Danna

1. Limitations of DCF?
Discounted cash flow analysis is a type of analysis that determines a company’s
or investment’s value based on what it might earn in the future. The goal of the study is
to figure out what the present worth of expected future profits is.
Discounted cash flow has certain disadvantages, one of which is that it is based on
future cash flow forecasts. While these forecasts are based on current cash flow, they are
better described as attempts to forecast the future. They can be quite wrong, especially
when analysts are attempting to forecast cash flow over multiple years. As a result of
these flaws, the discounted cash flow analysis may yield an erroneous value. A
discounted cash flow analysis has its own set of restrictions, since it necessitates the
collection of a large quantity of data and depends on assumptions that might be incorrect
in some circumstances.
The biggest drawback of DCF is that it necessitates a lot of assumptions. For one
thing, an investor would have to accurately anticipate future cash flows from a project or
investment. Future cash flows would be determined by a number of factors, including
market demand, economic conditions, technology, competition, and unanticipated
dangers or opportunities.

Overestimating future cash flows can lead to the selection of an investment that
may not pay off in the long run, reducing earnings. Estimating cash flows too low, which
makes the venture look more expensive, might lead to missed opportunities. Choosing a
discount rate for the model is also an assumption that must be accurately estimated for
the model to be useful.

The following are the main drawbacks or limitations of a discounted cash flow
analysis:
A. Requires Significant Data, Including Data on Projected Revenue and
Expenses
 A discounted cash flow analysis requires a significant amount of
financial data, including cash flow and capital expenditure predictions
for several years. Gathering the necessary data may be challenging for
some investors; even simple operations take time.
B. Sensitive to the Projections It Relies On
 The study’ factors, which include future cash flow predictions, the
investment’s perpetual growth rate, and the discount rate that experts
say is appropriate for the investment, are all quite sensitive.
C. Analysis Depends on Accurate Estimates
 The estimates and forecasts that are used in a discounted cash flow
analysis are only as good as the estimates and projections that are
used.
D. Prone to Complexity
  The analysis might become unduly complicated due to the data
required for the discounted cash flow formulae.
E. Doesn’t Consider Valuations of Competitors
 Discounted cash flow has the advantage of not having to evaluate the
worth of rivals, but this may also be a negative. In the end, DCF values
might be far off from the true worth of competing firms or similar
assets. That might indicate that the other business valuations are
incorrect, but it could also indicate that the discounted cash flow
estimate is flawed because it ignores market realities.
F. The Terminal Value Challenge
 The terminal value of the investment, which is the current value of a
firm or investment after a multiyear projection period, is an important
aspect of the discounted cash flow calculation. That terminal value
may be the overall worth of the firm or investment if it were sold at the
end of the forecast period, or it could be the assumed cash flow in all
future years beyond the forecast period. In any case, estimating the
final value is quite difficult. It also accounts for a significant amount
of the overall value generated by the discounted cash flow
methodology.
G. Difficulties with Weighted Average Cost of Capital
 As part of its calculation, the discounted cash flow analysis employs
the subject company’s weighted average cost of capital (WACC),
which measures the company’s cost of capital from all sources. It’s a
tricky number to figure out.

