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Discounted Cash Flow (DCF) Tutorial: Wednesday, January 31, 2007
Discounted Cash Flow (DCF) Tutorial: Wednesday, January 31, 2007
Tutorial
Wednesday, January 31st, 2007
Tutorial Objectives
• Basic Underlying Principles
– Time Value of Money
– Present/Future Value
– Opportunity Cost
• What is a business worth?
• What is Free Cash Flow?
• Basics of DCF Analysis
– Compostion
– Computation
– Forecasting
Present Value
• Time Value of Money: A dollar today is worth more
than a dollar tomorrow.
– A dollar today can be invested to earn a rate of return or
interest.
• What is today’s dollar worth tomorrow (future value)?
FV PV (1 i ) N
• What is tomorrow’s dollar worth today (present value)?
PV FV /(1 i ) N
Time Value: Example
• You are given $5,000 and decide to invest it in
the stock market for 10 years and expect an
average annual rate of return of 10%. What is
that $5,000 worth 10 years from now?
FV $5,000 * (1 10%) 10 years
FV $12,969
• Likewise… PV $12,969 /(1 10%) 10 years
PV $5,000
What is a Business Worth?
• A business is worth the present value of the
expected future cash flows of the business.
• A company's stock price is a reflection of the
market's concensus expectation regarding the
value of the equity in the business.
Ex. Target Corp (TGT):
$60 Share Price
x 858.89 Shares Outstanding (mm)
= $51,533 Market Capitalization or Market Value of Equity
• Is the market always right?
Capital Budgeting
• The process of determining how a firm should allocate scarce
resources to available long term investment opportunities
• Decisions whether a company should undertake a given project
• Goal: Increase (Maximize) shareholder wealth
• One capital Budgeting tool is NPV
Add: Depreciation
Less: Capital Expenditures (CAPEX)
S im p le A v e r a g e 6 .6 0 %
W e ig h te d A v e r a g e W e ig h t G r o w th
3 3 .3 % 5% 1 .7 %
2 6 .7 % 1% 0 .3 %
2 0 .0 % 8% 1 .6 %
1 3 .3 % 12% 1 .6 %
6 .7 % 7% 0 .5 %
1 0 0 .0 % 5 .6 %
Forecasting Cash Flows
• Historical Trend Exrapolation