DISCOUNTED

CASH FLOWS
METHOD
 In Financial Management, it has been dis cus s ed that a way to
determine the va lue of a n investment opportunity is by determining
the actual cas h generated by a particular as s et.

The Net Cash Flows refer to the amount of cas h available for
distribution to both debt and equity claims if the busines s or a s s et.

For GCBO, the net cas h flows generated will be bas ed on the
cash flows from opera ting and investing activities, since this
repres ents already the amount earned from the bus ines s and the
a mount ea rned or will be earned from the business and the a mount
that is required to be infus ed in the operations to generate more
profit.
 Net Cash Flows is preferred to as bas is of valuation if any of
the following conditions are present:

• Compan y does not pay dividends.

• Compan y pays dividends but the amount paid out significantl y differs from it’s capaci ty
to pay dividends.
• Net Cash Flows and profits are aligned within a reasonable forecas t period.
• Investor has a contr ol perspectiv e. If an investor can exert control over a compa ny,
dividends can be adjuste d based on the decision of the contr olli ng investor.
• EBITDA and EBIT are both metrics that are before taxes; cash flows that are available to
investors should be after satisfying tax requirements of the governm e nt.
• EBITDA and EBIT also do not consider differenc es in capital structures since it does not
captur e interest payments , dividends for preference shares and funds sourced from
bondhol de rs to fund additional investments.
• All these measures also do not consider reinvestme nt of cash flows made into the firm for
additiona l working capital and fixed assets investment that are necessar y to maximize long
term-sta bili ty of the business.
In valuation, analys ts find analyzing cas h flows and it’s s ources helpful in
u n ders tanding the following:
• Source of financing for needed inves tments
• Reliance on debt financing
• Quality of earnings

Th ere are two levels of Net Cash Flows :

(1) Net C as h Flows t o t he Firm -is the amount made available to both debt
an d equity claims agains t the company.

(2) Net C ash flows to Equi ty - repres ents the amount of cas h flows made
available to the equity s tockholders after deducting the net debt or the
ou ts tanding liabilities to the creditors les s available cas h balan ce of the
company.
 NET C A SH FLOW T O T HE FI RM

N et cash fl ow to the firm refers to the cash flow av ailab le to the

p arties who sup p lied cap ital (i.e.) l end ers and shareholders) after
p aying all op erating ex p enses, includ ing tax es, and inv esting in
cap ital ex p enditures and work ing cap ital as req uired b y b usiness
need s.

Enterp rise v al ue of a comp any refers to the theoretical v alue of

it’ s core b usiness activ ities as reflected b y it’ s net cash flows.
 A . BA S E D FROM NET I NC OME ( OR I NDI RE CT A P P ROACH )

• Ne t In co m e Ava i la ble to C o m m o n S h a r e h o lde r s

Basi c m easure of a firm ’s p rofit ab ilit y which refers t o t he b ot t om li ne i n an i ncom e
st at e m e nt .
• No n - C a s h C h a r ge s (Ne t)
Pert ains t o non -cash it em s t hat are includ ed i n t he com put at i on of net incom e.
• Depreciation and amortization
• Restructuring chargers
• Provisions for Doubtful Accounts
• After -Tax Interest Expense Interest expense (net of any
tax savings)
• Working Capital Adjustment
• Investment in Fixed Capital
B. F ROM S T A T EMENT OF C A S H F LOW S

• C a s h f l o w fr o m o pe r a ti n g a cti vi ti e s
Thi s re p resent s how m uch cash t he com p any generat ed from it ’s op e rat i ons.
• C a s h flo w fr o m i nves ti ng a cti vi ti es
Thi s re p resent s how m uch cash is d isb ursed (received ) for invest m e nt s i n (sale of)
long-t erm asset s like propert y , p lant and equipm ent and st rat egi c i nvest m ent s in ot her
com p ani e s.
• C a s h f l o w fr o m fi n a n ci n g a cti vi ti e s
This represent s how m uch cash was rai sed (or rep ai d) t o finance t he com pany .
C . F ROM EA RNI NGS BEFORE I NT EREST, T A X ES, DEP RECIAT ION
A ND A M P RT IZAT ION ( EBI T DA)

• EBITDA or Earning Before Interest, Taxes, Depreciati on and Amortizat i on

pertains to income before deducting interest, taxes, depreciati on and
amortiz ati on, net of taxes.

