DISCOUNTED CASH FLOW

METHOD
VIJAYARAGAVAN N

Valuation
Purpose of Valuation
Various Approaches
DCF method

Estimation Process - worth of an object/instrument

Examples:

Bike sale - Hero Honda Vs Bajaj

Real Estate - ECR beach side Vs Non beach

Valuation of Asset - fire sale Vs normal sale

Sale of shares by a person to another.

Merger of two or more companies

Absorption - capital restructuring

Tax Purposes
Acquisition/ transfer of shares in an Indian
company by a non-resident
Ascertainment of the premium at which shares
are to be issued

INCOME
BASED
MARKET
BASED

DCF
Maintainable Profits
Dividend Discount
Comparable
Transaction based
Prior Sale of Biz. based

NET ASSETS
Asset liabilities valuation
BASED

Based on Free Cash Flows and riskiness of

capital

Valuation based on
a. Cash Flow Projections
b. Discount Rate
c. Terminal Value

Growth prospects & Earnings Capacity

Discontinuation of biz
Expansion of capacity
Turnaround Cases
Entire Biz Cycle
Consideration Policy change
Operating Leverage Utilization Capacity
Product Mix
Financing Policy
Capex
Expansion Capex
Maintenance Capex
Income Tax

CAPM Method

Leveraged Entity
Weighted Average Cost of Capital (WACC)

Deleveraged Entity
Cost of Equity

Equivalent to liquidation/sale value

Value of CF after forecast period

Methods - Perpetual Growth & Multiple

Approach

Step 1. Project free cash flow for the forecast period

Step 2. Determine a discount rate
Step 3. Discount the projected free cash flows to the
present and sum
Step 4. Calculate the perpetuity value and discount it
to the present
Step 5. Add the values from Steps 3 and 4, and divide
the sum by shares outstanding

DCF Model
Parameters
Value/detail
Sales growth rate YoY
10%
Current Assets
35% of the sales
Current Liabilities
15% of the sales
Cost of Goods Sold
70% of the sales
Tax rate
35%
Dividend Payout ratio
40% of the PAT
Gross Fixed Assets to Sale
0.48
Interest Rate on Debt
9%
Debt Pricipal Repament
2,000,000 per year at the end of FY
Projection Period
5 years
Equity shares outstanding (FV - Rs.10)
100,000
Other Income
4% YoY

Dream Engineers Ltd

Income statement:
Year
1 Sales
2 Cost of Goods Sold
Profit/(loss) before Other income,
3 Interest, depreciation & Taxes
4 Other Income
Profit/(loss) before Interest,
5 depreciation & Taxes
6 Depreciation
7 Interest on Debts
8 Profit/(loss) before Taxes
9 Tax @ 35%
10 Profit/(loss) after Taxes
11 Dividend @ 40%
12 Retained earnings

Amount in `
0
25,000,000

1
2
3
4
5
27,500,000 30,250,000 33,275,000 36,602,500 40,262,750
19,250,000 21,175,000 23,292,500 25,621,750 28,183,925
8,250,000 9,075,000
20,000
20,800
8,270,000
3,000,000
810,000
4,460,000
1,561,000
2,899,000
1,159,600
1,739,400

9,982,500 10,980,750 12,078,825

21,632
22,497
23,397

9,095,800 10,004,132 11,003,247 12,102,222

3,300,000 3,630,000 3,993,000 1,392,300
702,900
586,161
458,915
320,218
5,092,900 5,787,971 6,551,332 10,389,704
1,782,515 2,025,790 2,292,966 3,636,397
3,310,385 3,762,181 4,258,366 6,753,308
1,324,154 1,504,872 1,703,346 2,701,323
1,986,231 2,257,309 2,555,019 4,051,985

Balance Sheet:

Amount in `
Year

Cash
Current Assets
Fixed Assets
Cost
Depreciation
Net Fixed Assets
Total Assets

0
500,000
6,250,000
12,000,000
(3,000,000)
9,000,000
15,750,000

2
3
4
5
149,400 2,598,531 5,378,001 5,521,536 6,936,298
9,625,000 10,587,500 11,646,250 12,810,875 14,091,963

