Discounted cash flow method

Description of the Discounted cash flow method and its use cases

The value of the company is primarily based on the forecast of future cash flows. This method is based on the premise of the company as a going concern in perpetuity. Therefore, we can apply a two-phase approach. The first phase represents the future cash flow generated within the projected period, while the second phase takes into account that the company will continue with its operations beyond the projected period.

As a first step we determine the EBIT. Assuming a debt-free enterprise, we adjust the EBIT by the corresponding corporate tax. As a result, we derive the Net Operating Profit after Taxes ( NOPLAT). In order to calculate the discountable free cash flows, we eliminate from the projected NOPLATs the non-cash earnings and expenses and we replace them by the corresponding cash proceeds and outlays (i.e. net working capital and CapEx forecast, among others).

To derive the enterprise, all free cash flows are discounted to the valuation date using the weighted average cost of capital (WACC). Finally, after adjusting the company enterprise value by the Net debt, the resulting equity value is adjusted by the illiquidity discount.

Take aways:
Discounted cash flow (DCF) is a valuation method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future.