The DCF Model: The Complete Guide… to a Historical Relic?

Learn more: breakingintowallstreet.com/co...
For the full written version and Excel files, please see:
www.mergersandinquisitions.co...
Table of Contents:
0:00 Introduction
2:29 Part 1: The Big Idea Behind a DCF
5:21 Part 2: Company/Industry Research
8:36 Part 3: DCF, Step 1: Unlevered Free Cash Flow
21:46 Part 4: DCF, Step 2: The Discount Rate
28:46 Part 5: DCF, Step 3: The Terminal Value
34:15 Part 6: Common Criticisms of the DCF - and Responses
39:09 Recap and Summary

[@financialmodeling]

Note that this is an OVERVIEW video of the DCF modeling process. Since it is an overview, of course, we do not go into each step in excruciating detail. Yes, I know the part on the Discount Rate is short. That is intentional because it would have taken 1 hour+ to explain the full process. The goal here was to give you a short, free method you can use to approximate it. If you want more on any step of the process, please see the recommended resources in the accompanying articles and the other examples on both sites and this channel: www.mergersandinquisitions.com/dcf-model/

[@blacknoteinvestment3321]

One of the few investing channel that actually gives value to viewers and helps them become better investors, thanks.

[@financialmodeling]

Thanks for watching!

[@yohanmalet2372]

Hands down the best KZbin channel for finance-related videos. Thank you for making so much knowledge available to everyone !

[@financialmodeling]

Thanks for watching!

[@IvanIB-md9hj]

Thank you so much. This was EXTREMELY helpful. I'm in my 2nd year of Uni , and around two weeks ago I participated in an investment banking case competition with literally ZERO IB knowledge. I dedicated myself to intensive preparation, and ended up winning first place! I have an upcoming interview with TD Securities based on that case competition win, and your videos and website have been so helpful I can't even explain. If I land this summer role I'll be forever indebted to you

[@financialmodeling]

Thanks for watching and good luck!

[@juhwapark8111]

cant believe I just discovered you! my life would have been in such a better condition if i found your channel during my college years. thank you very much. :) you da best

[@financialmodeling]

Thanks for watching

[@danzz7583]

The quality of your lesson inspires me to do better, no cap. Excellent stuff

[@financialmodeling]

Thanks for watching!

[@chika7343]

Thank you for sharing this! I love all your contents!

[@financialmodeling]

Thanks for watching!

[@user-or7ji5hv8y]

This is really practical and well explained.

[@financialmodeling]

Thanks for watching!

[@kurado21411]

Very informative video.. I love it. Thank you so much!

[@financialmodeling]

Thanks for watching!

[@AwesomeCrackDealer]

Incredible video!

[@financialmodeling]

Thanks for watching!

[@johnlau8461]

Very detailed DCF model and thanks for the template as well. Can you tell us more about how you project the growth of the financial metrics here? Using its history, or analyst report? Especially it dsnt change linearly with time. Such as the projected growth rate of retail sqaure feet, it changes in 0.5% increment with 0.5% per 2 year at first, and completely stops for the last four years. I am really curious on how you decided this pattern.

[@financialmodeling]

When there is uncertainty, the best approach is to build in scenarios and/or sensitivities to look at different potential outcomes. We skipped it here because this is a simplified example. With something like the growth in square feet, the exact change each year doesn't matter that much - what matters is the average annualized change over the projected period. Is it a 10% growth company? 5%? Something else? The annualized rate here is ~1%, which about matches Walmart's annualized growth over the past 5-10 years. We assumed higher growth in the beginning falling to lower numbers at the end to get there. Mature companies rarely tend to start growing at rates outside the historical average.

[@cristianojunior3829]

Hey, thanks for the video! It was very helpfull. One question: if we use a 3-financial-statement model to project the cash flows, would we get a more precise result? Usually I use the 3-statement-financial model when doing a DCF, but this looks way more practical and less time consuming.