2. What is financial modeling? Why it is useful?

Financial modeling is the process of constructing a spreadsheet that contains a
summary of a company’s costs and earnings and may be used to evaluate the impact of a
future event or decision. For business leaders, a financial model may be useful in a
variety of ways. It is most commonly used by financial analysts to examine and forecast
how future events or executive choices will effect a company’s stock performance.
Financial modeling is a numerical depiction of a business’s activities in the past,
present, and predicted future. Models like this are meant to be used as decision-making
aids. They might be used by company leaders to estimate the expenses and profitability
of a proposed new project. They are used by financial analysts to explain or forecast the
influence of various events on a company’s stock, ranging from internal elements such as
a change in strategy or business model to external ones such as changes in economic
policy or legislation.
Financial models are used to evaluate a company’s value or to compare
companies to their industry counterparts. They’re also utilized in strategic planning to run
simulations, assess the costs of new initiatives, set budgets, and allocate company
resources.
Jessa.
1 What are the advantages and disadvantages of using IRR and NVP?
Internal Rate of Return (IRR): The discount rate employed in capital planning is called
the internal rate of return (IRR). This discount rate is used to reduce the project’s present value
of all cash flows to zero. As a result, the greater the projected rate of return, the higher the IRR.
An investment with a higher internal rate of return is always better to one with a lower internal
rate of return. This IRR may be used to rank the business’s planned projects. As a result, it
demonstrates the maximum rate of growth that a project may achieve. The actual IRR may differ
from the forecasted IRR. It’s possible that this is due to unforeseen market conditions. The
project with the highest IRR, on the other hand, is always predicted to generate bigger returns
than the others.
Advantage of IRR:
Time Value of Money: The IRR Method takes the Time Value of Money into account, making
it extremely trustworthy. The time value of money examines the worth of money in terms of
time, making it more reliable. This functionality is absent from many other projects, which is a
disadvantage.
Simplicity: One of the nicest things about IRR is how simple it is to understand. It’s simple to
use, and the IRR findings, unlike those from other approaches, can be simply evaluated and
taken into account. These are really trustworthy findings. Managers utilize this strategy because
it is simple to use, unless there is a unique case that requires the use of additional ways.
The Required Rate of Return is also known as the Hurdle Rate. It is difficult to determine a
meaningful hurdle rate from which to make conclusions. However, while reviewing the data, the
IRR approach does not consider the Required Rate of Return, which protects this method from
any possibility of incorrect interpretation.
Required Rate of Return is a Rough Estimate: The required rate of return is a rough estimate
that the IRR approach does not fully utilize. When you’ve determined the IRR, you may
compare it to the Required Rate of Return. Because the IRR is unrelated to the needed rate of
return, the management may make their decision with confidence.
DISADVANTAGES:
Ignores Economies of Scale: The IRR technique fully disregards economies of scale. It assigns
a score to each project based on the expected returns.
Mutually Exclusive Projects are those that cannot be approved if one is accepted. As a result,
determining which project provides a greater return not just on a percentage basis but also on a
quantitative level is challenging.
Positive and negative future cash flows: The IRR is calculated by discounting the project’s
future cash flows at a rate that brings them to present value. Cash flows might be both good and
negative. As a result, IRR is predicated on a multiple IRR foundation, making it untrustworthy in
terms of outcomes and interpretation.

The net present value (NPV) of a corporation is measured in dollars. It is the difference between
a company’s present value of cash inflows and present value of cash outflows over a given time
period. NPV estimates a company’s future cash flows of a project. It then uses a discount rate
that accounts for both the project’s capital expenses and risk to convert them into present value
values. Future positive cash flows from the investment are then combined into a single present
value calculation. This sum is subtracted from the investment’s starting capital. In a nutshell, the
net present value is the difference between the cost of a project and the income it generates. The
NPV approach is inherently complicated, because it necessitates assumptions at every level, such
as the discount rate or the possibility of getting the cash payment.
Advantages of the NPV Method:
Increases Company Value: While most techniques employ the required rate of return to choose
which plan or project to pursue, the NPV Method focuses on the Net Present Value produced.
Use of Time Value of Money: The time value of money compares the current worth of money
to the value of money in the future. Similarly, NPV is used to determine the future cash flows of
current projects. As a result, it ensures that this model is adopted with confidence.
Disadvantages:
Prone to Forecasting Errors: Estimates are primarily employed in the NPV. The greater the
danger of mistakes, the longer the project will be in operation. A short-term project estimate may
be more accurate than a long-term project estimate. As a result, forecasting errors may make the
NPV Method ineffective.
Discount Rate Reliability: The Discounting component is the foundation for the NPV Method.
This discounting factor is essentially a rate that is determined based on a guess. If this rate turns
out to be inaccurate, the entire result will be deceptive.
Both IRR and NPV may be used to assess if a project is worthwhile and will bring value
to the organization. One is stated as a percentage, while the other is expressed as a cash amount.
While some people use IRR as a capital planning metric, it has drawbacks since it ignores
changing elements like discount rates. Using the net present value might be more useful in these
situations.

