## We’re creating a DCF for a company that is planning to buy a factory for \$100 in cash (no debt or other financing) in Year 4. Currently the present value of its Enterprise Value according to the DCF is \$200. How would we change the DCF to account for the factory purchase, and what would our new Enterprise Value be?

In this scenario, you would add CapEx spending of \$100 in year 4 of the DCF, which would reduce Free Cash Flow for that year by \$100. The Enterprise Value, in turn, would fall by the present value of that \$100 decrease in Free Cash Flow. The actual math here is messy but you would … Read more We’re creating a DCF for a company that is planning to buy a factory for \$100 in cash (no debt or other financing) in Year 4. Currently the present value of its Enterprise Value according to the DCF is \$200. How would we change the DCF to account for the factory purchase, and what would our new Enterprise Value be?

## When you’re calculating WACC, let’s say that the company has convertible debt. Do you count this as debt when calculating Levered Beta for the company?

Trick question. If the convertible debt is in-the-money then you do not count it as debt but instead assume that it contributes to dilution, so the company’s Equity Value is higher. If it’s out-of-the-money then you count it as debt and use the interest rate on the convertible for Cost of Debt.

## Walk me through a Dividend Discount Model (DDM) that you would use in place of a normal DCF for financial institutions.

The mechanics are the same as a DCF, but we use dividends rather than free cash flows: 1. Project out the company’s earnings, down to earnings per share (EPS). 2. Assume a dividend payout ratio – what percentage of the EPS actually gets paid out to shareholders in the form of dividends – based on … Read more Walk me through a Dividend Discount Model (DDM) that you would use in place of a normal DCF for financial institutions.

## If I’m working with a public company in a DCF, how do I calculate its per-share value?

Once you get to Enterprise Value, ADD cash and then subtract debt, preferred stock, and minority interest (and any other debt-like items) to get to Equity Value. Then, you need to use a circular calculation that takes into account the basic shares outstanding, options, warrants, convertibles, and other dilutive securities. It’s circular because the dilution … Read more If I’m working with a public company in a DCF, how do I calculate its per-share value?

## How does the terminal value calculation change when we use the mid-year convention?

When you’re discounting the terminal value back to the present value, you use different numbers for the discount period depending on whether you’re using the Multiples Method or Gordon Growth Method: Multiples Method: You add 0.5 to the final year discount number to reflect the fact that you’re assuming the company gets sold at the … Read more How does the terminal value calculation change when we use the mid-year convention?

## What discount period numbers would I use for the mid-year convention if I have a stub period – e.g. Q4 of Year 1 – in my DCF?

The rule is that you divide the stub discount period by 2, and then you simply subtract 0.5 from the “normal” discount periods for the future years. Example for a Q4 stub:

## Explain why we would use the mid-year convention in a DCF.

You use it to represent the fact that a company’s cash flow does not come 100% at the end of each year – instead, it comes in evenly throughout each year. In a DCF without mid-year convention, we would use discount period numbers of 1 for the first year, 2 for the second year, 3 … Read more Explain why we would use the mid-year convention in a DCF.

## A company has a high debt load and is paying off a significant portion of its principal each year. How do you account for this in a DCF?

Trick question. You don’t account for this at all in a DCF, because paying off debt principal shows up in Cash Flow from Financing on the Cash Flow Statement – but we only go down to Cash Flow from Operations and then subtract Capital Expenditures to get to Free Cash Flow. If we were looking … Read more A company has a high debt load and is paying off a significant portion of its principal each year. How do you account for this in a DCF?

## What types of sensitivity analyses would we look at in a DCF?

Example sensitivities: – Revenue Growth vs. Terminal Multiple – EBITDA Margin vs. Terminal Multiple – Terminal Multiple vs. Discount Rate – Long-Term Growth Rate vs. Discount Rate And any combination of these (except Terminal Multiple vs. Long-Term Growth Rate, which would make no sense).

## Why would you not use a DCF for a bank or other financial institution?

Banks use debt differently than other companies and do not re-invest it in the business – they use it to create products instead. Also, interest is a critical part of banks’ business models and working capital takes up a huge part of their Balance Sheets – so a DCF for a financial institution would not … Read more Why would you not use a DCF for a bank or other financial institution?