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 (14)

 
Oct 31,2015

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.

Learn More

7,548 questions across 469 investment banks. The WSO Investment Banking Interview Prep Course has everything you'll ever need to start your career on Wall Street. Technical, Behavioral and Networking Courses + 2 Bonus Modules. Learn more.

 
Oct 31,2015

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.

 
Oct 31,2015

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..

 
Oct 31,2015
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.

 
Oct 31,2015

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..

 
Oct 31,2015
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.

 
Aug 31,2016

Hi, I have a follow up question on this issue. So just to clarify, is it right to order the factors affecting DCF valuation from greatest to least as follows:
1. Discount rate
2. Terminal value
3. Revenue

Just wanted to clarify because some sources like StreetOfWalls says that "FCF (and Terminal Value, which uses FCF as an input)" is the factor affecting the most.

Also, I don't quite understand what you mean when you say that growth rate has a small effect on the terminal value whereas it has a fairly large effect on the 5 year of projections - I was under the impression that terminal value is significantly affected by the terminal growth rate, since you're effectively assuming that as a constant perpetual growth rate forever into the future...?

 
 
Best Response
Aug 31,2016

The company will have revenue someday. You probability weight the expenses associated with achieving revenue and then take the present value of the revenue generated by investments today.

 
Aug 31,2016

DCF built far into future (biotech) when company actually starts to generate revenue, otherwise there any point in building DCF as you will get negative value

 
 
Aug 31,2016

Couple of ideas: i) check in the company presentations, ii) call IR, iii) check with sell side

absolutearbitrageur.blogspot.com

 
Aug 31,2016

Is there any database platform for asia companies?

 
Aug 31,2016