2 When to use enterprise value and equity value?

The term “enterprise value” refers to more than simply the amount of money owed to a
company. It supposedly exposes how much a company is worth, which is important for
comparing organizations with different capital structures because capital structure has no impact
on a company’s value. While the worth of the company’s shares and loans that the shareholders
have made available to the firm is referred to as equity value. The equity value is calculated by
adding enterprise value to non-operating assets (non-operating assets), then subtracting the debt
net of cash available. The value of shareholders’ loans and outstanding (both common and
preferential) shares can then be subtracted from the total equity value.
In mergers and acquisitions, investment bankers and analysts use enterprise value to
determine the company’s market worth. Portfolio managers employ it in their stock selecting
process as well. While portfolio managers utilize equity value/market cap to make strategic
investments. Each market-cap category includes information about the company’s stage, sector
position, stability, business focus, growth potential, price volatility, and risk. There are styles
within each category.
In a merger or acquisition, a business’s enterprise value and equity value are two popular
methods of valuation. Both can be used to value or sell a company, but they provide significantly
different perspectives. While enterprise value, like a balance sheet, provides an accurate
measurement of a company’s whole current worth, equity value provides a snapshot of the
company’s present and possible future value. An enterprise value is a quick and easy approach to
determine the value of a firm for a stock market investor or someone interested in buying a
controlling stake in a company. Owners and present shareholders, on the other hand, frequently
use equity value to aid in future decision-making.
Lara
1. terminal value need to be discounted?
The worth of a project’s predicted cash flow beyond the specified forecast horizon is
known as terminal value. In a discounted cash flow assessment, an estimate of terminal value is
crucial since it accounts for a considerable part of the project value. In this article, we’ll look at
how to determine terminal value in a project finance model.
Similar to discounted cash flow, terminal value focuses on expected cash flows for all
years past the discounted cash flow model's limit. The terminal value of an asset is usually added
to future cash flow predictions and then discounted to the present day. Because the terminal
value is utilized to link the money value between two separate points in time, discounting is
done. The majority of businesses do not anticipate ceasing operations beyond a few years. They
believe that business will continue indefinitely (or at least a very long time). The terminal value
is an effort to predict a company's future worth based on current pricing. Only by discounting
future worth can this be accomplished. Because money's worth fluctuates with time, it's useless
for today's investor to merely grasp a company's nominal value many years in the future.

2.What portion did the terminal value contribute to the enterprise value?
In a DCF analysis, the terminal value (TV) quantifies the worth of a company beyond the
projection period and is the present value of all future cash flows. In a 5-year DCF, the terminal
value can be around 75% of the value and 50% of the value in a 10-year DCF, depending on the
circumstances. As a result, terminal value assumptions must be carefully considered. There are
two techniques for calculating the terminal value.
Most terminal value formulae, like discounted cash flow (DCF) analysis, predict future
cash flows to return the present value of a future asset. The liquidation value model (also known
as the exit approach) entails calculating the asset’s earning capacity using a suitable discount
rate, then adjusting for the projected value of outstanding debt.
The corporation will not be liquidated after the terminal year, according to the steady
(perpetuity) growth model. Instead, it implies that cash flows are reinvested and that the
company can continue to expand at the same rate indefinitely. The multiples technique employs
a multiple of a company’s estimated sales revenues during the last year of a discounted cash flow
model to arrive at the terminal value without any additional discounting.
The terminal multiple technique presupposes that the firm will be valued based on public
market valuations at the conclusion of the projection period. The terminal value is often
determined by multiplying the relevant statistic expected for the previous year by a suitable
multiple (EV/EBITDA, EV/EBIT, etc.).

Marifer
1.Differentiate value enterprise and equity values.
The term "enterprise value" refers to more than simply outstanding equity. It supposedly
exposes how much a company is worth, which is important for comparing enterprises with
different capital structures because capital structure has no effect on a company's value.
Enterprise value calculates the business’ current value similar to balance sheet. The calculation
of enterprise value is the sum of market capitalization and debts minus the cash and cash
equivalents it holds. It accounts the company’s current debts and cash. Debts can be interest due
to shareholders, preferred shares or another things that company host. Enterprise value provides
investors with a fast and easy way to estimate a company’s value.
While the worth of the company’s shares and loans that the shareholders have made
available to the firm is referred to as equity value. The equity value offers snapshot of the current
and potential future value. Equity value uses the same calculation as enterprise value but it add
stock options and convertible securities and other potential assets and liabilities because it
considers factors that may not currently impact the company but can at anytime. Equity value
reveal potential future value and growth potential. Equity value may fluctuate daily with stock
market. However, it helps company owners and shareholders shape future decision.

2.What are the advantages of discounted cash flow?

 Discounted cash flow (DCF) is a valuation approach for estimating an investment’s value
based on predicted future cash flows. DCF analysis aims to determine the current value of an
investment based on forecasts of future earnings. This pertains to decisions made by investors in
firms or securities, such as buying a company or stock, as well as capital budgeting and
operational spending decisions made by business owners and managers.
The use of accurate statistics and the fact that it is more objective than other ways of
assessing an investment are the key advantages of a discounted cash flow analysis.
Extremely detailed: To get at a value, it employs exact data that incorporate crucial
assumptions about a firm, such as cash flow estimates, growth rate, and other factors.
Determines a company's "Intrinsic" Value: This approach is more objective than
others in that it determines value without taking into account subjective market opinion.
DCF Analysis Doesn't Require Comparables: DCF analysis does not necessitate
market value comparisons with similar firms.
Considers Long-Term Values: It evaluates a project's or investment's profits throughout
the course of its whole economic life, taking into account the time value of money.
Allows for Objective Comparison: DCF analysis allows you to examine various types
of businesses or assets and come at a consistent and objective value for all of them.