[@financialmodeling]

A 3-statement model is not at all necessary for a valuation or DCF, which is why we usually skip it. The results would be better only if Working Capital were extremely important to the company, which is rare. To calculate UFCF, all you need are revenue, expenses, non-cash adjustments, Change in WC, and CapEx... so you can project just those and ignore the rest of the statements.

[@WhiteCarBlackWheels]

the pre-tax cost of debt formula gave me 5 secs of anxiety haha! great work as always, thanks for keeping us informed. tho much easier way of analyzing a company than this is just buying whatever wallstreetbets tells us to buy...

[@financialmodeling]

Just wait for the WallStreetBets ETF...

[@chiragdalal5548]

A great video where you have covered all the necessary points. I just have one issue with it at 31:40 mins. To check the EBITDA multiple as per the perpetuity method in TV, you divide the TV by EBITDA and get 12.3x. Now to find the TV using EBITDA multiple, we must use a computed EBITDA multiple from the market and not merely pick up the 12.3x that we calculated in the previous method. Because if you do that, you are essentially just saying that x*y=z, therefore x=z/y. If we have a multiple computed using comparables, then we apply the said multiple to the EBITDA of the last year which results in the save TV using Multiples method and Perpetuity, that is when we can confirm that both our methods draw the same results. Hope makes sense. Happy to connect via email to discuss.

[@financialmodeling]

The point of this method is that the Perpetuity Growth Rate method is the most reliable way to calculate Terminal Value. If you use multiples from the comps, you could get implied growth rates that are wildly off the mark because you don't know how these multiples will change over the long term as companies mature and growth rates slow down. You could do plenty of more complicated things to estimate Terminal Value, but we didn't really have time to go into a detailed explanation here in this short overview video.

[@michaelb1544]

Great content! 1. Can you give a little clarity about the deferred income tax? is it the result of a mismatch between tax statements and financial statements? does it imply that a firm can push back its income tax and thus it pushes up the UFCF number? 2. What is an optimal level for NWC? as changes driven by higher A/P relative to A/R and inventory also happen to push the UFCF up? i'm sure it's way more intricate than that.

[@financialmodeling]

1) It's not exactly a mismatch but because of items like accelerated depreciation, R&D tax credits, etc. that may reduce a company's cash taxes. And yes, it does imply that companies can play tricks with these items to record a high Pre-Tax Income while paying much less than expected in Cash Taxes. 2) It's completely dependent on the industry and company. But the key point is that the Change in WC is rarely, if ever, a key value driver in a DCF, so it's not worth thinking about in detail unless the company is very unusual.

[@goncalosilva200]

Outstanding video, thank you for this. I just have two questions regarding the discount rate. 1) Shouldn't we model different risk-free scenarios (e.g.: yields could escalate above 2% and that would make companies less valuable) 2) Imagine we are talking about Alibaba, which trades both at the Hong Kong Stock Exchange, but also has ADS on Nasdaq. In this case, which risk-free rate and equity risk premium should we use? Thank you in advance!

[@financialmodeling]

1) Yes, it would be better to model multiple scenarios, but this is a simplified model, and it was already running long. It's most useful to include multiple operational scenarios, though. The Discount Rate is better dealt with in sensitivity tables. 2) You should use the "original" stock exchange whenever possible, so the risk-free rate should be tied to the 10-year Chinese government bond yield (since Alibaba operates primarily in China), and the equity risk premium should be based on the HK stock exchange data.

[@CriptoFarmItalia]

I love y channel, tnk for new video.

[@financialmodeling]

Thanks for watching!

[@Slickrussian]

Great video

[@financialmodeling]

Thanks for watching!

[@forfreedomssake4315]

thanks thanks thanks. Bless you man

[@financialmodeling]

Thanks for watching!

[@mrworldwork]

Quick question, for the exit multiple method to calculate terminal value - are you using an LTM multiple or multiply against the final year EBTIDA? Or should we be using forward multiples instead? Thanks!

[@financialmodeling]

You usually want to pick a multiple that is somewhat lower than the forward multiples from the public comps. But the real answer is "Pick a multiple that implies a long-term growth rate below the rate of long-term GDP growth in the country."

