Investment Banking Bootcamp: Week 6 – DCF Valuation Pt 2 Fall 2018

Agenda Delving deeper into WACC and CAPM Model Sensitivity Analysis Mid-Year Convention Comprehensive DCF Valuation Intermediate Interview Questions Please take notes and ask questions throughout. Decks will be available on our website.

I. WACC and CAPM Model

Recap of WACC

Calculate the WACC Fall 2019 April May - June The bar is to help them visualize what happens!

Calculating the Cost of Equity -> CAPM Model I’m thinking of going deeper into the components (CAPM model etc in Pt 2). Eg. How to calculate Ke & Kd and introducing preferreds etc

II. Sensitivity Analysis

Remember the Key Drivers of a DCF Valuation? Terminal Value -> Essentially the EV/EBITDA Multiple you use and the Gordon Growth Rate WACC -> The assumptions you make regarding Risk Free Rate, Beta and Market Risk Premium Revenue Growth Rate Assumptions -> The assumptions you make regarding the growth prospects of a company

Sensitivity Tables Since these assumptions change the value of a DCF so much, it makes sense to use a number of different inputs and get a DCF Valuation Range Excel has a function called data tables, which allow you to change the the inputs to allow a range of different values Simple example of a data table ->

Sensitivity Table in a full DCF Model

Football Field Valuation Chart

III. Mid-Year Convention

Mid-Year Convention When you use discount periods of 1, 2, 3, 4, and so on, it’s not accurate because those whole numbers imply that the company’s cash flows all arrive at the ends of years.  But that’s not true: The company generates cash flow every day, and on average, it’s evenly distributed throughout the year.  So it is more accurate to use discount periods of 0.5, 1.5, 2.5, 3.5, and so on when you’re calculating the cumulative discount factor and the Present Value of Free Cash Flows.  The company’s Implied Value will increase because the cash flows arrive earlier, and money today is worth more than money tomorrow. 

Mid-Year Convention Present Value = Cash Flowt/(1+Discount Rate)^t The bolded portion is essentially your “discount factor” Since the cash flows is generated earlier (mid-year instead of end of year), the PV increases! Remember the time value of money -> money today is worth more than money tomorrow Just understand the high level concept! It is not necessary to apply the mid-year convention when building an actual DCF

IV. Comprehensive DCF Valuation

Project FCF

Calculate WACC

Calculate Terminal Value Fall 2019 April May - June The bar is to help them visualize what happens!

Discount FCF & Terminal Value Fall 2019 April May - June The bar is to help them visualize what happens! Can back into Equity Value by using the formula, and then share price by dividing by no of shares outstanding

V. Intermediate Interview Questions

Intermediate Interview Questions Conceptually, what is beta? Why do you relever and unlever beta? Can beta ever be negative? What does that mean? Give an example How do you determine a firm’s optimal capital structure? Which TV Method is better at intrinsically valuing a company? Why? Why is D&A added back to NOPAT? If current assets > current liabilities, what happens to UFCF?

Thanks so much for coming, and see you next week!