In: Finance
What are the most common DCF valuation models?
Companies are valued for the following purposes: |
1. during mergers or acquisitions |
2.to know their true & fair networth or saleable value or market price |
3. by potential lenders/investors when they lend/invest money --so as to gauge the safety of their money as well as returns/earnings surety |
4. to self-assess about growth ---ie. Whether the company is growing& by how much? |
DCF or discounted cash flow valuation is of immense use to the investor/purchasor ,who discounts all the expected future cash flows to happen in that investment , at his cost of capital /financing & the sum of the present values ,so obtained is its current value or purchase price. |
For this analysis, |
different types of DCF valuation models are used depending on the type of free cash-flows employed in the process, like --- |
free cash-flows to firm (FCFF) or |
free cash-flows to equity (FCFE) or |
discounted dividend model (DDM) that uses dividend cash flow to be received in future . |
1..Free cash-flows to firm (FCFF) |
FCFF=EBIT*(1-Tax rate)+Depn.& Amortisation-CAPEX+/-Changes to working capital |
This FCFF is obtained for the future periods, including the terminal value & discounted at the weighted average cost of capital (ie.both debt & equity) to the company. |
2..Free cash-flows to equity (FCFE) |
FCFE=Net Profit after tax +Depn.& Amortisation-CAPEX+/-Changes to working capital+/- Changes to debt |
Yearly FCFE is obtained for the future periods, including the terminal value & discounted at the cost of equity to the company. |
3. Discounted dividend model (DDM) that uses dividend cash flow to be received in future . |
Future dividends are estimated along the lines of growth ,including the terminal dividends , and then discounted at the cost of equity. |
Thus all the DCF models give importance to : |
future real,hard-cash flow rather than book income |
time value for that cash flow and |
selects its cost of financing as the discount rate to discount the cash flows to their respective present values. |