DCF Valuation Method

I have learned the rough steps of how to do a DCF analysis, but understand that prof. Damodaran has his own website with links to various DCFs on excel. I don't understand why someone/or a BB firm would take the time to create their own valuation models when they have the best valuation teachers at their fingertips. Just curious to know why its so important to know the details of DCF? Wouldn't your firm give you the models in excel and you just input the numbers into it? Just want to get a better understanding of what an intern would do at a BB relating to valuation models. Thanks.

 
I don't understand why someone/or a BB firm would take the time to create their own valuation models when they have the best valuation teachers at their fingertips.
  1. Intellectual exercise. I'd rather have a group of analysts understand the flow of valuation than be a robot to it's computation, building models from the ground up is one of the best intellectual exercises you can do for yourself..

  2. Every company is different. For example, when I value my company for our investors (comps to generate proper unlevered betas, cost of capital, and exit multiples. Something that is not intuitive with any baseline DCF model.

Wouldn't your firm give you the models in excel and you just input the numbers into it?

This is contradictory to your "best valuation teachers" question. Don't contradict your flow of logic and create dichotomies...

 

Ok that makes sense. Thanks a lot for the response. As far as a general rule for predicting FCF what do you use? Would taking the 3 year average, projecting it another 3 years and then cutting it in half for the next 2 years, then using LT inflation rate for the terminal value work? Or is this too simplistic? Just want to find a conservative FCF method to work across all industries. Thanks.

 
Best Response
Just want to find a conservative FCF method to work across all industries.

Yeah, I don't think you understand the work around of a DCF. You can't apply some universal FCF method to midstream O&G and then to biotechnology, etc... Granular detail will always be required, it's too simplistic, and applying some inflation rate to a growing EBITDA as a % of revenue could undercut a lot of your TV as a % of EV.

 

From my understanding NOPLAT is similar to NPAT(ebit*(1-t) however it also makes a bunch of adjustments to taxes. However what I dont understand is what is the advantage of calculating FCF based on second method given the extra complexities in determining NOPLAT and net investments. Surely it must yield some extra sort of insight that is not avaliable from the traditional method we use.

 
eviloctal:

From my understanding NOPLAT is similar to NPAT(ebit*(1-t) however it also makes a bunch of adjustments to taxes. However what I dont understand is what is the advantage of calculating FCF based on second method given the extra complexities in determining NOPLAT and net investments. Surely it must yield some extra sort of insight that is not avaliable from the traditional method we use.

Perhaps it provides a more refined output (FCF) the more detail you dig into for taxes? Is it worth the extra time/hassle? Probably not.

It is essentially the same thing as the poster above stated. Never used anything other than EBIT/Op Inc.

 

yes because they represent a "fair" return for their risk...

... i think. That's what I remember from Damodaran's Investment Valuation. You should check out his website; he basically puts everything he knows on there so you don't have to buy any of his books.

http://pages.stern.nyu.edu/~adamodar/

I think you can also think of it this way: assume the market accurately prices the marketable securities (ie their worth is the present value of their future cash flows). Then save yourself the time and the trouble by valuing the firm w/o the securities income and then adding the value of the securities on to the DCF

 

For the interest expense, you look up the debt schedule and see how it is being paid off every year (which affects the projection of Liabilities in the BS). Then for every remaining debt tranche, however large or small it is, each year you take the interest expense. These interest expenses for all the tranches then are added up and appear on the IS.

To sum up: In order to project the interest expense, you need to have an idea of how the debt is being paid off and how much of it will be remaining each year. For the remaining debt (and different tranches of it) each year you take the interest expense.

A/R and A/P you can project from the % of say, sales, that they represent in the last year with actual data (not projected,) given that it didn't change much from the previous years.

Good luck.

 

Intrinsic Value tends to be derived from a DCF. Relative would be comparables, like P/E, P/B or EV/EBITDA.

Is the question: are the above weightings correct for a valuation?

I'm not in equity research but for I Banking, (FIG) I typically use 50 - 60% for (DCF, Residual Income, and sometimes DDM),
20-25% for comps and 20-25% weighting for precedent transactions.

Hope that helps

 

yup, so u take a set of comparable companies similar to that division and get the min, max, median ebitda multiples

then take the ebitda for your division and multiply it to those multiples. that should give u the EV of your company.

------------ I'm making it up as I go along.
 

at the risk of being harpooned by the NY BB intelligencia, when I advise clients on potential corporate transactions (MM M&A) we base DCF on EBITDA to try to gauge the available free cash flow to support debt, as well as to aid in comparing multiple targets. as part of this, we evaluate various target alternatives on a pre-tax basis because the applicable tax rate is dependent on numerous factors, many of which can be manipulated during the transaction and structuring. for example, if the target is a "S" corp or a LLC (and you elect either partnership treatment or disregarded entity status with the IRS - and yes, I know you don't "elect" to be a disregarded entity), you could very well have "pass through" tax whereby the applicable tax rate is dependent on the circumstances of the owner. alternatively, in a "C" corp setting, between NOLs, 338 elections and special depreciation provisions in the IRC ("bonus" and 179 depreciation) the tax implications vary widely between each target under analysis. therefore, in order to compare each option on a "apples to apples" basis, we ignore the tax side during the DCF analysis (and then adjust as appropriate on the back end when evaluating transaction value, which can change radically if stock/assets/368 reorg's).

 
HMG:
You might want to consider writing your masters dissertation on something more original...

