Problem with WACC in DCF
Hi,
Lets say I have the following fcff schedule:
2023.30.06 -$35k
2023.31.12 -$35k
2024.30.06 -$25k
2024.31.12 -$15k
If I’m making dcf analysis is it logical to just take total annual amount and discount by annual WACC? Or is it more correct to consider semi-annual re-investment? Finally, if the latter is more correct, but I still want to present my results on an annual basis do I need to consider compounding when calculating annual discount rate?
thanks,
There's a BIWS guide/M&I article on mid-year discounts.
Hi, thanks for replying,
so to clarify my question, how would you build an annual dcf model if data was provided on semi-annual basis? Does it even make sense to perform such analysis? what if you had to work with semi-annual and annual data i.e some fcff info was for full year, part of info for half a year only.
To build an annual DCF, just simply sum up all the cash flows for that year and discount it normally with the WACC. Using your example figures above, 2023 CF = $70k and 2024 CF = $40k.
Ik your follow-up question will be "won't that undervalue the company/cashflows since you're discounting it more heavily by assuming all the cash flows come in at the end of the year?" and my answer, or rather, Brian Dechesare's answer, would be that yes, u r correct in that the annual DCF will discount the cash flows more heavily than a mid-year discount approach but that is the trade off between the "complexity" and "accuracy" of a model. Neither method is "better," it's just whether u want a quick and dirty model or maximal precision in your model.
As for ur 2nd question, when u r considering or only presented with partial cash flows for the year, u can either use a stub period/TTM approach (u need 10-Q for this) or simply annualize the numbers (most common method), so for example, if the company generated $10k FCF in the first 3 months of 2023, u would assume it generates $40k for the entire year of 2023. Obviously, annualizing assumes 0% growth in the CF/revenues/expenses for that year so some academics like to apply a growth rate to the partial cash flows but that makes the formula significantly more complicated so in practice we all just straight-line annualize it. I interned in PE last summer (summer of 2022) and when I was building LBO models and estimating FCF, I only had the CF for the first half of 2022 and my managing partner instructed me to annualize it by multiplying everything by 2. I would assume most other shops do the same.
Awh gross, are you Waccing yourself off in the bathroom again!? C'mon man, not cool.
Behave, just trying to wrap my head around this shit, lol
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