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DCF method of share valuation


Shridhi Jain (Company Secretary)     28 June 2010

Shridhi Jain
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Hi to all,

Anybody can pls provide me the method for valuation of shares by DCF (Discounted Cash Flow) method and how to derive the different figures used in the formula? Kindly reply me soon. Its urgent. If possible, also give some eg.

Thanks in advance....

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Yogesh Bhatt (Company Secretary)     28 June 2010

Yogesh Bhatt
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What Does Discounted Cash Flow - DCF Mean?
A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.  

Calculated as:

Discounted Cash Flow (DCF)



Also known as the Discounted Cash Flows Model.

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Yogesh Bhatt (Company Secretary)     28 June 2010

Yogesh Bhatt
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The discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows available to all providers of capital, net of the cash needed to be invested for generating the projected growth. The concept of DCF valuation is based on the principle that the value of a business or asset is inherently based on its ability to generate cash flows for the providers of capital. To that extent, the DCF relies more on the fundamental expectations of the business than on public market factors or historical precedents, and it is a more theoretical approach relying on numerous assumptions. A DCF analysis yields the overall value of a business (i.e. enterprise value), including both debt and equity.

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Yogesh Bhatt (Company Secretary)     28 June 2010

Yogesh Bhatt
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Key Components of a DCF

  • Free cash flow (FCF) – Cash generated by the assets of the business (tangible and intangible) available for distribution to all providers of capital. FCF is often referred to as unlevered free cash flow, as it represents cash flow available to all providers of capital and is not affected by the capital structure of the business.
  • Terminal value (TV) – Value at the end of the FCF projection period (horizon period).
  • Discount rate – The rate used to discount projected FCFs and terminal value to their present values.

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Yogesh Bhatt (Company Secretary)     28 June 2010

Yogesh Bhatt
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DCF Methodology

The DCF method of valuation involves projecting FCF over the horizon period, calculating the terminal value at the end of that period, and discounting the projected FCFs and terminal value using the discount rate to arrive at the NPV of the total expected cash flows of the business or asset.

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Yogesh Bhatt (Company Secretary)     28 June 2010

Yogesh Bhatt
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Steps in the DCF Analysis

The following steps are required to arrive at a DCF valuation:

  • Project unlevered FCFs (UFCFs)
  • Choose a discount rate
  • Calculate the TV
  • Calculate the enterprise value (EV) by discounting the projected UFCFs and TV to net present value
  • Calculate the equity value by subtracting net debt from EV
  • Review the results

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Nitin Grover (CS)     28 June 2010

Nitin Grover
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Dear Shridhi

I have mailed the format for calculation to you dear.

Pls check

 

Regards

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Yogesh Bhatt (Company Secretary)     28 June 2010

Yogesh Bhatt
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e.g

Compute the net present value for a project with a net investment of Rs. 1, 00,000 and the following cash flows if the companys cost of capital is 10%? Net cash flows for year one is Rs. 55,000; for year two is Rs. 80,000 and for year three is Rs. 15,000. [PVIF @ 10% for three years are 0.909, 0.826 and 0.751] Solution Year Net Cash Flows PVIF @ 10% Discounted Cash Flows 1 55,000 0.909 49,995 2 80,000 0.826 66,080 3 15,000 0.751 11,265 1,27,340 Total Discounted Cash Flows 1,27,340 Less: Net Investment 1,00,000 Net Present Value 27,340 Recommendation: Since the net present value of the project is positive, the company should accept the project.

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CA Shammi Prabhakar (Managing Director)     28 June 2010

CA Shammi Prabhakar
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DCF is the most widely used technique to value shares of a company. It takes into consideration the cash flows arising to the company and also the time value of money. That’s why, it  is so popular. What actually happens in this is, the cash flows are calculated for a particular period of time (the time period is fixed taking into consideration various factors). These cash flows are discounted to the present at the cost of capital of the company. These discounted cash flows are then divided by the total number of outstanding shares to get the intrinsic worth per share.

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Nitesh (service)     28 June 2010

Nitesh
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Start Ups cannot be valued by DCF method. Similarly Insurance Companies should be valued by Embedded value.


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