What is the main advantage and disadvantage of a DCF
It doesn’t factor in what the market thinks, this is good because it helps find opportunities that others haven’t realized. Bad because if you are trying to sell your company, it is all about what the market thinks.
What is the NPV formula
NPV = Value * 1/(100%+discount)^n
What is the annuity formula
NPV = Value * (1 - (1/(100%+discount))^n)/discount
How do you project unlevered cash flow
- Revenue trends (YOY)
- EBIT via ratio trends (Ratio)
- Apply tax expense (Multiplication)
- Change in non-cash expenses (D, A and stock based compensation mostly) and operational accounts (Ratio or constant)
- Change in capex (Ratio or constant)
Essentially, this is a normal FCF calculation but you neglect ANY financing activity
Use percent of revenue or constant value, whatever makes the most sense
Deferred liability, Asset or Liability
liability
What is different about projecting levered cash flow
After you find EBIT, apply interest expense. Then apply tax expense and continue normally. Then subtract mandatory debt repayments at same stage as capex.
How do you project levered cash flow
- Revenue trends (YOY)
- EBIT via ratio trends (Ratio)
- Apply interest expense (known)
- Apply tax (known)
- +/- changes in operational accounts
- Mandatory debt repayments
- Capital expenditure
What type of companies have higher discount rates
Smaller companies (all things being equal)
Companies primarily equity funded
Risky companies
What is the contributed discount from debt and preferred shares
debt - interest expense
preferred shares - expected yield
What is the cost of equity?
Comes from the prospect of dividends and forgoing the appreciation of the companies shares. More quantitatively it is
COE = Risk Free Rate (30yr gov bond) + Equity Risk Premium (Index fund performance or discretion) * beta (how risky you SHOULD be compared to entire market - use public comps)
How do you calculate beta
This is preferably done via public comps. Firstly see how market performs (index used in risk premium) relative to a company you compare with. Find how much the company goes up / how much the index fund goes up. Then you calculate the unlevered rate (remove the risk of the public comps debt risk). Then you apply it to your companyies debt (re-lever).
What is un-levering beta
You can find the beta of a public company but must determine what aspect of it is purely from equity. Apply the formula
ULB = LB / (1 + (1 - Tax)*(debt/equity))
this compensates for the the amount of beta incurred by debt and the amount of savings on taxes related to interest expense (tax shield).
What is re-levering beta
This is changing the unlevered beta from public comps to your own company.
LB = ULB * (1 + (1 - tax))*(deby/equity)
What are the two ways of evaluating a companies terminal value.
- Most common is determine a multiple (or range of multiples for sensitivity) based on EBITDA (Enterprise / EBITDA) and for the nth year of your predictable period, take the projected EBITDA, determine value and discount.
