cash in dcf model

Hi guys,

I have a question regarding expected returns on stocks. Expected returns on stocks are calculated using the CAPM model. In the DCF model to value a stock cash flows to equity holders are discounted by this cost of equity (via the wacc). If you calculate the enterprise value using a dcf model, subtract the debt and add the firm's cash you get the equity value of the firm. My question: the cash of the firm is not yet invested and could not earn the expected/ required return. However, the expected return of the stock is for the whole equity value. So, does the firm's cash lower the expected return or is there an assumption that the cash the firm holds, gets reinvested?

Private Equity Interview Course

  • 2,447 questions - 203 PE funds. Crowdsourced from 750k+ members
  • 9 Detailed LBO Modeling Tests and 15+ hours of video solutions.
  • Trusted by over 1,000 aspiring private equity professionals just like you.

Comments (3)

Most Helpful
Jul 20, 2018 - 3:22pm

The present value of cash is the current cash value, while the current price of a stock reflects the present value of the future stock price. You are reflecting the present value of the future stock price based on the cost of equity, and then adding the present value of the cash (or net debt) to get the total present value. Since the cash is not invested, and therefore there is no gain from the outflow of cash (like an LBO with a negative cash flow for investment), it is not actually reflected in the NPV of the operations.

  • 3
Jul 20, 2018 - 3:45pm

Thanks for the answer, but I still don't quite get it. E.g. you calculate using dcf an enterprise value of 100 with 40 debt and 15 cash. Equity value = 75. The expected return of a stock is equal to the required return of the stock (= cost of equity). So, if the expected return for example is 5%, this is over 75 dollar right? So, there is also an expected return for the cash holdings of the firm?

Or am I overthinking this? DCF is just for valuing a company and should not be compared to asset pricing (expected returns).

Jul 20, 2018 - 4:56pm

Quia aut voluptatem aut est. Ut explicabo ipsa id debitis quia officia sit id. Magni quae facere odit dicta. Ut architecto cupiditate sint et eius facilis accusantium.

Incidunt laboriosam quisquam facilis. Cum totam et vero aliquid consectetur. Id velit sit magni temporibus commodi nisi odit. Deserunt aspernatur architecto incidunt deserunt laborum voluptas natus voluptatibus.

Voluptatem corporis quisquam praesentium consequatur qui beatae et. Impedit iste et vel veritatis modi voluptatibus. Et molestiae itaque fugit enim quos officia.

Start Discussion

Total Avg Compensation

September 2021 Private Equity

  • Principal (7) $694
  • Director/MD (18) $575
  • Vice President (68) $367
  • 3rd+ Year Associate (68) $270
  • 2nd Year Associate (139) $254
  • 1st Year Associate (284) $219
  • 3rd+ Year Analyst (26) $159
  • 2nd Year Analyst (61) $135
  • 1st Year Analyst (185) $118
  • Intern/Summer Associate (20) $67
  • Intern/Summer Analyst (219) $59