3.Give 3 types of financial model and explain each.

1.Consolidated Model
A consolidated financial model, also known as a consolidation model, is a financial
model that combines the financial statements of two or more entities to create consolidated
financial statements. Consolidation models combine the financial statements of multiple entities
and often include eliminations to avoid double-counting of line items like revenue and loans
between the entities in the consolidation. a consolidation model that combines the financial
statements of distinct legal entities to produce pro forma consolidated financial accounts.
The financial results of many business units are combined into a single model to create a
consolidation model. The model's initial worksheet is usually a summary or consolidation view
that displays the highest-level numbers (monthly and annual sales, profits, expenses, productivity
rate, and so on) in the form of tables, graphs, or charts. Financial data is shown by departments,
business units, and other tabs in the model. The information from a parent firm and its
subsidiaries is considered as if it came from a single entity in consolidated accounting. On the
parent company’s balance sheet, the business’s total assets, as well as any revenue or costs, are
noted. This information is also included in the parent company’s financial statement. When a
parent firm owns a majority ownership in a subsidiary business and controls more than 50% of it,
consolidated financial statements are utilized. Consolidated accounting is available to parent
firms with more than 20% ownership. If a parent business owns less than 20% of a firm, it must
account for it using the equity method.
Consolidation is typically thought of as a time of indecision that ends when the asset’s
price rises above or below the trading pattern’s prices. When a large news event occurs that has a
considerable impact on a security’s performance, or when a series of limit orders is triggered, the
consolidation pattern in price movements is disrupted. A set of financial statements that displays
a parent and a subsidiary firm as one entity is known as consolidation.

2.Option Price Model

Option pricing models are mathematical models that compute the potential value of an
option based on a set of factors. An option's theoretical value is an estimate of what it should be
worth based on all known inputs. To put it another way, option pricing models tell us how much
an option is worth. Finance experts might change their trading strategies and portfolios based on
an estimate of an option's fair value. As a result, option pricing models are effective tools for
financial professionals who trade options.
Calls and puts are the two main forms of options. A call option offers you the right, but
not the responsibility, to purchase the underlying asset at a fixed price before or on the expiration
date. While a put option contract allows you the right, but not the responsibility, to sell the
underlying asset at a defined price before or on the expiration date.
Different Option Pricing Model
Model of Binomial Option Pricing
A binomial option pricing model is the simplest way to price the options. The assumption
of fully efficient markets is used in this model. The model can price the option at each point in a
specified time frame based on this assumption.
The binomial model assumes that the price of the underlying asset will either rise or fall
over time. We may compute the payout of an option under these scenarios using the underlying
asset’s various values and the strike price of an option, then discount these payoffs to obtain the
option’s current value.
Model of Black-Scholes
The Black-Scholes model was created primarily to price European stock options. The model is
based on specific assumptions about the stock price distribution and the economic environment.
The following are some of the stock price distribution assumptions:1. The stock's continuously
compounded returns are regularly distributed and time independent. 2. Continuously
compounded returns have a known and consistent volatility. 3.The amount of future payouts is
known (as a dollar amount or as a fixed dividend yield).
The following are the assumptions concerning the economic environment:1.The risk-free rate is
well-established and consistent. 2.There are no fees or taxes associated with this transaction. 3.It
is feasible to borrow at a risk-free rate and short sell at no expense.

3.Forecasting Model
Forecasting is a strategy that uses previous data as inputs to produce well-informed
predictions about the direction of future trends. Forecasting is used by businesses to determine
how to allocate their budgets or plan for anticipated costs in the future. This is usually
determined by the anticipated demand for the goods and services provided.
Investors use forecasting to see if events impacting a firm, such as sales estimates, will
cause the price of its stock to rise or fall. Forecasting is also a valuable benchmark for businesses
that require a long-term view of operations. Forecasting is used to solve an issue or analyze a set
of facts. Economists make assumptions about the issue being studied, which must be established
before the predicting variables can be computed. An acceptable data collection is picked and
employed in the alteration of information based on the items specified. The data is examined,
and a prediction is made. Finally, a verification phase occurs during which the prediction is
compared to actual outcomes in order to create a more accurate model for future forecasting.