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

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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.

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..

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.

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..

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.

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

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.

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

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

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