.
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