Here is the next part of our series on Fundamental Analysis📈
Let's learn about Discounting Future Cash Flows & DCF Model of valuation
A thread 🧵👇#LearnwithICICIDirect
Let's learn about Discounting Future Cash Flows & DCF Model of valuation
A thread 🧵👇#LearnwithICICIDirect
[A] What is Discounting?
Discounting is the method of determining present value of future payments/inflows.
It helps us to factor time value of money.
The value of INR 1,00,000 is more today vis-à-vis having the same amount 10 years down the line
Discounting is the method of determining present value of future payments/inflows.
It helps us to factor time value of money.
The value of INR 1,00,000 is more today vis-à-vis having the same amount 10 years down the line
[B] What are Cash flows (CF)?
CF are the cash generated by business. CF can be from operating, investing or financing activities
CF are the cash generated by business. CF can be from operating, investing or financing activities
[C] What is a Discounted Cash Flow (DCF) Model?
🔶DCF analyses the value of business based on projections of how much cash that business will generate in future
🔶DCF model can be applied to value a stock, company, project, and many other assets for the purpose of valuation
🔶DCF analyses the value of business based on projections of how much cash that business will generate in future
🔶DCF model can be applied to value a stock, company, project, and many other assets for the purpose of valuation
![[C] What is a Discounted Cash Flow (DCF) Model?
🔶DCF analyses the value of business based on projec...](https://pbs.twimg.com/media/Fuy5b5PXwAAMReO.jpg)
[D] How to calculate DCF?
Steps to perform DCF exercise:
🔶Forecast the free cash flow (FCF)
🔶Calculate weighted average cost of capital (WACC)
🔶Calculate terminal value (TV)
🔶Discount free cash flow (FCF) & terminal value (TV)
🔶Calculate implied share price
Contd. 👇
Steps to perform DCF exercise:
🔶Forecast the free cash flow (FCF)
🔶Calculate weighted average cost of capital (WACC)
🔶Calculate terminal value (TV)
🔶Discount free cash flow (FCF) & terminal value (TV)
🔶Calculate implied share price
Contd. 👇
![[D] How to calculate DCF?
Steps to perform DCF exercise:
🔶Forecast the free cash flow (FCF)
🔶Calcul...](https://pbs.twimg.com/media/Fuy5hiwXgAEM2gH.jpg)
[D.1] Forecast FCF
🔶FCF is the cash available for debt and equity holders after the business pays its operating expenses
🔶We should project FCF until they reach a steady state (usually 5-10 years)
Check out the below image for the steps to calculate FCF 👇
🔶FCF is the cash available for debt and equity holders after the business pays its operating expenses
🔶We should project FCF until they reach a steady state (usually 5-10 years)
Check out the below image for the steps to calculate FCF 👇
![[D.1] Forecast FCF
🔶FCF is the cash available for debt and equity holders after the business pays i...](https://pbs.twimg.com/media/Fuy5nQ3WAAEFP4-.jpg)
[D.2] Calculate WACC
🔶WACC is the average cost of each capital source of the Company
🔶It represents the overall Cost of Capital for the business
🔶It is used as a discount rate for future cash flows in DCF Model
Find below the formula for WACC👇
🔶WACC is the average cost of each capital source of the Company
🔶It represents the overall Cost of Capital for the business
🔶It is used as a discount rate for future cash flows in DCF Model
Find below the formula for WACC👇
![[D.2] Calculate WACC
🔶WACC is the average cost of each capital source of the Company
🔶It represents...](https://pbs.twimg.com/media/Fuy59jfWAAIz9IV.png)
[D.3] Calculation of TV
🔶It's not practical to assume FCF beyond Nth year
🔶It's value of the Co’s future FCF beyond the Nth year
🔶There are many ways to calculate TV but most commonly known method is to apply perpetual growth rate
Refer below image for calculation of TV 👇
🔶It's not practical to assume FCF beyond Nth year
🔶It's value of the Co’s future FCF beyond the Nth year
🔶There are many ways to calculate TV but most commonly known method is to apply perpetual growth rate
Refer below image for calculation of TV 👇
![[D.3] Calculation of TV
🔶It's not practical to assume FCF beyond Nth year
🔶It's value of the Co’s...](https://pbs.twimg.com/media/Fuy6CAmWIAUfBCa.jpg)
[D.4] Discounted FCF
🔶In this step we’ll calculate present value of FCF using WACC as discount rate
🔶DCF analysis helps in assessing viability of an investment by calculating the present value of expected FCF
Refer to below image👇
🔶In this step we’ll calculate present value of FCF using WACC as discount rate
🔶DCF analysis helps in assessing viability of an investment by calculating the present value of expected FCF
Refer to below image👇
![[D.4] Discounted FCF
🔶In this step we’ll calculate present value of FCF using WACC as discount rate...](https://pbs.twimg.com/media/Fuy6JdbXwAE4Y-U.jpg)
[D.5] Calculate Implied Share Price
Value of the Co. as per DCF Model = Sum of PV of Free Cash Flow + PV of terminal Value
Value per Share = Value of the Company /No. of shares
Through this DCF model helps us calculating fair value per share
Value of the Co. as per DCF Model = Sum of PV of Free Cash Flow + PV of terminal Value
Value per Share = Value of the Company /No. of shares
Through this DCF model helps us calculating fair value per share
[E] How is it used?
🔶To determine the fair value of an investment
🔶Help business owners make budget and investment decisions
🔶Help users account for different projections that might be possible
🔶Also facilitates Sensitivity Analysis
🔶To determine the fair value of an investment
🔶Help business owners make budget and investment decisions
🔶Help users account for different projections that might be possible
🔶Also facilitates Sensitivity Analysis
[F] Limitations of the DCF Model
🔶DCF analysis involves estimates, not the actual figures
🔶FCF depends on no. of factors, such as market demand, technology, unforeseen threats etc. These can't be quantified precisely
🔶It involves Complex analysis
🔶DCF analysis involves estimates, not the actual figures
🔶FCF depends on no. of factors, such as market demand, technology, unforeseen threats etc. These can't be quantified precisely
🔶It involves Complex analysis
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TL;DR
[1] What is discounting
[2] What is Cash Flow
[3] What is DCF Model
[4] Steps to calculate value of Co. using DCF
[5] Uses of DCF Model
[6] Limitations of DCF Model
[1] What is discounting
[2] What is Cash Flow
[3] What is DCF Model
[4] Steps to calculate value of Co. using DCF
[5] Uses of DCF Model
[6] Limitations of DCF Model
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