[@mattrushmere]

Brian thank you for such a fantastic video. Would it be possible to cover NAV modelling for oil E&P companies in a future video? Thanks again!

[@financialmodeling]

There are videos on E&P companies and elements of the NAV model elsewhere in this channel. But we don't officially cover energy anymore.

[@oldJimmyWales]

Hey, would capitalized interest be a capital outlay that should be discounted by WACC or should only be included as a leveraged outlay and discounted by the cost of equity?

[@financialmodeling]

Capitalized interest should not be a part of an Unlevered DCF at all because it relates to the company's capital structure. If you're using a Levered DCF (not recommended at all), you can deduct the capitalized interest there and consider it a cash outflow because it increase the company's debt principal, reducing its value to shareholders in the future.

[@user-user101]

Hi Brian - Thanks for the video! How did you obtain the value of Median TEV / EBITDA of Comps for the Terminal Value - Multiples Method?

[@financialmodeling]

This came from Capital IQ data. But you can find this information from publicly available data for the peer companies as well - look at the video on Comparable Company Analysis in this channel.

[@bilhanbilge1382]

Official tax rate vs effective tax rate, can we use both to calculate DCF as long as it's the same both in cost of debt and free cash flow calculation?

[@financialmodeling]

Yes

[@sonerguney3225]

Very good

[@financialmodeling]

Thanks for watching!

[@casvallee556]

Thx Brian good stuff. One question where did u get the 9,179 NOL number?

[@financialmodeling]

It's in the footnotes somewhere in the Walmart filing. Search for "Deferred Tax Asset" or "Net Operating Loss" or similar terms.

[@giuseppebv9068]

Just a quick question/consideration: How experienced do you need to be to understand the full content of this video? Because I am thinking to get into investment banking at an entry-level and I'm trying to study some concepts that I knew but not so in-depth like DCF modelling, WACC etc., and I found this video quite hard to follow at some stages. Do you think I should consider a different career path?!

[@financialmodeling]

It's difficult to answer this question because I don't know much preparation work you've done so far. I would recommend starting with accounting and the financial statements before moving to valuation, or it will be difficult to understand. This channel presents free samples and tips on specific topics but does not offer structured/sequential training, which is available in our courses.

[@berkaycelikkol4711]

Hey Brian, I was looking into valuating American Express and got stuck with finding key value drivers. There is not much information on 10-K, and I was. thinking moving with Number of Cards in Force or Number of Transaction. How do you think I should approach this? Thanks!

[@financialmodeling]

We cannot advise on specific case studies, homework assignments, or independent work in this free channel, only the content that is here. My recommendation would be to use the most accessible data here with the best historical trends, and to remember that since AmEx earns a huge amount of net interest income, it's really more like a bank... so you should be using a Dividend Discount Model rather than a DCF.

[@KrishanSingh-gz9op]

My question is what if the cash flow (or earnings) growth rate is same as the capex ( all the earnings went into expansion), then in this case free cash flow will be zero. Then what we forecast and discount in DCF? In other words, my question is, In early stage of a business if the Capex is greater than the Cash flow from operations, then how to project Free cash flow growth into the future?

[@financialmodeling]

You have to assume that eventually Free Cash Flow turns positive at some point in the future. Most companies do not require the same capital intensity to maintain their business or grow it at a low rate, even ones that depend on physical assets. You can look at similar companies that grew quickly and then matured to benchmark this.

[@chrishenriksson2942]

Wow... Thanks alot.

[@financialmodeling]

Thanks for watching!

[@himanshuverma9723]

Hi, to calculate EBIT, why haven't you deducted D&A from sales, is it assumed to be a part of Opex??

[@financialmodeling]

If D&A is not shown separately on the Income Statement, you can assume it is embedded in COGS, OpEx, or a mix of both, so EBIT should reflect this full deduction.

[@nobobonobo]

Can you please elaborate why you prefer unlevered free cash flows in DCF? Is it mostly because levered free cash flow is harder to model? I wonder how much the company's financial structure could affect the value of a share, and whether or this could skew the value calculation.

