How does revenue impact a company's DCF valuation?

How might a 10% change in revenue impact a DCF valuation? I mean, step by step, where does it flow through?

Comments (7)

Oct 26, 2015 - 12:09am

- StreetofBulls
- Rank: Senior Gorilla
- | 827

This question isn't a test that requires a ton of critical thinking, its more-so of a gauge to see whether or not you understand how financial statements and a DCF analysis work conceptually. Memorizing an answer that WSO gives you isn't going to help your case, especially if they follow up with questions to your answer. To answer this question on an interview, talk about how revenue flows down the income statement to your calculation of FCF, and the purpose of calculating cash flows in a DCF analysis and the implications a 10% change in your top line.

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Oct 26, 2015 - 7:55am

- Sil
- Rank: Human
- | 12,538

Another important thing to keep in mind is what impacts the DCF the most. I got this revenue question in one interview, and it was then followed up by "What would have the greatest impact on the DCF: a 5% change in revenue or a 5% change in terminal value?" Just remember that changes to WACC (or whatever your discount rate is) and terminal value are what impact the DCF the most.

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Oct 29, 2015 - 9:27am

- bankertobe27
- Rank: Senior Monkey
- | 80

So I understand that a 10% change in rev might affect the dcf more than a 1% change in the discount rate (b/c a change in rev flows through ebitda, the fcf's, future fcf's and even the terminal value). But why is it that a 5% change in terminal value would affect the dcf more than a 5% change in revenue? Is it because you're discounting back all those years by that discount rate which just by definition would have a greater impact? Probably cause I'm a beginner but I'm not really seeing the math..

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Oct 29, 2015 - 9:48am

- Sil
- Rank: Human
- | 12,538

bankertobe27:
So I understand that a 10% change in rev might affect the dcf more than a 1% change in the discount rate (b/c a change in rev flows through ebitda, the fcf's, future fcf's and even the terminal value). But why is it that a 5% change in terminal value would affect the dcf more than a 5% change in revenue? Is it because you're discounting back all those years by that discount rate which just by definition would have a greater impact? Probably cause I'm a beginner but I'm not really seeing the math..

The 10% change in revenue affects a much smaller number of cash flows than the terminal value does. In theory, the terminal value affects the entire period after year five in the DCF, while the growth rate has a small effect on the terminal value (if you used Gordon's Growth Method) and a fairly large one on the five years of projections. I hope that helps.

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Oct 29, 2015 - 9:53am

- bankertobe27
- Rank: Senior Monkey
- | 80

That's really helpful actually thanks. And when you say it has a fairly large effect on the 5 years of projections, you mean through the formula, FCF/(1+r)^year right? Just so we're on the same page..

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Oct 29, 2015 - 10:34am

- Sil
- Rank: Human
- | 12,538

bankertobe27:
That's really helpful actually thanks. And when you say it has a fairly large effect on the 5 years of projections, you mean through the formula, FCF/(1+r)^year right? Just so we're on the same page..

Yup. You can easily verify this if you created your own DCF and then started changing your growth rate and then separately your terminal value. Basically, the terminal value affects a larger part of your DCF, so it will have a greater affect. Make sure to remember this because it's an interview question that a lot of people like to ask to make sure you really understand the DCF and did not just memorize what the interview guides said.

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Aug 14, 2016 - 11:10am