Hi,

This is a conceptual question. I am confused with a DCF situation. The attached Excel file shows my calculations.

I am trying to do a very simple three-period DCF by two methods: 1. deducting interest expense from cash flow 2. accruing interest expense to debt. However, for some reason the two methods are giving me different answers (the yellow cells show the answer). Theoretically, both of them should yield the same answer. Can anyone here please help me understand what I am doing wrong?

Thanks.

AttachmentSize
60 KB

can you please make this a little less messy ? sometimes people are turned off if presentation of the model isn't that good.

"so i herd u liek mudkipz" - sum kid
"I'd watergun the **** outta that." - Kassad

musicgold:

Hi,

Theoretically, both of them should yield the same answer.

Please provide support for this statement.

musicgold:

Hi,

This is a conceptual question. I am confused with a DCF situation. The attached Excel file shows my calculations.

I am trying to do a very simple three-period DCF by two methods: 1. deducting interest expense from cash flow 2. accruing interest expense to debt. However, for some reason the two methods are giving me different answers (the yellow cells show the answer). Theoretically, both of them should yield the same answer. Can anyone here please help me understand what I am doing wrong?

Thanks.

AttachmentSize
DCF question.xls54.5 KB

Your model is taking into account that when you accrue interest expenses, the interest gets compounded as well. If you set the interest rate to 0%, you'll notice that both answers are equal now.

• 1
Sav:
musicgold:

Hi,

Theoretically, both of them should yield the same answer.

Please provide support for this statement.

In the first case I am deducting the interest expense (@5%) before discounting back the cash flow. In the second case, I am increasing the debt amount by the same rate. Conceptually, both treatments are the same.

mudkipz:

can you please make this a little less messy ? sometimes people are turned off if presentation of the model isn't that good.

For some reason I am not able to remove the old file and upload a new file.

Why are you discounting FCFF by the Cost of Equity and not your discount rate (WACC). I know this is supposed to be Unlevered Cash Flow (right?), so in that case, cost of equity is the right discount rate, but FCFF implies that you are measuring by cash flow to the firm (or debt and equity holders). Which in that case, should be WACC to account for cost of debt and equity...

"An investment in knowledge pays the best interest." - Benjamin Franklin

Levered for Equity Value --> use Cost of Equity
Unlevered for EV --> use WACC.

"An investment in knowledge pays the best interest." - Benjamin Franklin