[@financialmodeling]

It's because Unlevered FCF tends to produce more consistent results that do not depend on the company's capital structure. Capital structure usually only makes a big difference in valuation at the extremes, i.e., if a company has so much debt it is on the verge of bankruptcy. Within normal debt/equity levels, you adjust for it via the Discount Rate and don't pay much attention if it's within range of other companies in the sector.

[@nobobonobo]

@@financialmodeling fair enough, thanks for the explanation

[@shocktrop]

How did you find the net operating losses of $9179? Can't find this on your reference material

[@shocktrop]

Found it. it should be under deferred tax asset on the 10k

[@aplaexwdikio3190]

Hi Brian, I have a few questions. What is the difference between minorty interest and equity investments? Shouldn't these values be the same? I see in your Excel, that to arrive at the "current enterprise value" you subtract the equity investment and add the minority interest to your "current equity value". Could you please explain your thought process on this? I know that we add the minority interest but I cannot understand why you subtract the equity investment. Many thanks for your content man, it is highly apprecated.

[@financialmodeling]

Please see the tutorial in this channel on equity investments and the ones on Enterprise Value. Also, see the ones on Noncontrolling Interests. This one explains the Enterprise Value bridge: kzbin.info/www/bejne/q5TJeYmAjJihr68

[@tarunsodvadiya]

I have a very simple question. So when we talk about Minority Interests, do we take the value from balance sheet or we take the value from p&l. I noticed you have used the noncontrolling interest from balance sheet. Can you tell us why is that please?

[@financialmodeling]

If you're asking about what to use in the TEV bridge at the end, you always use the Balance Sheet number for Noncontrolling Interests or the fair market value if you can find it. The Income Statement number does not represent the value of that item, only the Net Income earned by the partially owned company in a specific period. See the tutorials here on Noncontrolling Interests.

[@tarunsodvadiya]

@@financialmodeling Thank you so much! I think it answers my question. I did see the tutorial on Noncontrolling Interests, but I still a little confusion. Hence, I had to ask. I really appreciate your swift response.

[@civirus0796]

How come the cost of debt is the yield? The yield is what debt holders earn considering they reinvest the proceeds, therefore how can that reinvestment assumption also be applied to debt issuers

[@financialmodeling]

The Yield to Maturity on Debt represents what it would cost the company if it issued a *new* Debt issuance today, and that's also what the Cost of Debt is supposed to represent. You can't go by coupon rates on existing issuances because interest rates and company credit quality change over time. If the coupon rates are 5%, but interest rates have changed since the issuances took place, the YTM will be different because the bond prices will change. Investors now have different yield expectations.

[@domvk3082]

If in the denumerator for Enterprise Value, Operating Leases are added, why in the corresponding numerator is the operating lease expense deducted to arrive at thr FCFF?

[@financialmodeling]

You have it reversed. If Operating Leases are added in Enterprise Value, the numerator of any valuation multiple, then the corresponding lease expense must be *added back* or *excluded* in the denominator. In a DCF, we almost always deduct the entire lease expense in the projections to simplify the treatment and avoid the need to deal with leases in the WACC calculation. In that case, leases should not factor into Enterprise Value or the Enterprise Value to Equity Value bridge at the end.

[@domvk3082]

@@financialmodeling Damn, you guys are the best! Thanks

[@sonerguney3225]

Thıs presentation is very good. Can we have the related Excel version? Thanks

[@financialmodeling]

mergersandinquisitions.com/dcf-model/

[@robimgabriel8063]

Thank you for the video, very comprehensive in nature regarding a somewhat complex subject. I have a question on a table @33:56 that really caught my attention: how do you setup a table of the discount rates and unlevered free cash flow growth rates to procede with a sensitivity analysis?

