Financial Modeling Quick Lessons: Building a Discounted Cash Flow (DCF) Model (Part 1) [UPDATED]

Summary

This video tutorial offers a comprehensive guide to building a basic discounted cash flow (DCF) model. It covers key concepts such as free cash flow, the differences between unlevered and levered DCFs, and the significance of capital expenditures. Viewers learn the process of constructing a DCF, from forecasting revenues and earnings to calculating present values of cash flows and terminal value. The emphasis on Excel functions streamlines the analysis, making it accessible for finance professionals looking to evaluate a company's intrinsic value against market valuation.

Takeaways

• 📊 A discounted cash flow (DCF) model projects future cash flows and discounts them to find a company's intrinsic value.
• 💵 The sum of discounted cash flows helps determine if a company is overvalued, undervalued, or correctly valued.
• 🔄 There are two types of DCF: unlevered (before debt payments) and levered (after debt payments).
• 🛠️ This video focuses on building an unlevered free cash flow (FCF) model.
• 📅 Forecasting cash flows typically spans five to ten years, depending on company stability.
• 🏗️ Free cash flow is calculated as operating profit minus capital expenditures (CapEx).
• 💡 Adjustments to EBIT are necessary to derive unlevered free cash flow, including non-cash expenses and changes in working capital.
• 🧾 Increases in accounts receivable represent a use of cash, requiring adjustments in calculations.
• 🚀 Terminal value, representing value beyond the forecast period, can be calculated using growth in perpetuity or exit EBITDA multiples.
• 📈 The Enterprise Value is the sum of stage one (explicit forecast) and stage two (terminal value) of the free cash flow analysis.

Q & A

What is a discounted cash flow (DCF) model?

A DCF model projects future cash flows and discounts them back to the present using a discount rate that reflects the riskiness of the capital. The sum of these discounted cash flows represents the intrinsic value of a company.

Why do finance professionals use DCF analysis?

DCF analysis helps determine if a company is overvalued, undervalued, or valued correctly by comparing its intrinsic value to market values.

What are the two types of DCF models mentioned in the transcript?

The two types are unlevered DCFs, which are calculated before debt payments, and levered DCFs, which are calculated after interest expenses and debt paydown.

What is unlevered free cash flow?

Unlevered free cash flow is the cash generated by a company's operations before accounting for interest and debt repayments, focusing on the company's operating profitability.

What is the importance of capital expenditures (CapEx) in cash flow analysis?

CapEx is critical because free cash flow is calculated as operating profit minus reinvestment in capital expenditures. It reflects the cash needed to maintain or expand the company's asset base.

How long is the typical forecast period for cash flows in a DCF model?

The typical forecast period for cash flows ranges from five to ten years, depending on when the company is expected to achieve stable earnings.

What adjustments are made to calculate unlevered free cash flows from EBIT?

Adjustments include adding back non-cash expenses, making accrual adjustments, and subtracting reinvestment, which primarily consists of capital expenditures.

What does terminal value represent in a DCF model?

Terminal value represents all cash flows beyond the explicit forecasted period, capturing the value of the company into perpetuity.

What are the two methods to calculate terminal value?

The two methods are the growth in perpetuity method and the exit EBITDA multiple method, with the transcript focusing on the growth in perpetuity approach.

What is the significance of WACC in the DCF model?

WACC, or the weighted average cost of capital, is essential for discounting future cash flows and terminal value back to the present value, reflecting the overall risk of the capital structure.