The three key assumptions in a DCF model are: The operating assumptions (revenue growth and operating margins) The weighted average cost of capital (WACC) Terminal value assumptions: Long-term growth rate and the exit multiple.
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.
DCF is a good model, providing its inputs are accurately predictable. That's why DCF works reasonably well with bonds valuation, because bonds' cashflow is reasonably predictable. The discount rate is also known for bonds. For businesses, however, I think the DCF inputs are not predictable to a substantial level.
The enterprise value (which can also be called firm value or asset value) is the total value of the assets of the business (excluding cash). When you value a business using unlevered free cash flow in a DCF model, you are calculating the firm's enterprise value.
Discounted cash flow is a valuation technique that uses expected future cash flows, in conjunction with a discount rate, to estimate the present fair value of an investment. It is a calculation that is concerned with the time value of money, or TVM. TVM is the idea that money today is worth more than money tomorrow.
EV is calculated by adding market capitalization and total debt, then subtracting all cash and cash equivalents. Comparative ratios using EV—such as a comparison of EV to earnings before interest and taxes (EBIT)—demonstrate how EV works better than market cap for assessing a company's value.
The main Cons of a DCF model are:
Prone to overcomplexity. Very sensitive to changes in assumptions. A high level of detail may result in overconfidence. Looks at company valuation in isolation.
The three most common investment valuation techniques are DCF analysis, comparable company analysis, and precedent transactions.
Conclusion. For SaaS companies using DCF to calculate a more accurate customer lifetime value (LTV), we suggest using the following discount rates: 10% for public companies. 15% for private companies that are scaling predictably (say above $10m in ARR, and growing greater than 40% year on year)
A three-statement model links the income statement, balance sheet, and cash flow statement into one dynamically connected financial model.
The first stage may have the companies grow at unearthly speeds of 50%, 100% or 200% a year. The second stage could have the companies grow at more earthly rates of 15%, 20% or even 30%. The third stage could have the growth rates decline steadily to terminal or horizon stage growth rates.
Summary. Discounted cash flow (DCF) evaluates investment by discounting the estimated future cash flows. A project or investment is profitable if its DCF is higher than the initial cost. Future cash flows, the terminal value, and the discount rate should be reasonably estimated to conduct a DCF analysis.
However, some common key drivers are revenue growth, operating margin, discount rate, and terminal value. Revenue growth reflects the market size, demand, and competitive position of the company or project, while operating margin measures its profitability and efficiency.
DCF investigations are initiated for various reasons, all indicating concern for a child's well-being. The primary goal of these inquiries is to verify that children are in safe living environments. Key triggers for investigations include reports of neglect, physical, emotional, or sexual abuse.
Level 3 is unique. This tier was created as a kind of “none of the above” category for perceptible yet hard-to-value assets with no observable inputs. Generally speaking, Level 3 Inputs either are illiquid or traded so rarely there is no independent market price.
Three major categories of equity valuation models are present value, multiplier, and asset-based valuation models.
Appraisers utilize three primary approaches to value when assessing a property: the Sales Comparison Approach, the Cost Approach, and the Income Approach.
A discounted cash flow (DCF) analysis is highly sensitive to key variables such as the long-term growth rate (in the growth perpetuity version of the terminal value) and the weighted average cost of capital (WACC).
DCF Valuation truly captures the underlying fundamental drivers of a business (cost of equity, weighted average cost of capital, growth rate, re-investment rate, etc.). Consequently, this comes closest to estimating intrinsic value of the asset/business. Unlike other valuations, DCF relies on Free Cash Flows.
Sensitivity to Assumptions
The reliance on assumptions is the main drawback of the DCF approach, in which minor adjustments to key assumptions could have material impacts on the DCF valuation.
A good enterprise value is subjective and depends on the industry, company size, and market conditions. However, you can use EVs to calculate important financial ratios, such as EV to EBITDA, which you've already seen can help assess a company's financial health and profitability.
Businesses calculate enterprise value by adding up the market capitalization, or market cap, plus all of the debts in the company. The calculation for equity value adds enterprise value to redundant assets. Then, it subtracts the debt net of cash available.
Equity value is calculated by multiplying the outstanding shares by the market share price. Another way of calculating equity value is by subtracting the net debt from the enterprise value of the business.