Different approaches of the DCF analysis
hello im very new to finance ,and i've been trying to study a bit the DCF analysis can anyone enlight me on the differencies between:
-entity approach -equity approach -adjusted present value approach
thanks
Keep studying.
http://www.investopedia.com/university/dcf/#axzz1doKuaibu
i have already read that tutorial, and while it has been very helpfull, it didnt help me finding the differencies between the 3 approaches.
for example, from what i understand the difference between entity and equity approach are:
-entity: the discount rate used is a proportion of the cost of equity and debt based on the "quota" of debt and equity of the firm
-equity: it uses only cost of cost of equity as discount rate
is that right?
thanks
This "Entity" is more commonly referred to as "Enterprise Value," hence my confusion. Also, arriving at Enterprise value is not a different approach from arriving at Equity value, but rather a step in the process depending on where you want to go with the analysis...
Enterprise Value = Equity + Debt + Preferred + Minority Interests - Cash
You are technically correct correct in saying, "the discount rate used is a proportion of the cost of equity and debt based on the 'quota' of debt and equity of the firm." However, this is commonly referred to as the Weighted Average Cost of Capital (WACC) and is used to discount levered (enterprise value) Free Cash Flows back to Net Present Value.
Adjusted Present Value (APV) is a different approach for running a DCF and aims to separate the Present Value of the company from effects of financing such as an Interest Tax Shield.
^^ incorrect. The WACC is used to discount UNLEVERED free cash flow, i.e. cash flow to the firm, to calculate enterprise value. LEVERED free cash flow would be discounted at the cost of equity to arrive at total equity value.
That is correct, I was originally addressing his cost of equity claim then deleted it to talk about WACC and didn't change it to unlevered fcf. However, while his post was rife with clear misunderstanding, you chose to find the one error in my response and frame it in a condescending way? Fuck you guy.
sorry, as entity i meant asset approach, which should be something like valuing the entire company without keeping track of how its financed
edit:sorry if i sound vague, but its the first time that i have to study stuff like that, so i will probably have tons of errors in my posts
The only Asset Approach I know of is finding the Net Assets = Assets - Liabilities. This approach represents the Book Value of the assets, or basically what GAAP says their worth, NOT the market valuation. However, because the balance sheet keeps track of how the assets are financed, this is necessarily taken into consideration. The three most common approaches used by Investment Bankers for valuation:
1.) Precedent Transactions 2.) Comparable Companies 3.) Discounted Cash Flow
Get the basics first.
Two good places to start (one free, one you must pay for - but well worth your money):
Professor Damodaran's website (he also has several books on valuations): http://pages.stern.nyu.edu/~adamodar/New_Home_Page/home.htm
And Josh Rosenbaum and Josh Pearl's Investment Banking book (has a very practical chapter on how to perform a DCF): http://www.amazon.com/Investment-Banking-Valuation-Leveraged-Acquisitio…
Once you get the fundamentals down, then feel free to ask some more nuanced or peculiar questions (related to finance). You'll get a lot more from this site that way.
Cheers.
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