13,200,000
(6,300,000)
6,900,000
16,674,400

14,520,000 15,972,000 17,569,200 19,326,120

(9,930,000) (13,923,000) (15,315,300) (16,846,830)
4,590,000 2,049,000 2,253,900 2,479,290
17,776,031 19,073,251 20,586,311 23,507,551

Current Liabilities
Long Term Borrowings

3,750,000
9,000,000

4,125,000 4,537,500
7,810,000 6,512,900

4,991,250
5,099,061

5,490,375
3,557,976

6,039,413
1,878,194

Share Capital
Retained earnings
Total Liabilities & Equity

1,000,000
2,000,000
15,750,000

1,000,000 1,000,000 1,000,000 1,000,000 1,000,000

3,739,400 5,725,631 7,982,940 10,537,959 14,589,944
16,674,400 17,776,031 19,073,251 20,586,311 23,507,551

Free Cash Flow (FCF) Computation:

Year
PAT
Add: Depreciation
Less: Loan Repayment
Less: Capital Expentiture
less: changes in WC
Free Cash Flow (FCF)
Net Working Capital

Amount in `
0

0
2,500,000

2,899,000
3,300,000
(2,000,000)
(1,200,000)
(3,000,000)
(1,000)

2
3
4
5
3,310,385 3,762,181 4,258,366 6,753,308
3,630,000 3,993,000 1,392,300 1,531,530
(2,000,000) (2,000,000) (2,000,000) (2,000,000)
(1,320,000) (1,452,000) (1,597,200) (1,756,920)
(550,000) (605,000) (665,500) (732,050)
6,390,385
7,150,181 4,985,166 7,552,788

5,500,000 6,050,000

6,655,000

7,320,500

8,052,550

Weighted Average Cost of Capital (WACC):

Year
Sales
Net Profit
NPM
Expected return (RM)
Risk free Return ( RF)
Beta Value
Cost of Eqity ( CAPM )
Long Term Borrowings
Equity + Retained Earings
Total

1
2
27,500,000 30,250,000
2,899,000 3,310,385
10.54%
10.94%

7.70%
3
33,275,000
3,762,181
11.31%

4
36,602,500
4,258,366
11.63%

12.24%
9.00%
1.31 Sector:Engineering/Construction
13.24%
9,000,000
0.75
3,000,000
0.25
12,000,000
1

Cost of debt

5.85% 9%*(1-0.35)

WACC

7.70%

5
40,262,750
6,753,308
16.77%

Equity Valuation:
Amount in `
Weighted Average Cost of Capital (WACC)

7.70%

Long Term FCF growth rate

5.00%

Year
Free Cash Flow (FCF)

(1,000)

6,390,385

7,150,181

4,985,166

7,552,788

293,880,858

Total Cash flow

(1,000)

6,390,385

7,150,181

4,985,166

301,433,646

Discount Factor

0.929

0.862

0.801

0.743

0.690

Discounted Free Cash Flow

(929)

5,509,441

5,723,845

3,705,448

208,038,204

Add: Terminal value

Sum of Discounted Cash Flow

Add: Cash
Enterprise Value
Less:Long Term Borrowings
Equity Value
Value per Share in `

222,976,009
500,000
223,476,009
(9,000,000)
214,476,009
2,144.76

MERITS

Sound Model Estimated Future CF

Expectation of Biz performances
Not vulnerable to creative accounting
Suitable method for startup projects

DEMERITS
Garbage in & Garbage Out
Not considering qualitative factors
Non linear growth in biz
Risk Element
Non-financial factors

Inconsistency in Govt. policy Taxation (FII MAT)

& Regulatory (PAN req. any purchase > 1 Lac)
Company performance will be affected operating
management
Discount rate & Terminal value estimation
valuation impact
Macro Economic issues