[@financialmodeling]

That's a sensitivity table, which we cover in the Excel training on our site... at a basic level, press Alt, D, T in Excel or go to Data --> What If Analysis --> Data Table and enter the assumptions there. For more, please see: breakingintowallstreet.com/biws/kb/excel/sensitivity-analysis-excel/

[@deepakj1809]

@@financialmodeling will definitely enroll

[@KrishanSingh-gz9op]

I have two questions related to beta Question1:- The formula for linear regression is Y=b0+ b1X+ € Where b0 is the y-intercept; b1 is the slope; & € is the error. Which one represents the beta? Question 2:- Why is the beta calculated using regression, or covariance/variance method; or the slope method is Levered beta.? We never added or calculated the debt of the company in our beta calculation. We just downloaded the stock & market returns data of previous years & loaded it on the excel & applied the formulas for beta calculation. So how it became Levered OR why the beta calculated using above methods is called as levered?

[@financialmodeling]

So, we do not answer questions about topics not covered directly in these videos, and no one ever calculates Beta manually, so I cannot help with question #1. With question #2, the company has already had debt through all the months and years used in the Beta calculation, which means it is already Levered Beta by default since these data sources do not remove the company's leverage when calculating it.

[@cafeaulait69]

I thought only cash taxes are included in UFCF not deferred tax, is that correct?

[@financialmodeling]

A DCF should reflect a company's Cash Taxes, but typically you calculate Cash Taxes by taking Book Taxes (should be negative on the IS) and then adding the Deferred Taxes on the CFS (could be either positive or negative). Cash Taxes could be anything from 0 to negative based on that math.

[@KrishanSingh-gz9op]

At 25:15, why we calculated the unlevered beta of other companies , why not simply take walmart's levered beta and then unlever it? Or Why are we taking median value of all companies.

[@financialmodeling]

Please see the WACC Formula video for an explanation of this point.

[@Muskaan942]

Why cant i find the excel template even on the webpage he suggested?

[@financialmodeling]

The direct link is here: youtube-breakingintowallstreet-com.s3.amazonaws.com/107-25-Walmart-DCF-Model.xlsx

[@yasseransari]

Can I do a DCF model on a company that is not making money right now? But in the future, it will. so the expenses come higher than the revenue which gives it a negative cash flow, so is that okay in a DCF model?

[@financialmodeling]

Yes. Please see the Uber or Snap examples in this channel.

[@LucasMartins-el7kn]

Do you have a course that teaches how to invest your own money in the stock market/REITs? I'm not looking to get a job in this field, I just would like to learn how to make better financial decisions for myself.

[@financialmodeling]

I replied to your email separately, but our courses don't focus on this topic. You might gain something out of them, but they're geared toward job seekers in the finance industry.

[@gmax0]

Why do you assume that all Cash Flows happen at the end of the period? Why don't you use a mid-year conception for discounting Cash Flows?

[@financialmodeling]

You could use the mid-year convention, but it tends to make a very small difference (1-2%) in most models. And this was an introductory/overview video, so we didn't have time to get into all the nuances and special features of a DCF (stub periods, mid-year convention, normalized Terminal Year, changing Discount Rates, different growth stages, etc.). Some of these topics are covered elsewhere in the channel.

[@shocktrop]

How did you get $150/sqft for growth capex?

[@financialmodeling]

A rough estimate based on usual maintenance CapEx per sq ft levels when the company's retail square feet did not change in a few years, plus the company's $14 billion CapEx estimate. $14 billion Total CapEx - Estimated Maintenance CapEx on Existing Square Feet = Growth CapEx, which we then link to the # of new square feet in the first projected year.

[@shocktrop]

@@financialmodeling Thanks! I also found this on page 42 of the 2021 walmart 10-k report

[@ggawsomeness6650]

I'm confused as to why you'd take FY22's Maintenance CapEX per SqFt and multiply that by FY21's SqFt. Wouldn't you spend money on FY21 to maintain 2021's Square feet.

[@financialmodeling]

The idea is that Maintenance CapEx for the current year corresponds to assets that already existed in the previous year. If new assets were built in FY 21, Maintenance CapEx does not kick in until FY 22 for those assets.

[@mistertrailerman]

With with what walmart is going to do…I would agree it’s undervalued too!

[@financialmodeling]

Yeah, maybe. Though the price hasn't changed much in the past year.