The purpose of DCF-Valuation is to determine the value of a company in terms of its future cash flows. The cash flows are adjusted with certain items (e.g. those not related to company´s core businesses or those with no cash effect) in order to make sure the flows reflect the actually generated cash as good as possible.
This document describes DCF valuation in detail and in our valuation model. If you would like to get an overview of valuation in general or practical examples (numerical and graphical) about it, then you should look at our valuation tutorial. It approaches equity valuation first with EVA instead of DCF but as the tutorial reveals EVA approach is only an another name for the old familiar DCF valuation. Both end up to identical end result i.e. identical equity valuation.
The underlying idea of DCF-Valuation is to compute the fair value of a company i.e. the intrinsinc value of the company´s share. The potential of the share price (which the investors are particularly interested in) is then computed by comparing the fair value with the current market price of the company´s share. The basic formulation of Discounted cash flow valuation is as follows:
Free cash flow to firm is discounted with WACC to the Year 0 (the forecast year) in order to get the present value of free cash flows. •
Cumulative discounted free cash flow is a yearly item in which all the forecast years´ discounted cash flows are summed up. Hence, the first item is the sum of all forecast years´ free cash flows at present value terms. •
Value of equity FCFF is divided by the number of shares outstanding to get the fair value of the company´s share. More detailed formulation of Discounted cash flow valuation is as follows:
EBIT is adjusted with with Taxes and Share of associated companies´ profit/loss in order to get Operating cash flow - the figure that reflects the cash actually generated by the company much better than the EBIT (accounting figure). •
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