Valuation under Discounted cash flow
I am little confused on DCF Valuation. I did a valuation of a cash inflow for 2 years and terminal value cash flow at the end of 2nd year. I arrived at "x" value. Now by just increasing forecast period from 2 years to 5 years (assuming growth at equal to Cost of capital) and keeping all other assumption constant, I get higher value.
Now, I think this is against basic principal. By just increasing the forecast period how can we increase value of organisation.
The increase in value is equal to PV of cash flow of additional 3 years.
Not vary sure, is this correct way to value.
I'd really need to see your model in order to understand, BUT:
1- if you set rev growth to +5% over 2 years and then extend it for another 3 years (5 years in total), then you will see an increase in value because the numerator in your dcf calc is rising (sum of future cash flows)
2- what's the difference in value between a 2 year annuity paying 5% and a 5 year annuity paying 5%? equal to cash flows generated in the additional time periods...
Hope this helps.
This is not correct. It's not arbitrarily +5% -- it depends on what the discount rate is, etc.
But the premise is correct -- if you achieve great enough growth over a longer discount period, presumably you might capture some value that wasn't included in your prior terminal value calc -- either not baked into the terminal growth rate or not baked into the terminal multiple. The calculation sounds fine; this is just a result of your assumptions.
Remember: a DCF can say whatever you want it to say.
You need to make assumptions around reinvestment rate, ROIC and long-term growth rate relative to risk free rate (in real terms). If there are inconsistencies across any of these assumptions then increasing the projection period will impact firm value. Illustrative DCF posted at link below.
As an aside, there really should be functionality for people to respond with uploaded files rather than having to create a new thread. It could vastly improve the quality of content posted to answer technical questions.
https://www.wallstreetoasis.com/forums/dcf-illustration
Questions on Assumptions Used for DCF Valuation of a Company! (Originally Posted: 08/21/2015)
Hello folks,
I am a complete valuation virgin here and I just have a question regarding DCF valuation projection of a company post M&A.
When projecting labor expenses, I am projecting both the number of future employees and the prospective salary level for the projection period.
Does it make sense if I were to gradually reduce the number of employees specifically related to Admins throughout the projection period, accounting for the reduction in abundant personnel post the merger (and under the assumption that the buyer is more "efficient?"
Would this logic stand? Have you guys ever had an instance where you gradually reduced the labor expenses throughout the projection period and if so, what was the reasoning behind em?
Ah perhaps my question is too dumb to be worth the attention!
Are you using a perpetuity growth calculation for TV or a multiple or fixed number?
If using perpetuity growth method with a consistent growth rate and cost of capital (growth rate input must be less than cost of capital), you'll see that the valuation doesn't change with projection period.
If you're using a multiple or fixed number, then you will see that "distorted" result. This is because you're viewing the organization as a finite-life business and aren't decreasing the terminal value to account for 3 years of age. The reason that most people wouldn't do this, though, and are okay with assigning additional value after 3 years is because in those 3 years, you have grown the business beyond the t=0 cash flow and thus, it should be more valuable.
DCF Valuation Help (Originally Posted: 09/20/2015)
Hi All,
On page 22 of Valuation, 6th Edition there is the attached table, the details are;
Year 1 to 15; - Year 1 Earnings: $100 - Growth: 9% - ROIC: 25%
After 15 years; -Growth 4.5% -ROIC: 25%
Cost of capital: 9%
The table has the company’s value at $2,700.
Can anyone explain how that value is derived?
The valuation I derive is $2,244.24. Year 1-15 > = $880.73 Valuation into perpetuity = $1,363.51 Formula = (Year 15 * 1.045) / (9% - 4.5%)
Any idea why my valuation dosn't match the one in the table?
Thanks
I would emphasize that if you are doing a perpetual growth formula you are implicitly assuming reinvestment in excess of maintenance capital. By growing FCF without reinvestment and subtracting the growth rate from your WACC you will overstate firm value.
Either you should assume (i) no growth for both the numerator (CY+1 FCF) and the denominator (WACC less growth) or (ii) impute the same statistics including reinvestment required to bring on that incremental FCF in perpetuity. Reinvestment rate as a % of CY+1 FCF can be estimated using the ratio of the long term growth rate divided by WACC. Consider the companies with negative long-term growth rates...these businesses are spending less than maintenance capex which is effectively a source of cash to stakeholders as invested capital decreases over time.
If this doesn't make intuitive sense, try doing a DCF in excel, calculating the perpetual growth firm value then compare that to a DCF with the same assumptions that goes out 100 years. The DCF terminal value will be significantly lower.
Can you post a bigger version of what you were trying to post? I can't read it.
I get to $2,707 which is pretty dang close. A few reasons you might be off: - the implicit reinvestment rate (g/ROIC) is 36%; make sure you deduct reinvestment from earnings to get to free cash flow. - I'm using a midyear discount, which appears to be what he is doing also. For the terminal free cash flow, I'm using 15 years of discounting, not 14.5 - Your terminal multiple is wrong. The formula for the terminal NOPAT multiple is (1-g/ROIC / WACC - g). You apply this multiple to forward NOPAT, i.e. year 15 NOPAT * 1.045
I would have to see his numbers to know why I'm slightly off. It could be that he rounded down too for simplicity.
Hi There,
Thank you for your help.
I have been through your points, but couldn't quite arrive at the same figures as you have.
The screen shot of the book has now been added to my original post as an attachment, along with what my spreadsheet looks like.
Once again, thanks for your help!
Hi All,
For future reference, the table in the book was slightly wrong. Some numbers were rounded incorrectly
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