I agree. However i am examining this from a 3rd world [erspective. There hasn't been that much research done on the use of DCF valuation for African companies, and i thought it might be an interesting topic.

It isn't set in stone. My supervisor may decide its been done way too many times and help guide me to more original topics. For now though, this is what i got.

 

That's an impossible question to answer. Everything is about your inputs on the DCF (along with every other type of model you use), hence why so many different analysts and firms have different recommendations and price targets on the same company. The market price is generally going to be different than any model you use which is how you would determine whether or not you believe the market is over/under valuing.

"It is hard to fail, but it is worse never to have tried to succeed." Theodore Roosevelt
 
Something Creative:
That's an impossible question to answer. Everything is about your inputs on the DCF (along with every other type of model you use), hence why so many different analysts and firms have different recommendations and price targets on the same company. The market price is generally going to be different than any model you use which is how you would determine whether or not you believe the market is over/under valuing.

Thank you! This narrows down my research question.

 

There is nothing wrong with that. NPV should be calculated as pv of return AFTER subtracting initial investments, and thus NPV less than equity investment signifies nothing. The fact that NPV is positive and equity IRR is positive is logical - whether those numbers are correct will depend on your model, but conceptually, there is nothing wrong.

As for FCFE and FCFF, yes they should be the same if there has been / will not be any debt. However, even with projections, you may want to make assumptions as to their future capital structure to capture potential tax shields.

 

Growth rates, chosen comparable multiple, and terminal value are the easiest to fuck with.

HFer_wannabe:

lol at gaming a DCF to fit somebody else's valuation

Valuation is an art, not a science. He's just painting a different picture.
 
HFer_wannabe:

lol at gaming a DCF to fit somebody else's valuation

lol, welcome to the wonderful world of investment banking!

I always messed with growth rates/assumptions first. They're "assumptions", so they're easy to justify with a bit of sweet-talking and "analyst sentiment".

Currently: future neurologist, current psychotherapist Previously: investor relations (top consulting firm), M&A consulting (Big 4), M&A banking (MM)
 

I personally enjoy an arbitrary risk premium for something like customer concentration, regulatory risk, etc.

"For I am a sinner in the hands of an angry God. Bloody Mary full of vodka, blessed are you among cocktails. Pray for me now and at the hour of my death, which I hope is soon. Amen."
 

Magnam totam possimus quam soluta numquam. Dicta facere velit deserunt facilis. Est sunt nihil corporis accusamus. Iure sequi dolore ducimus esse sapiente nihil.

Ratione molestias deserunt laudantium in quisquam. Iure autem facere consequuntur nam et harum eveniet ea. Perspiciatis et quo consequatur cum aliquid similique necessitatibus. Est eligendi dicta sit ut et aliquid. Tempora sunt amet expedita sint dolorem.

 

Corporis numquam ut laboriosam cum porro sint. Et quia nihil iusto. Ex corrupti et doloribus provident temporibus harum. Quibusdam tenetur autem maiores error.

Saepe ad nemo accusamus sed corporis possimus. Quis quia inventore aperiam. Pariatur repudiandae iure temporibus pariatur aliquam tenetur voluptatem. Qui asperiores eum quibusdam. Molestiae dolorem quod nesciunt ducimus. Maiores quia ut quos sit. Voluptatum reiciendis et soluta quas ipsa.

Deleniti excepturi natus eum nobis sint non. Et tempora pariatur ipsum sint ut sit excepturi. Sunt illo eum non labore neque sit quidem. Consequatur ipsam dolorem et est. Aliquam qui quis architecto consequatur. Voluptatum ipsa aut quia culpa rerum nesciunt et.

Et qui sed dicta sit. Ex voluptatem dolorum aut quae nesciunt. Earum assumenda ad quibusdam voluptate accusantium ratione quis.

Career Advancement Opportunities

March 2024 Investment Banking

  • Jefferies & Company 02 99.4%
  • Goldman Sachs 19 98.8%
  • Harris Williams & Co. (++) 98.3%
  • Lazard Freres 02 97.7%
  • JPMorgan Chase 03 97.1%

Overall Employee Satisfaction

March 2024 Investment Banking

  • Harris Williams & Co. 18 99.4%
  • JPMorgan Chase 10 98.8%
  • Lazard Freres 05 98.3%
  • Morgan Stanley 07 97.7%
  • William Blair 03 97.1%

Professional Growth Opportunities

March 2024 Investment Banking

  • Lazard Freres 01 99.4%
  • Jefferies & Company 02 98.8%
  • Goldman Sachs 17 98.3%
  • Moelis & Company 07 97.7%
  • JPMorgan Chase 05 97.1%

Total Avg Compensation

March 2024 Investment Banking

  • Director/MD (5) $648
  • Vice President (19) $385
  • Associates (86) $261
  • 3rd+ Year Analyst (13) $181
  • Intern/Summer Associate (33) $170
  • 2nd Year Analyst (66) $168
  • 1st Year Analyst (202) $159
  • Intern/Summer Analyst (144) $101
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
BankonBanking's picture
BankonBanking
99.0
3
Secyh62's picture
Secyh62
99.0
4
Betsy Massar's picture
Betsy Massar
99.0
5
dosk17's picture
dosk17
98.9
6
DrApeman's picture
DrApeman
98.9
7
GameTheory's picture
GameTheory
98.9
8
CompBanker's picture
CompBanker
98.9
9
kanon's picture
kanon
98.9
10
Linda Abraham's picture
Linda Abraham
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”