How would an increase in net working capital affect your DCF? What does that mean?
An increase in net working capital would decrease unlevered free cash flow. It represents more money being tied up in the daily operations of the business. For example, an increase in inventory would tie up more cash.
What are the top 5 questions you would ask management if you were building a DCF?
How do you choose a projection period in the DCF?
Typically, you project 5-10 years because it’s expected that the company will be a mature company after the projection period. Also, it’s often very difficult to project beyond that. Once the company is mature, we can apply a terminal value.
How would you sensitize your DCF?
You would sensitize model assumptions like WACC and perpetuity growth rate / exit multiple. You can also sensitize operating metrics like revenue growth, EBITDA margin, and capex. Finally, you can also look at different upside, base case and downside scenarios.
When does discounting UFCF and LFCF produce the same value? When do they not?
The UFCF method relies on assuming a target capital structure throughout the projection period. However, LFCF may have their capital structure change throughout the projection period as the company pays back debt or borrows more. As a result, they usually result in slightly different values. However, if the target capital structure and the actual capital […]
How do you find fully diluted shares outstanding?
The treasury stock method is used to calculate fully diluted shares outstanding. Typically, companies will tell you common shares outstanding and options outstanding in the MD&A section of their financial statements. Options give people the right to buy stocks at a specific price, also known as the strike price. Usually, options will be listed at […]
Why is it better to give a range for the implied share price from a DCF?
The implied share price is the share price the company would be worth if all assumptions in the model are correct. However, it’s unrealistic to guess every assumption correctly, so we give a range of implied share prices by sensitizing a key variable such as WACC or perpetuity growth rate / exit multiple.
How do you decide on the exit multiple?
After the projection period, it can be assumed that the company is at a “mature” stage. To find the exit multiple, we can take the median EBITDA multiple from a set of mature comparables. These companies should be larger and more mature, and therefore have a lower EV / EBITDA multiple compared to fast growth […]
How do you calculate terminal value?
Enterprise value is the value of the business, which is calculated as the total present value of free cash flows the company would obtain throughout its lifetime. Since we can only project cash flows reasonably for a limited number of years, usually 5-10 years, we have to calculate the value of the company after this […]
What is the risk-free rate?
The risk-free rate is the rate at which governments can borrow, since governments in developed markets are relatively unlikely to default given their ability to raise taxes. In the US, the risk-free rate is the 10 year treasury bond. In Canada, it is the prime-rate of the 10 year government bond,
