# Discounted Cash Flow

## 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 …

## 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 …

## 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 …

## 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 …

## 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: