Question

Using the financial statements of a company over a 3 year period how do I calculate the intrinsic value of a stock using the discount cash free flow method? what figures in the financial statement do I use in the calculations

Answer 1

Free cash flow to equity (FCFE)

1. Take earnings before interest, tax, depreciation and amortization (EBITDA) which is available in income statement.

2. Deduct the interest from it to find earnings before tax, depreciation and amortization

3. Deduct tax also; we will get earnings after interest and tax but before depreciation and amortization.

4. Since the amount of depreciation does not result in actual cash outflow, it is available to that extent in the form of cash. Hence it is not deducted. The above 4 steps can be done with the help of income statement itself.

5. + or – the change in working capital. It is available in cash flow statement under cash flows from operations. The base for this is change in current assets – change in current liabilities. The figures are available in Balance sheet.

Change in current asset = Closing current asset – Opening current asset

Change in current liability = Closing current liability – Opening current liability.

6. Add the net borrowing from Balance sheet. (Long term loans / debentures etc. which are not covered under current liabilities.)

7. Deduct the capital expenditure. It can be found in cash flow statement – investing activities.

8. We obtain FCFE. This is total FCFE for the company.

9. To find the FCFE per share, divide this by number of shares which is available in Balance Sheet / Notes on accounts.

In case of future projections available, the discounted value of future cash flows can be calculated using Gordon’s formula.

Discounted cash flow = Cash flow * Discount factor

Where Discount factor = 1/(1+Discount rate)^No. of years

Cash flow refers to free cash flow as above. It can be computed individually for each of the years.