Question

In: Finance

What are the most common DCF valuation models?

Expert Solution

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.

jeff jeffy answered 2 years ago

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