Discounted Cash Flow | Bizcovering

Discounted Cash Flow | Bizcovering

What is the Discounted Cash Flow method of valuation and how to go about developing one?

The Discounted Cash Flow (DCF) method is a type of business valuation method that estimates the investment opportunity of a new business undertaking. Discounted cash flow analysis through the DCF method utilises free cash flow projections and discounts the free cash flow projections to arrive at a present value and DCF terminal value for a typical business valuation.

How to Prepare a Discounted Cash Flow (DCF) Valuation Model

To go about doing preparing a DCF model, a business owner has to first understand how to value a business venture using the DCF method:

1. Project free cash flows available to equity holders over a particular period which is typically 5 to 10 years

2. Project free cash flows beyond the terminal year based on any simplifying assumption

3. Discount free cash flows to equity holders at the weighted average cost of capital. The discounted amount will be the estimated value of free cash flows available to equity holders

4. Input all necessary data such as the discount rate into the DCF model on a DCF spreadsheet

5. Calculate Net Present Value (NPV) and the DCF terminal value for the business valuation

The business owner should then seek to research the above information in order to build a DCF model on a compact DCF excel spreadsheet. The business owner should also consider the realistic issues in obtaining data that management may not be able to provide, such as market risk premium, beta, risk free rate and the appropriate weighted average cost of capital (WACC).