• Tax Savings on Non - Cash Charges

Non-cash charges are not typicall y adjusted if NCFF starts with
EBITDA.
NET C A SH FLOW T O EQUI T Y

• P r o ceeds fr o m Bo r r o wi ng - t hi s refers t o t he am ount of cash received by t he

com p any as a result of b orrowing of long -t e rm d e b t .
• Debt Service - is the total amount used to service the loans or debt financing.
• P r o ceeds fr o m Is s ua nce o f P r ef er r ed S ha r e s - sam e wi t h d eb t , p referred shares as
anot he r form of financing, ot her t han t he issuance of ord inary eq ui t y , m ust also b e
fact ore d in t he calculat ion of net cash flows availab le t o eq uit y .
• Dividends on Preferred Shares - since payments made to preferential
shareholders in the form of dividends are outflows .This must be incorporated in
the calculation as a reduction of the net cash flows to the equity.
A . BA S ED FROM NET I NC OME ( OR I NDI RECT A P P ROACH )
B. F ROM S T A T EMENT OF C A S H F LOW S
C . F ROM EA RNI NGS BEFORE I NT EREST, T A X ES, DEP RECIAT ION
A ND A MORT IZAT ION ( EBIT DA)
TERMINAL VAL UE
T erminal V al ue rep resents the v al ue of the comp any in
p erp etuity or in a g oing concern env ironment. In p ractice, there
are sev eral ways on how to d etermine the terminal v alue.
BASIS OF TERMINAL VAL UE

1 . L iquida tion Va lue

2 .E s tim a te d Pe rp e tua l V a l ue

F or example, a Filipino company is

expecting for 15% returns for a venture and
assumes that their net cash flows for the
next five years are as follows:
In the given illustration, you may note that the net cash flows are growing annually. Assuming
this is a GCBO, and it is expected that the net cash flows will behave on a normal trend. The
growth rate (g) is computed using compounded annual growth rate formula:

S ub st i t ut i ng t he given figures, t he growt h is com p ut ed as :

Since the growth rate is 10%, it will be applied on the farthest cash flows i.e. on
the 5th year equivalent to Php 7.32, thus the farthest cash flows is now Php 8.05
or will substitute the CFn+ 1. It is now assumed that the cash flows will
continuously growth at the rate of 10% per annum. thus, the formula can now be
applied.
In some cases, that the historical growth pattern undetermined, some analysts
only consider the cost of capital or their required return to determine the
terminal value. In the given illustration, you may note that difference on the
terminal value:

You may observe that the terminal value in this case is more conservative by
about Php107.
BASIS OF TERMINAL VALUE

3. Constant Growth

4. Scientific Estimates

OTHER INPUTS IN THE NET CASH FLOWS

DCF Analysis is most applicable to use when the following are available:

• Validated Operational and Financial Information

• Reasonable appropriated cost of capital or required rate of return
• New quantifiable information
Illustrative Example No. 1
Bagets Corporation has projected to generate revenues, cash operating expenses, and the
corresponding tax payments for the next five years:

The investment in fixed capital that was purchased and invested in the company amounted to
Php100 million. To be financed by:
• 60% from loan borrowing with an annual interest of 10% payable equally in five years. First
payment will be due after 1 year, and
• 10% preferred shares with 8% coupon rate.
If you are going to purchase 50% of Bagets Corporation, assuming a 15% required return, how
much would you be willing to pay?
Bagets Corporation Discounted Cash Flows Analysis
Financial Models in Discounted Cash Flows
Analysis

1. Gather historical information and references

2. Establish drivers for growth and assumptions